Markets: Fixed Income
On Tuesday, global bonds slipped into sideways, choppy trading and ended the session little changed. There was no meaningful trigger available to give the bond market direction, as also equities hovered around listless.
In EMU, the calendar was uneventful and this wasn’t much different in the US. The trade deficit for November was much smaller than expected and consumer confi-dence (IBD economic optimism/ABC Consumer confidence) stabilized, but these data aren’t really market movers for Treasuries, even if a small negative reaction was wit-nessed after the release of the trade figures. The smaller trade deficit was however largely an oil phenomenon, while the drop in both imports and exports confirms the dire conditions of the global economy. The intra-day moves of bonds, down in late European morning and early US session, reversing higher later on might have due to heavy corporate supply ($ 16.7 billion) and the hedging activity surrounding it. McDonalds, FedEx, Ontaria and Goldman amongst others all tapped the dollar mar-ket.
In EMU, the intra government bond market was driven by supply and rating action. The Netherlands and Belgium tapped the market and S&P put Portugal’s Aa1 rating on Credit Watch negative, while Moody’s, after trading, changed the outlook of Bel-gium’s AA+ rating to stable from positive. The spread widening between Germany and its EMU peers continued.
US Treasuries stabilize in session dominated by corporate supply
Today, the calendar is interesting as it contains the December retail sales, Novem-ber business inventories and December import prices. Besides these eco reports, there are speeches by Fed governors Plosser and Stern and the Fed releases its Beige Book.
The retail sales report for December will give us a good picture of how the Christmas selling season ended. Given the disappointing weekly ICSC sales statistics, bell-wether Walt-Mart sales/outlook and the oil price related expected drop in sales at gasoline stations, the monthly retail sales should again have fallen for the sixth month in a row, while the core sales (that excludes the car sales) should have done so for the fifth time. The report will underline the fast adjustment that is taking place in the consumer sector. We see the risks on the downside of expectations. Import prices are expected to have dropped by another 5.2% M/M in December, after falling by 6.7% M/M in November. The yearly figure is forecasted to come out at -9.6% Y/Y (from -4.4% Y/Y). The outcome will remind markets that inflation is falling as a stone, a message that might be repeated later in the week when the December CPI may show its first drop on a yearly basis since 1956.
The Beige Book that prepares the January 31 FOMC meeting will also give a very up-to-date picture of the economy and might influence the FOMC growth and inflation projections that will be deliberated at that meeting.
The speeches of Fed governors Plosser and Stern are interesting. Both haven’t spo-ken in public for quite some time, but haven’t a vote in the 2009 FOMC meetings. Plosser is a hawk, who dissented last year a few times against easing of better for less easing than the FOMC decided. So he might be more optimistic than other gov-ernors on the recovery and might utter some long-term concerns about inflation. Stern is a middle-of-the-road FOMC member. Bernanke spoke yesterday on the credit crisis and Fed policy. He didn’t add important issues, but clarified the policy ori-entation taken in the past and offered some forward looking guidance. He devoted at-tention to the communication challenge, now the Fed cannot refer to the Fed Funds rate. This complicates communication, at a time when it is of crucial importance. He explained the quantitative policy of the Fed with the one of the BOJ in 2001-2006 and termed the Fed policy as a credit-driven one. Decisions on credit (asset side balance sheet) drive policy and not the wish to expand excess bank reserves (liability side), even if of course at the end the decisions on credit lead to higher excess reserves. In-terestingly, he devoted time on the exit strategy, which is an important feature to keep the faith of markets and citizens in the anti-inflation credibility of the Fed. He also suggested that the Obama administration may turn again to the idea of purchasing toxic assets. He added that the stimulus package needed to be supplemented with measures to ease the credit crisis.
Regarding trading, yesterday, Treasuries traded sideways testing both the upside and downside. Today, the eco data, weak retail sales and plunging import prices, are intrinsically Treasury positive. The same probably applies to the beige book. Gover-nor Plosser might be a hurdle, but in the current environment and with Bernanke en-joying broad-based support in the FOMC for his quantitative policy, the market shouldn’t react in a lasting way to eventual hawkish comments. US equities stabilized yesterday following a few weak sessions when risk aversion flared up. In this context, it will be interesting how the markets react on the expected weakness of the data. It will tell us about the current sentiment and whether the gloomy sentiment again gets the markets firmly in its grip. That would of course be great for Treasuries, but at the current stage we don’t feel too eager to front-run such a development. We suspect the market needs a pause in the run up to next week’s flurry of earnings reports and position ourselves for more sideways activity in the Treasury market. Only when we get the impression that equities hit the skid and are on their way for a retest of the lows, another downleg in yields may occur.
