Global core bonds ended with modest gains

Markets: Rates

On Wednesday, global core bonds ended with modest gains. Technical levels capped bond gains in a trading session devoid of important economic releases. Risk sentiment changed to risk aversion, halting the rise in EUR/USD and on equity markets.

Intraday the Bund opened higher, copying late treasury gains and taking into account overnight Asian developments. China’s biggest lenders tripled the amount of bad loans written off in the first half of the year and triggered a risk averse environment. At the start of European trading, the ECB announced methodology for upcoming asset quality reviews of the banking sector (see below), but this didn’t impact bond markets. Following the higher opening, the Bund advanced to the 140.87 resistance, but a real test didn’t occur. Eco data were few and little inspiring. US house price index was somewhat weaker than expected and EC consumer confidence in line with expectations (see below). During the US session, risk off sentiment remained with amongst others an ugly earning miss for industry bellwether Caterpillar, which also cut the outlook. Bonds gradually moved higher again. A real test for the Bund of 140.87 was rejected and in the US, the 10-yr yield bounced off 2.47% (38% retracement from May to September rise in yields). Afterwards, bonds traded quietly into the close. At the end of the day, the changes on both the German and US yield curves were limited. German yield changes ranged between -3 bps (10-yr) and +0.5 bps (2-yr), whereas US yield changes varied between -1.4 bps (30-yr) and +1.6 bps (2-yr).

On intra-EMU bond markets, 10-yr yield spread changes versus Germany ranged between -4 bps (Spain) and +5 bps (Italy). Spanish bonds profited from the Bank of Spain, who released a preliminary estimate for Q3 GDP. For the first time since Q1 2011, the BoS recorded a positive growth number (0.1% Q/Q) and indicated that Spain would return to growth over 2013 as a whole. Recently, more signs emerged from greater confidence towards Spain. Sareb, the Spanish bad bank, easily sold a portfolio of non-performing loans, as did Banco Sabadell.

Today, the focus will be on first estimate of the October PMI’s in the euro zone, while in the US the trade balance and jobless claims will be released. The Norwegian and Swedish central bank will decide on rates and EU leaders will start their two-day Summit in Brussels. On the supply front, the US will hold a 30Yr TIPS auction.

Since March, the euro zone PMI’s showed a remarkable rebound with the composite PMI increasing for already six consecutive months. For October, the consensus is looking for a further, albeit limited increase in the composite index, from 52.2 to 52.4. Last month, services sector sentiment improved further while the manufacturing PMI fell back slightly. For October however, the consensus is looking for an increase in the manufacturing PMI, from 51.1 to 51.4, while the services PMI is expected to stay unchanged at 52.2. For the manufacturing sector, we believe that the risks are for an upward surprise as recently there were encouraging signs from the manufacturing sector. The Bundesbank said in its monthly report that activity picked up in the fourth quarter, while also Bank of France business confidence indicators surprised on the upside yesterday. For the services sector, we believe that the risks might be for a limited decline. Ahead of the euro area readings, we will already receive indications from the German and French PMI’s. In the US, the delayed August trade balance will be released. In August, the trade deficit is expected to have remained broadly unchanged from July. The consensus is looking for a limited widening in the deficit from $39.1 billion to $39.5 billion. While both imports and exports of goods are forecast to have dropped, imports and exports of services are forecast to remain little changed. Finally, US jobless claims remain subject increased volatility due to both the computer updates in California and the government shutdown. In previous weeks, jobless claims remained elevated mainly due to the processing of backlogs related to computer updates in California. We believe that the claims should hover lower in the weeks to come, but the impact of the government shutdown and processing of backlogs in unsure. For the week ending the 19th of October, the consensus is looking for a drop in initial claims from 358 000 to 340 000, but we continue to see upside risks due to distortions.

The ECB announced the methodology of its comprehensive assessment of the EMU’s biggest banks in advance of taking up its role as Single Supervisor (SSM) in November 2014. The exercise aims to foster transparency, to repair and build confidence. It consists of three elements: first, a supervisory risk assessment to review key risks and an asset quality review (AQR) take place. The outcome of these will lead to a stress test by the ECB in collaboration with the EBA. Banks will be required to meet an 8% core tier one capital ratio. The AQR will cover sovereign and institutional, corporate and retail exposure. The ECB will examine the banking and trading book, as well as on balance and off balance exposures.
This seems rigorous, but not really surprising. The assessment will commence in November 2013 and will take 12 months to complete. Upon completion, the ECB will disclose the outcome at country and at bank level and announce which banks need more capital. ECB’s Draghi already warned that a number of banks will fail the tests, to prove the credibility of the review. The ECB said that for the exercise to be successful, it is critical that financial backstops are in place: “Capital shortfalls identified for viable banks should, first and foremost, be made up with private sources of capital. Should that not be sufficient, public backstops might need to be drawn upon”. Following the release of the ECB methodology, the banking sub index from the EuroStoxx underperformed, losing over 2.5%.

Yesterday, the German Finanzagentur held the only scheduled EMU bond auction of the week: the on the run 30-yr Bund (€2B 2.5% Jul2044). This was likely the final tap of the July 2044 Bund.

The results were mixed. Total bid amounted €2.26B, well below this year’s average of €2.71B. The Bundesbank set aside €0.36B of the issued volume (in line with average), resulting in an official bid cover of 1.4. Whereas the total bids were rather low, they were aggressive. The auction tailed 4 cents compared to 12 cents in July, 6 in March and 3 in January.

Eurostat releases that at the end of Q2 2013, the EMU debt ratio stood at 93.4% of GDP, compared with 92.3% at the end of Q1 2013. Compared with the Q2 2012, EMU debt to GDP rose from 89.9%. On a country level, the highest debt ratios were recorded in the peripheral countries: Greece (169.1%), Italy (133.3%), Portugal (131.3%) and Ireland (125.7%). Belgium follows with 105%.
Compared with Q2 2012, 6 countries saw their debt ratio rise by more than 10 percentage points: Greece, Ireland, Cyprus, Spain, Slovenia and Portugal.

Overnight, Asian equities trade positive with the exception of China and Hong Kong. Chinese repo rates surged further (20% rise over the past week), after the PBOC refrained from conducting reverse repo’s for a third straight auction. This overshadowed a slightly stronger HSBC manufacturing PMI. The US note future trades flat whereas EUR/USD catapulted above 1.38.

Regarding trading today, the eco calendar heats up, with especially EMU PMI’s. We see risks for a slightly better outcome overall, which is a negative for core bonds. In that case, technical levels should be able to hold. In the US, claims risk to be distorted. The EU Summit will likely be a non-event.

The Bund tested 140.87 resistance a first time yesterday. In yield terms, the 1.74%/1.73% zone is important. The US 10-yr yield remains close to key support at 2.47% (38% retracement) to 2.40% (final target double top). The US Note future definitively broke through the upside of the sideways trading channel, though a break of the 10-yr yield below 2.47%/2.4% is needed to confirm this bullish signal. The technical picture of the Bund remains neutral.