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Sunrise Market Commentary

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Bond markets pressured between supply concerns and equity market correction

Wed, Jul 29 2009, 07:04 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Tuesday, government bonds rebounded, as equity markets fell prey to profit-taking on the recent tremendous rally higher. The short end in the US however underperformed sharply after the 2-year Note auction disappointed. Overall, the eco data were mixed yesterday. The first monthly rise in the Case Shiller House price index since July 2006 indeed offered some hope that the US housing market is finally stabilizing, but the larger than expected decline in the Conference’s Board’s index of US consumer confidence indicated that consumer spending may still remain weak. At the same time, the earnings of Deutsche Bank disappointed and again raised concerns about the state of the German and European banking system given the sharp rise in credit losses.

In a daily perspective, the US yield curve flattened, as 2-year yields rose by 4.3 ba-sis points, while 10- and 30-year yields fell by respectively 3.3 and 7.7 basis points. In the euro zone, German yields flattened too, as 2-year yields fell by 4 basis points and 10-year yields by 6 basis points. In contrast to the correction on most markets, the intra-EMU sovereign spreads continued to narrow.

Bond markets pressured between supply concerns and equity market correction

Today, the calendar contains the German CPI inflation data (July), Belgian second quarter GDP and the US durable good orders (July). In June, German CPI inflation stayed flat on a yearly basis, but is expected to fall into negative territory in July. The yearly figure is forecasted to come out at -0.4% Y/Y, but the risks might be on the up-side of expectations due to rising oil prices. In the coming months, CPI inflation is ex-pected head back above zero due to reverse base effects as oil prices peaked last year in July. After two consecutive increases, US durables are expected to have de-clined again in June. On a monthly basis, US durable goods orders are forecasted to have dropped by 0.6% M/M, but we believe that the risks might be on the downside of expectations, partially due to declines in orders for motor vehicles.

Besides the eco data, the ECB bank lending survey will attract quite some attention given the recent debate about a ‘credit crunch’ in the euro zone. Indeed, the sharp slowing in lending to both households and non-financial corporations over the past months has increased fears that credit supply restraints would stifle the nascent eco-nomic recovery. The question for the ECB is to judge whether the slowdown in lending is mainly demand or supply driven. Today’s survey will indicate to what extent banks are still tightening lending conditions, which should give more insight in the contribution of the supply factors to the slowdown in lending growth. In the US, New York Fed president Dudley will speak on the US economic outlook. Yester-day, Yellen sounded cautiously optimistic on the economic outlook, as she saw the ‘first solid signs since the recession started more than a year and a half ago that eco-nomic growth may be poised to resume’, but warned that ‘the recovery is likely to be painfully slow’ and added that core inflation will probably remain below 2% ‘for sev-eral years’. As such, she concluded that ‘this is not the time’ to raise rates and sin-gled out the commercial property market and the labour market as potential weak spots for the US economy. This evening, the Fed will also publish its Beige Book.

On the supply front, the focus will be on the $39B 5-year Note auction in the US, which will raise all cash. Yesterday, the 2-year Note auction disappointed, as the bidding was rather sloppy. This will raise concerns about the financing of US debt and is likely to keep the downside in US yields limited ahead of this and next week’s auctions. In the euro zone, Italy will tap its inflation-linked BTPei 2.6% September 2023 for an amount of €1.25B. Yesterday, the Netherlands sold €0.9B of three off the run DSL.

Regarding trading, bond markets rebounded yesterday on the back of the profit-taking seen in the equity markets. Supply concerns however kept the gains limited in the US, as the 2-year Note auction disappointed and ahead of this and next week’s auctions. This morning’s substantial decline on the Chinese equity markets, where fears about a liquidity-driven asset bubble have mounted over recent weeks, however suggests that more correction on the equity markets can be expected. A reversal of last week’s technical break higher would further support the bond markets. Overall, we expect some range trading between the recent highs and lows in the Bund at re-spectively 122.49 and 119.92.

In the UK, the June mortgage approvals and lending data are on the agenda. Mort-gage approvals are expected to pick up somewhat further in June, while consumer credit is forecasted to stay at 0.3B.

The DMO will tap its 5-year benchmark 2.25% March 2014 for an amount of £5B. The auction results will be closely monitored to see whether the uncertainty about the fate of the Bank of England’s asset purchase facility has dented investor’s appetite for Gilts. The Bank of England will also hold a reverse auction today for an amount of £2B.

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Published on  Wed, Jul 29 2009, 07:09 GMT