Summarizing, the March Note future broke above 125-22, neckline of a previous double top, re-installing a bullish ST picture, which might eventually lead to a re-test of the contract highs at 128-22+. Should equities threaten to go for a test of the cycle lows, Treasuries may get another boost. If not, the upside should be limited to the cy-cle highs at best (128-22+ for March contract; 2.03% fort 10-year yield). We would play the 122-22 to 128-22+ range (March Note future) with a positive inclination as long as above 125-22/124-25+ (channel top/ LTMA).
Intra-EMU government yield spreads widen further on more rating actions
Today, the calendar contains the euro zone industrial production figures (November), German annual growth rate and French CPI figures (December). In October, industrial production dropped 1.2% M/M in the euro zone and is expected to show its third consecutive decline in November. The headline index is forecasted to decline 2.1% M/M, but a lower outcome is not excluded after the disappointing regional fig-ures. Although the data are rather outdated, a significantly lower outcome might have an impact on markets ahead of tomorrow’s ECB meeting. The German annual growth rate is forecasted to come out at 1.4% and French CPI is expected at 1.3% Y/Y.
Besides the eco data, government bond supply will remain at the forefront of investors’ minds, as Germany and Italy will tap the market and Belgium will price its new 10-year OLO. From the start of the credit crisis mid-2007, the intra-EMU government yield spreads have been widening significantly and are currently at their highest level since the beginning of the EMU in 1999. The rise in the spreads re-flects increasing concerns about the impact of the global credit crisis on the public fi-nances of the respective countries and potential financing problems. These concerns came to a (first) climax this week following the credit warnings of S&P on Greece and Ireland (Friday), Spain (Monday) and Portugal (yesterday). Yesterday evening, Moody’s also lowered the positive rating outlook for Belgium to stable, as the rating agency considered ‘an upgrade to AAA unlikely to take place in the next 12 to 18 months’. ‘The global financial crisis and a possibly lengthy macroeconomic down-turn are likely to weigh on public finances, preventing further improvement of the government's debt affordability metrics and a reduction of its susceptibility to event risk -- the two major rating constraints’. Price guidance for the new Belgian 10-year OLO had already risen over the past days from 45-50 above mid-swap to 50 basis points. The issue will be priced later today.
Today, Germany is expected to sell €7B of its 2-year Schatz 2.25% December 2010, while Italy will tap three different BTP’s in the 5-, 20- and 30-year segment for a total amount of between €5.5-7B. Yesterday, the Netherlands sold €3.275B of its new 3-year benchmark, which was above the pre-announced range of 2.5-3B. The strong demand at the Dutch auction indicates that demand is still quite strong for short-term maturities. This was also reflected in yesterday’s auction of Greek Treas-ury bills that raised a record amount of €2.55B compared to 0.408B at the previous auction last September. The huge amount issued in Treasury bills may however raise doubts about the capability of Greece to sell longer-term bonds in the current difficult market environment and may even result in a further widening of the spreads. In a similar vein, the results of today’s Italian longer-term bond auctions will be closely monitored.
Yesterday, Germany unveiled the details of its second stimulus package, which will amount to €49.25B over the next two years. To ease concerns about the budget implications of the stimulus plans, the German government indicated it will set up a repayment fund and draw strict rules to repay the extra debt it is now raising.
Regarding trading, German bonds yesterday tested the cycle highs, but no break higher occurred. As long as the Bund doesn’t break above the contract high at 125.56 in a sustainable manner, we remain careful and wouldn’t add to long posi-tions given the upcoming German bond auction today and tomorrow’s ECB rate deci-sion, where we still see some risks of an unchanged decision compared to current firm market expectations for a 50 basis points rate cut. As such, we are still looking for more correction before going long again, but if the Bund were to break higher this would open the way towards the tar-gets of the double top formation in 10-year yields at around 2.70%.
In the UK, the Gilt market sharply underperformed the German bond market. This may also be related to the concerns about the funding needs of the UK, although yesterday’s 10-year Gilt auction went quite well. Today, no eco data are on the agenda, but PM Brown may announce new measures to guarantee bank lending to Britain’s small businesses. There is also talk about a ‘bad bank’ that would buy as-sets from the UK banks. This may lead to a further steepening of the UK yield curve and a narrowing of the swap spread, as concerns about the health UK’s public fi-nances increase.
