Weekly Euro area rates review

The past week has been extremely volatile with developments in China, commodity prices and EM markets creating notable contagion to DM equities. Following the poor price action on Friday, 21 August, US and European equity prices fell precipitously this Monday. Risk sentiment improved later in the week, partly due to the very sharp technical nature of the down move, strong data on both sides of the Atlantic and somewhat dovish comments from Fed and ECB members. 

NY Fed President William Dudley said at a news conference that the case for starting rate normalisation in September was less compelling now given recent global market events, adding also that it was important not to overreact to short-term market developments. On the ECB front, Board member Peter Praet's interview with reporters in Mannheim indicated that risks for achieving a sustainable inflation path towards 2% have increased recently. He also emphasised that there should be no ambiguity on ECB's willingness and ability to act by adjusting the size, composition and/or length of its QE programme. 

Price action in the rates market included sharp moves in cross-market spreads between US and EUR rates. While Treasuries rallied notably on Monday due to a flight to quality and expectations of a first rate hike being pushed out, 10y yields are about 13bp higher on the week. Against this, price action in Bunds has been somewhat puzzling: on Monday, the 10y Bund struggled to rally much on the sharp equity market fall, yet it sold off as much as 13bp on Tuesday and ended the week about 18bp cheaper despite the dovish ECB comments. There are several potential reasons behind this: profit taking from investors who were long EUR duration due to attractive supply/demand dynamics in August; cross-market stops in long EUR rates versus short US; media reports suggesting Chinese authorities selling DM fixed income to manage their currency liquidity; and 10y Finnish deal pricing.