Markets: Fixed income

On Tuesday, the Greek debt agreement was rapidly ignored by the markets, after which trading went on quiet for the remainder of the session. As the decision was widely discounted, the price moves were understandably limited. The “risk-on” event left European equities modestly higher on the day. German bond yields were flat to 3.2 basis points higher, the 5-year underperforming, maybe due to positioning ahead of the Obl auction today. Peripheral yield spreads narrowed. EUR/USD even lost some ground in a buy-the-rumour, sell the fact reaction after the 1.30 handle proved too high to take out. US bonds ended modestly higher for the second day in a row. US yields fell between 0.6 and 2.6 basis points, the belly outperforming the wings.

Intraday, the Bund opened lower and immediately tested the 141.95 support area, as the Greek deal was a risk-on event. However, the test failed and towards noon, opening losses were largely recouped. European equities opened as expected higher, but immediately slid in a sideways trading range that would dominate equity trading for the remainder of the session.
Economic data were ignored in Europe (few), but also in the US, which is more remarkable, as these were of bigger interest. Indeed, the durable goods orders, the Richmond Fed and Consumer confidence all were stronger than expected, but couldn’t stop US Treasuries from “rallying” higher. Equities played no distinctive role in the Treasury market either. The 2-year Note auction was strong and might have supported the overall market, but more likely given the outperformance of the belly, some investors started to buy Treasuries for month-end extension reasons. US equities fell late in the session after comments of both democrats and republicans that they were disappointed about the absence of progress in the fiscal cliff talks. US Treasuries though didn’t react much anymore.

On intra-EMU bond markets, spreads versus German bonds narrowed yesterday following the Greek deal. A statistical annex showed that there is still a gap between the debt sustainability analysis given the measures taken (debt ratio of 115% by 2022) and the targets set out in the statement (debt ratio substantially below 110% by 2022). However, markets ignored this as Greece is off the radar for now and the threat of an immediate default has gone. EU officials also indicated that the OSI was part of the debate. As indicated earlier however, the timing (ahead of next year’s German election) made this solution not feasible for now. The Greek and Portuguese 10-yr spread dropped by 30 bps, the Spanish by 13 bps and the Italian, Belgian, French and Austrian by 5 bps. The recent risk on rally pushed Spanish and Italian yield back to the lower bounds of their sideways trading ranges. The Italian 10-yr yield is even close for a test of this year’s low (4.68%). Yesterday, the Portuguese government approved the 2013 budget proposal in a final vote.

Today, the eco calendar contains the euro zone M3 money supply and credit growth data, German HICP inflation and the US new home sales. The Fed will release its Beige Book and Italy (BOT), Germany (Bobl) and the US (5Yr notes) will tap the market.

The annual growth rate of euro zone M3 is forecast to have picked up in October. The consensus is looking for an increase from 2.7% Y/Y to 2.8% Y/Y, reversing the previous month’s decline. More interesting might be the lending data. Lending to both households and non-financials remains extremely sluggish, but there is strong cross-country heterogeneity with weakness led by the southern European countries. The latest bank lending survey showed that especially demand for credit was weak, while banks continued to tighten lending conditions. We believe therefore that lending will remain extremely slow in the coming months as also economic activity continues to weaken. The first estimate of German HICP inflation for November is forecast to show a further easing in inflationary pressures. The consensus is looking for a drop in the annual rate from 2.1% Y/Y to 2.0% Y/Y. We believe that the risks might be on the downside of expectations, but the regional CPI figures will provide already some indications ahead of the German figure. Finally, in the US, new home sales are forecast to have broadly stabilized in October. A marginal increase from 389 000 to 390 000 is expected. The Tropical Storm Sandy might have had some impact on sales in the Northeast, but will probably be limited. We have no reasons to distance ourselves from the consensus.

Yesterday, the Dutch debt agency tapped the on the run 3-year DSL (0.75% Apr2015) for €2.4B, compared to a maximum target of €3B. With this final auction of the year, the Netherlands completes their funding need for 2012. In Italy, the treasury successfully sold €3.5B zero-coupon bonds and €1B inflation-linked bonds yesterday. Tomorrow’s BTP auctions will however be more interesting. Today, the German Finanzagentur taps the on the run 5-yr Bobl (€3B 0.5% Oct2017). This year’s total bids averaged €6.7B this your, though the latest Bobl auction yielded only €4.88B. Nevertheless, the €3B on offer today will be easily digested by investors. The bond cheapened some 4 bps in ASW terms going into the auction and trades cheap compared to the surrounding bonds on the German yield curve.

In the US, the treasury started its end of month refinancing operation with a strong $35B 2-yr Note auction. The auction stopped cleanly through the 1:00 PM bid side and the bid cover was exceptionally high (4.07 versus 3.78 over the past year). The bidding details were also quite good. Today, the treasury continues with a $35B 5-yr Note auction and tomorrow it concludes with a $29B 7-yr Note auction.

Overnight, Asian equities trade weak in a reaction to the decline of US equities at the end of the session yesterday. It seems that the lack of progress in the fiscal cliff talks is weighing on sentiment. The Greek deal is now completely discounted and shouldn’t play a role anymore. However, besides the fiscal cliff, attention will still go to the remaining issues in the euro area, the banking union and in the background a Spanish demand for ESM help. Headlines on these issues may affect markets today and in the days ahead. The eco calendar is uneventful today, as no real market movers are scheduled for release. The US and German bond auctions should be easily absorbed, while an underlying demand for month-end extension reasons should be supportive. The Beige Book normally paints the same picture of the economy than the economic data and even if there would be a small surprise, it is unlikely to affect the outcome of the upcoming FOMC meeting. In this context, we think that the downside of both US Treasuries and Bunds is well protected and some modest gains might be booked. Indeed, the Bund tested unsuccessful support yesterday and equities which booked last week juicy gains in razor-thin conditions probably need to digest these gains via some profit taking. So, we are modestly positive on bonds today and maybe the next few days, even if gains may remain modest.