Markets: Fixed Income
On Monday, EMU and UK bonds corrected further down, especially in early morning, with most of the remainder of the session devoted to sluggish return action. Volumes were typically thin for a Monday. The closure of the US market was of course holding back investors. Technical considerations and supply concerns primed the gloomy economic news and the risk aversion bias of investors.
From a technical point of view, the Bund (and Treasuries) put in a new high last Thursday, but couldn’t sustain, leaving a doji (trend reversal) configuration on the charts. This suggested some more correction.
ECB comments weighed on the shorter end, as they emphasized that rates should not fall towards zero. The UK second bank rescue plan certainly raised fears that government finances would deteriorate further and ultimately lead to more Gilt supply. Also the EU-Commission deficit forecasts, that still excluded the cost of the bank bail outs worsened appreciably. The downgrade of Spain’s rating had only a temporary negative affect, but spreads with Germany stabilized for most government bond markets (including Spain) with the noticeable exception of Ireland.
Following the nationalization of Anglo Irish bank last week, fears are for more nationalization. The Ministry already announced a recapitalization of the countries two biggest banks. Some wild and denied rumours about Ireland leaving EMU continue to send shivers through the markets. As a result Irish bond yields surged 25 to 24 basis points across the curve. The 10-year yield spread with Germany jumped to 207 basis points, putting only Greece with a still wider spread.
Intra-day, the Bund opened little changed, but was soon badly hit by the above described supply concerns stemming from the UK banking plan. However, a bottom was soon found, after which the Bund struggled higher for the remainder of the session. In the afternoon session, gradually some more losses were recouped, temporarily interrupted by a setback.
Bund corrects lower
Today, the German ZEW survey, a not so reliable precursor for business confidence, is scheduled for release. The ZEW expectations index is forecasted to show a modest improvement (-42.5 from -45.2). We see the risks on the downside of expectations as recent data showed that German economic activity is deteriorating at a faster pace than previously thought and equities are falling. The ZEW is used as a precursor for the IFO business confidence, but recently the correlation broke down.
The EU Commission slashed its 2009 growth forecast for the EMU area to -1.9%, before staging a very weak recovery of 0.4% in 2010, while HICP inflation is projected at 1% in 2009 and 1.8% in 2010. At the same time, the overall government deficit is expected to rise from 1.8% in 2008 to 4% in 2009 and 4.4% in 2010, even as financial transactions, such as capital injections in banks are excluded. The unemployment rate is expected to surge to (average) of 10.2% in 2010 from 7.5% in 2008. The EU Commission forecasts are disconcerting and show that pessimism continues to mount.
S&P downgraded the AAA rating of Spain with one notch to AA+, after it put the country on Credit Watch last week. Spanish FM Solbes warned that Spain faced the deepest recession in 50 years, and expects a 1.6% contraction this year. Spanish non-performing loans (loans in arrears/total loans) tripled to 3.2% in November 2008 versus November 2007. In October 2008, the ratio stood at 2.9%. Especially the savings banks saw their loan portfolio deteriorating.
ECB Trichet and the Greek Central Banker Provopoulos took the floor. Provopoulos showed his hawkish feathers as he said that ECB rates were already at very low levels and so the room to cut rates further was limited. He clearly indicated that markets should not expect rates to drop to 1% and suggested that at some point the rate steps should become small. In a radio interview, Austrian ECB member Nowotny expressed a similar opinion. President Trichet warned that 2009 would be a difficult year and pleaded for structural reforms in the financial sector including end of the bonus culture and pro-cyclicality, a strengthening of the resilience of the financial sector and a re-evaluation of the use of models. He also said that Central Bankers and governments must be ready to act, suggesting that the crisis showed as of yet little signs of a fundamental improvement. On a more positive note, he said that to consider 2010 as the year of recovery seems like a good working hypothesis.
Interestingly, Greece will come with a new 5-year syndicated bond today. Given recent extreme spread widening and the rating downgrade, it will be interestingly to see how this new issue will be received by the market. It might also influence a number of other EMU government bond markets.
Regarding trading, German bonds were in correction mode at the end of last week, spilling over into this week. The general theme of risk appetite/aversion might be the dominating force this week with the Q4 earnings result season kicking into full swing and the banking sector under severe pressure. Of course the inauguration of Obama will get much attention. Therefore, flows may remain thin. Besides these general factors, the European bond market might get impulses from the ZEW survey, even if it has lost much of its appeal since the correlation with IFO business sentiment disappeared. The Greek bond auction is also a focal point, but unless there is new info about the European banks, trading might be more sideways oriented today.
In the UK, the calendar contains the December CPI and core CPI figures. CPI is forecasted to show its third consecutive monthly decline, falling 0.9% M/M after a drop of 0.1% M/M in December. The consensus is also looking for a significant decline in core PPI (1.3% Y/Y from 2.0% Y/Y). Part of the decline should come from the temporary VAT cut.
Gilts sharply underperformed German bonds, especially further out the curve, as investors correctly anticipate that the second bank plan will raise the amount of Gilt issuance, despite the government assurance that it won’t affect Gilt issuance. The curve steepened.
