Markets: fixed income

On Monday, the precarious political situation in Greece and increasing market chatter about a Greek exit from the euro dominated the session in all markets, with lingering concerns about Spain adding to the woes. So, the data-thin session developed in a full-blown risk off one. Global core bonds once more profited, this time fully. German yields set again new lows across the yield curve, with the 10-year closing convincingly below 1.5% for the first time ever.
However, also the US 10-year yield took a big step lower and closed just below important 1.79%, bringing the yield now close to the 1.67% all time low.
Similarly, the Bund set its 7th all time high in the last 9 sessions. The curves bull flattened in the US and Germany with yield changes in the 10-30-year sector of 7-9 and 6-to-8 bps respectively.

Interestingly, also other markets are making big moves that suggest a longer term change in sentiment, even if some of these moves should still be confirmed. The S&P fell about 1.1% to 1338, and starts showing a bearish triple top pattern. The Dax has already set such a configuration, as have the other European indices. Commodities got also sharply hit. The CRB fell 3 points to 288, dropping below main key support. Gold fell $23 to $1561, and nears major support, which if broken, would technically signal the end of a decadelong bull market. Finally, EUR/USD traded down too, closing just above 1.28.
Despite these moves, the traditional measures of market risks are not yet flashing red, even if some erosion is visible. The VIX, the basis swaps, liquidity spreads and the ITRAX crossover are still well below levels seen during the end-of-2011 market crisis.

On intra-EMU bond markets, spreads increased significantly. Spain and Italy underperformed, widening 28 and 25 bps respectively. The Spanish 10-yr yield set an intraday high just above 6.35%, the highest level since November last year. The Spanish spread set a record high at 476 bps. The Belgian spread added 10 bps, the French one 8 bps and the Austrian 5 bps. Intra-EMU bonds suffered in the risk-off session sparked by uncertainty about the faith of Greece and the tensed situation in the Spanish banking sector and regions. Regarding today, overnight news (see below) and developments were few giving little guidance at the start of intra-EMU bond trading.

A second day of meetings between Greek president Papoulias and Greek political party leaders to broker a last-minute deal ended also inconclusive.
Papoulias’ final proposal is forming an administration of “personalities” or technocrats and respected political figures with broad appeal. However, Democratic Left leader Kouvelis and SYRIZA leader Tsipras already rejected such a technocrat government as “it would be a defeat for politics” and go against the democratic vote of the Greek people. Today, coalition talks continue and Papoulias has until tomorrow evening to try forming a government but for now it still seems as if we are heading towards fresh elections.

Four Spanish savings banks (Banco Mare Nostrum, Liberbank, Unicaja & Ibercaja) are working on a merger supervised by the ministry of economy to create a more solvent group. This doesn’t automatically mean that this would create a strong bank, as last week’s ‘Bankia’ (merger of 7 cajas) example showed. Meanwhile, Spain’s five largest banks have said they will set aside €14B in new provisions following the latest reform plan for the financial sector, announced Friday. No bank has yet said they will take financial aid from the state.

Overnight Moody’s announced that it downgraded 26 Italian banks by between 1 and 4 notches. The rating agency cited increasingly adverse operating conditions in Italy, mounting asset-quality and weakened net profits as well as restricted access to market funding. All banks are on negative outlook. This could have a negative impact on Italian spreads.

Today, a €436M Greek bond (under international law) is due, which was not included in the Greek PSI (hold-out). The Greek finance ministry is prepared to make the full repayment on the bond, to avoid future legal action by holdout investors. However, apparently the political party leaders of the three biggest parties should also need to approve on the repayment. Currently it is unclear if they already did that or not. If Greece doesn’t pay today, it still has until May 30 to do so before officially having defaulted on the bond, but a missed payment would clearly cause a lot of negative headlines and spoil sentiment.

Today, the eco calendar is well-filled both in the US and euro zone with the first estimate of euro zone Q1 GDP, the German ZEW indicator, US CPI inflation, US retail sales, the Empire State manufacturing index and NAHB housing market index. EU Finance Ministers meet in Brussels and Greece and Belgium will auction T-Bills and the EFSF taps the April 2017 bond (€1B).

