Markets: Fixed Income
On Wednesday, global bonds ended the session mixed, the curve steeper. In EMU, yields still dropped 6.5 to 0.5 basis points, while the US yields increased sharply, notably by 6 to 17 basis points. The different opening and closing hours were part of the explanation of the disparity, but putting this aside, the US market underperformed the European one.
A return of risk appetite in the second half of the US session was the key factor in yesterday’s session. US equities tested Tuesday’s lows early in the session, but they held and an equity rally developed. It seems that some comments of the New Treasury Secretary Mr. Geithner about a comprehensive US eco/banking rescue plan were the trigger. The US House Appropriations Committee also approved the spending measures ($358B) of Obama’s stimulus package. The main equity futures almost recouped the previous day steep losses led by the financials and the cyclicals.
The eco data were of minor importance, but inside the EMU government bond markets, signs of strains intensified and spreads blew out. The Portugal AArating was downgraded to A+ by S&P (after trading).
US Treasuries in correction mode, as equities rebound
Today, the calendar heats up with the weekly jobless claims, December housing starts and permits and November house price index. In the week ended January 17, initial claims are expected to have risen to 540 000 from 524 000 in the week before. However, we see the risks on the downside of expectations due to the plant shutdowns in auto sector. Continuing claims, which are reported with a one-week lag, are forecasted to have risen to 4 527 000 after declining sharply in the week before. In November, both housing starts and permits plunged to its lowest level since series started in 1959, which indicates that housing market conditions are still worsening. A recovery is not expected for December as the consensus is seeking for a decline to 605 000 in housing starts and a drop to 600 000 in building permits. House prices are expected to have shown another steep drop (1.2% M/M) in November. In the coming months, it will be interesting to see whether the actions taken by the government will have an impact on the housing market.
New Treasury Secretary, Mr. Geithner, said that the Obama administration was preparing a comprehensive US eco/banking rescue plan while the US House Appropriations Committee also approved the spending measures ($358B) of Obama’s stimulus package. This injects a dose of risk appetite in the market.
Regarding trading, yesterday, Treasuries ended the session with big losses and the curve steeper. The return of risk appetite, coupled with supply concerns take centre stage. The housing data, on which we haven’t a view that deviates of consensus, shouldn’t be the main factor today, but if they would surprise (sharply) on the upside, they might, in the current sentiment, have some additional negative impact on Treasuries. After trading yesterday, Apple published good Q4 results which might be a plus at the start of trading, but other bellwethers like Google and Microsoft publish their results only after trading.
The retest of the 2002 and the current cycle lows (768/742), we speculated on yesterday, didn’t happen. A sustained break of these would be highly relevant and point to a market discounting a depression instead of a deep recession. This looks now at least postponed. We think that the correction shouldn’t go too far, even if the break of the 10-year yield above 2.5% is a negative, but no disaster. However, a break above 2.60% (and below 123-09 March Note future) would put our assessment at risk and would need a rethinking of strategy.
Intra EMU government spread blow further out.
Today, the economic calendar is again thin as it only contains the industrial new orders. Industrial new orders are forecasted to show its fourth consecutive monthly decline in November. The consensus is looking for a decline of 5.0% M/M after falling 4.7% M/M in October. A weaker outcome is not excluded, but market impact might be limited as the data are outdated, certainly compared to the various surveys. French household consumption for December will probably show a small decline following a small increase in November. The ECB monthly report will certainly paint a bleak outlook for the region, but that shouldn’t come as a surprise after the EU Commission forecasts and Trichet’s remarks during and after its monthly press conference last week.
The French AFT agency issues today three BTAN’s (tap of 2.5% 01/2014 and 2.5% 07/2010 and a new 2.5% 01/2014) for an amount of between €6 and 7.5B) and 2 linkers (2.1% 07/2003 OATi & 3.15% 07/2032 OATei). French debt traded well recently compared to other EMU sovereigns and saw relatively little extra widening of spreads versus Germany.
The Greek PDMA announced the results of the 5.5% August 2014 bond. The auction stopped at 260 basis points above mid-swap or 325.1 basis points versus German 4.25% July 2014. While the amount was rather easily placed there was a clear price concession needed. Times are indeed tough for sovereign issuers. Compared to the start of the year the spread in the sector widened 75 basis points and in May it paid a spread of 55 basis points over Germany when it issued a 10-year bond. Of course, the Greek S&P LT rating has been downgraded to A- last week on the back of weakening debt (93% of GDP) and deficit (3.4% of GDP fundamentals in a very tough economic and nervous political environment.
