The ECB holds its weekly MRO and SMP tenders

Rates

The crisis in Ukraine intensified and triggered risk-off sentiment yesterday with European equities hit the hardest. US equities held their composure and limited their losses (-0.75%). On currency markets, the Russian CB countered a slide of the rouble by an unexpected interest rate hike (5.5% to 7%). Currencies like the forint and the zloty are under pressure whereas main currency pairs remain relatively stable (see FX). On commodity markets, gas, oil & wheat prices spiked substantially higher and on bond markets US Treasuries and German Bunds profited from safe haven flows. German yields were up to 7.4 bps lower (10-yr), while US yields declined up to 4.6 bps (10-yr). For the first time since long, peripheral bonds felt a, moderate, negative impact from market stress. Italian and Spanish 10-yr yield spreads versus German are 5 bps and 7 bps wider.

The economic calendar is very thin today with only EMU PPI inflation data. In January, EMU PPI inflation is forecast to have dropped further into negative territory. The consensus is looking for a drop from -0.8% Y/Y to -1.3% Y/Y, which if confirmed would be the lowest level since early 2010. The outdated data are however less interesting for markets.

The ECB holds its weekly MRO and SMP tenders. The results allow us to have an idea about monetary conditions in the week ahead. Excess liquidity fell further and currently stands at €114B. After a spike higher at the turn of February, eonia trades again at 15-16 bps. We have started the last week of the reserve period.
Banks have frond-loaded on their reserve requirements, which suggests that the lower excess liquidity won’t have much impact on eonia. This may change next week when the new reserve period starts and if excess liquidity would still be close to current levels. Anyway, for today’s tenders, we don’t expect them to materially change conditions at the front end of the money market.

SF Fed Williams said the Fed should soon change its forward guidance. It is no longer appropriate to come up with one simple metric, like the unemployment rate. Such a FG would now bear greater costs than benefits as the economy is gradually coming closer to normal functioning. He also repeated that it would take a substantial change in the outlook before he would be willing to revisit the pace of the tapering. As long as monthly jobs growth stays above 100 000, unemployment would continue to come down. Before the European parliament, Mr. Draghi kept options open for the ECB to ease policy when it meets Thursday. “We know the longer inflation stays at the current level, the higher will be the risk that it will not go back to 2% in any reasonable time. In other words, the longer will be the risk that inflation expectations could be disanchored and we don’t want that”. So, while we don’t want to make too much from it, there still is a risk of some kind of action on Thursday.

Today, the Austrian debt agency kicks off this week’s scheduled EMU bond supply by tapping the on the run 5-yr RAGB (1.15% Oct2018) and 10-yr RAGB (1.75% Oct2023) for a combined €1.21B. Both bonds didn’t cheapen going into this auction. Whereas Moody’s decision to raise the outlook on the Austrian Aaa rating from negative to neutral is a positive element, some short term risks still remain. Austrian banks have the biggest exposure to CEE & Ukraine and then there is still Hypo Alpe. Therefore, the auction might go less smoothly than usual. This week’s EMU bond auctions won’t be supported by redemptions.

Overnight, most Asian equity indices trade positive. Losses on WS were contained and the end of this morning’s Asian trading session, equities got a boost by headlines that Russian president Putin ordered troops to return to their military base. The US Note future trades lower and the yen loses, indicating some risk-on at the start of trading. This is a negative for the Bund.

Today, the eco calendar is uneventful with only second tier eco data. The main topic remains developments in Ukraine. Tensions seemed to have eased somewhat, but might flare up easily. Therefore trading may remain volatile and difficult to predict. Yesterday, EU foreign ministers called the Russian incursion a clear breach of international law and warned of targeted measures if it does not back down. But they are also pressing for international observation and mediation in Crimea as an alternative.
The latter seems to be the priority: lowering tensions but without economic sanctions and offering Russia a way out. If the geopolitical risks would dissipate over time, core bonds should lose ground, especially if the period of sub-consensus economic figures would end. Little reaction yesterday on the above consensus ISM outcome, but if this would become the rule in a context of easing geopolitical tensions, the downtrend in yields could go in reverse.

Technically, the German 10-yr yield is back below 1.60%.Nevertheless, the jury is still not out, as Ukraine causes quite some volatility. This week, three items will decide on the Bund’s future: Ukraine, the ECB Meeting (Thursday) and US NF payrolls (Friday). This sort of event risk can still cause quite some volatility this week.