At the end of last year, the euro zone economy fell back into contraction after two years of growth. During the last three months of 2011, the euro zone economy contracted by 0.3% Q/Q due to broad-based weakness. Another quarter of contraction is expected at the start of 2012, although the pace of contraction should have slowed. The consensus is looking for a decline by 0.2% Q/Q, but we believe that the risks are on the upside of expectations with even a stabilization or marginal growth not excluded. Both Belgian (growing by 0.3% Q/Q!!) and Spanish GDP surprised on the upside and this morning German GDP came out remarkably strong (growing by 0.5% Q/Q!!!). The French reading was in line with expectations. Germany, the ZEW indicator held up remarkably well over the previous months. The index is at its highest level since mid-2010 led by strength in the expectations component. For May, the market is looking for a slight drop in sentiment from 23.4 to 19.0, but we believe that a weaker outcome is not excluded. Sentiment weakened due to the political turmoil in Greece, while also Spain is again in the focus. The Dax index fell significantly which should weigh on sentiment too. In the US, the main question is whether the strength in consumer demand continued in April. During the first three months of the year, US retail sales were remarkably strong, probably due to the extremely mild weather. For April, the consensus is looking for only a marginal increase in retail sales, by 0.2% M/M. We believe however that the risks are on the downside of expectations as the weather might act as a drag in April. Also in April, US CPI inflation is forecast to have eased significantly. The annual rate of inflation is expected to have slowed from 2.7% Y/Y to 2.3% Y/Y in April. On a monthly basis, inflation is forecasted to come out flat due to lower food prices, while energy prices will probably have stayed flat. We believe that the risks are for a slightly higher outcome. Core inflation is forecast to remain sticky in April.
Core CPI is expected to stay unchanged at 2.3% Y/Y, the highest level in 3.5 years. While the headline rate has already slowed significantly, core inflation shows no signs of a slowdown yet. In April, the US manufacturing ISM showed a remarkable rebound, while regional business confidence indicators were mixed, at best. The Empire State manufacturing index weakened sharply in April, falling from 20.21 to 6.56, while the details were more mixed. For May, the consensus is looking for a rebound from 6.56 to 9.50, but we believe that a stronger outcome is likely especially as last month’s sharp drop was not justified by the details. Finally, the NAHB housing market index is forecast to rise 1 point to 26.

Yesterday, the Italian debt agency successfully tapped the on the run 3-yr BTP (€3.5B 2.5% Mar2015), the off the run 10-yr BTP (€0.54B 4.25% Mar2020), the on the run 10-yr BTP (€0.65B 5% Mar2022) and the off the run 15-yr BTP (€0.56B 5% Mar2025). The total amount sold was the maximum of the intended range, despite the risk-averse sentiment. The Finnish treasury tapped the on the run 5-yr RFGB (€1B 1.875% Apr2017). It was only the second time Finland tapped the market this year with a euro denominated bond and the tap met with very good demand. Today, the EFSF taps the on the run 5-yr EFSF bond (€1B 2% May2017). It’s the first time the EFSF taps the market instead of launching a benchmark. We expect the tap will go well.

There was little news filtering out of the important Euro group meeting. We retain that chairman Juncker dismissed speculation about an imminent Greece exit as propaganda. He opened the door a little bit for some changes to the bailout package. “If there were to be dramatic changes in circumstances, we wouldn’t preclude a debate about an extension of the period (for Greece to meet targets).” However, chronology is important. First a Greek government fully committed to the programme, and then in case of exceptional circumstances, we wouldn’t exclude discussions. Juncker said that the exit was not subject of debate and added that “our unshakable desire is to maintain Greece within the euro area. We will do everything possible to that effect.” IIF Dallara spoke in the same sense that a Greek exit is not inevitable, but as the architect of the Greek debt restructuring two months ago, he might evidently be biased. According to the FT, Maria Fekter, the outspoken Austrian finance minister, went so far as to suggest Greece may have to leave the EU, since there is no legal provision for leaving the euro without exiting the union.

Regarding trading, Asian equity markets trade somewhat in the red, but nothing very outspoken. After the risk-off session yesterday, the calendar suggests that it might be the eco data that drive the price action today, even if news from Greece (including the repayment of a bond coming on maturity) or Spain might push the eco data to the background. The German Q1 GDP, released a few minutes ago, surprised on the upside and immediately triggered some profit taking, following yesterday’s juicy gains. The US data this afternoon are also enticing. Following a string of weak data in April, early May, there was a slight improvement last week in the data, but these were overshadowed by the euro crisis. Manufacturing, private consumption and housing data will give us a take whether the decline in momentum has continued and gathered pace or whether stabilization is at hand. In case of the latter, US Treasuries (and to lesser extent) Bunds may be vulnerable to some profit taking following the recent rally and given the lofty levels reached. However, that would not be enough to put the euro crisis on the backburner for long. The technical pictures of other markets bear watching too, as they are at, near or just beyond key levels.