ECB president Trichet downplayed the threat of deflation and called rumours that countries could leave the euro zone in the wake of the financial crisis unfounded. Governments remain of course responsible for their policies he added, suggesting that the governments shouldn’t count on a bail-out if needed. The ECB president pleaded for a thorough reform of the financial system (“we need to reform everything”). Further, he declined suggestions for changes to the ECB mandate as regards monetary policy. Interestingly, he said the ECB was not currently looking at buying up debt, but made a point not to rule it out. On the idea of the creation of an international bad bank in which banks would dump their toxic assets, he was sceptical. Trichet referred regarding monetary policy to his comments at last week’s press conference. The Irish Central Bank member Hurley, defended the bank nationalization of AIB and BoI which were essential institutions for the Irish economy and called the current eco situation very difficult. The Irish German 10-year yield spread in the mean time continues to explode and stood at 264 basis points at the close. It is clear that the markets are still at unease with the developments inside EMU and the confirmation of Trichet that a bail out is not on the table didn’t help the spreads either. After trading S&P cut the Portuguese LT rating to A+ from AA-, which probably won’t ease the tensions today.
The 100bp reduction in deposit facility (the floor to Eonia) to 1% implemented yesterday (new reserve period) pushed the eonia sharply down to 1.498% from 2.147% previously. In the past eonia traded always very close to the key ECB repo rate, but more recent it traded below. President Trichet suggested that the 3 month euribor was very much looked at and that the ECB wanted to bring it down close to the repo rate from previous very high crisis levels. It seems that the ECB therefore inevitable accepts that the eonia trades below the repo rate. This means that monetary policy in fact is easier than the main official repo rate suggests. The 3 month euribor was yesterday fixed at 2.30%, down 6 basis points from Tuesday and down from 2.56% last Wednesday, a positive development. After one day of trading with the enlarged spread repo-deposit rate, it is too early to judge whether that ECB measure is positively affecting the volume of trading in the interbank market.
Regarding trading, German bonds were in correction mode at the end of last week and that continued modestly on Monday and Tuesday. Yesterday, they opened higher on the overnight movement in equities, but moved essentially sideways afterwards. Until very late in the session risk appetite returned on the back of comments of the new, but not yet confirmed, Treasury Secretary, Mr. Geithner. However, at that time, the cash market was already closed. Therefore, compared to Tuesday, yields were down between 6.5 and 0.5 basis points, steepening the curve, but bonds probably will open lower today. The 2-year rate fell to a new low of 1.42% yesterday.
Today, the EMU calendar is uneventful, even if the monthly report is always interesting literature. The speech of ECB Tumpel-Gugerell probably won’t bring eye-catching headlines either. The French auction and the reaction on the Portuguese rating downgrade might keep intra-EMU government spreads under pressure. However, the overall market will be dominated at the start of the session by the return of risk appetite and further out if this sentiment remains intact. The test of the cycle lows of equities, we speculated on yesterday, is for the moment off the table. However, we wouldn’t change our strategy, which is bullish for bonds. The 2-year yield at 1.42% might still fall a bit further, but not today when it should rise. Indeed, given that the market expectation for the bottom of the rate cycle at 1.1% is close to our 1% target, there isn’t much room to fall anymore unless ECB rate expectations drop below 1%. This might ultimately happen, but with the ECB absolutely convinced it should try to avoid a liquidity trap, market rate expectations might have difficulties to drop below 1% for now. The space to move up and down from current yields at longer maturities is of course larger. While we had a bullish bias for the longer end, we recently played the upward correction for 10-year yields (around 3-2.9%). The most recent correction in yields higher, if it would end here, is however small. This raises odds for a break lower, eventually to 2.6%, the target of a double top formation where profit taking is likely. So while we still prefer opening long positions on upward corrections in yields (3.25/30%), we wouldn’t consider anymore to book profits when reaching 2.90-3%, but speculate on a break lower in yields, which of course looks postponed.
In the UK, the calendar contains the CBI Industrial Trends survey (January). In December, the survey showed a slight improvement in total orders (-35 from -38), but a slight deterioration is expected in January.
Gilts outperformed Bunds yesterday reversing some of the underperformance of the previous days that occurred in the wake of the new banking rescue plan. S&P dismissed speculation about a rating downgrade of the UK (AAA) as rumours of such a downgrade continued to circulate in the markets. Earlier in the session, Gilts were under pressure following weaker labour market data. Later, the Treasury released debt figures that showed the debt-to-GDP at the highest level since the 1970s.
