Markets: Fixed Income
On Monday, global bonds continued to slide lower with again European bonds hit the hardest. A return of risk appetite, following good news from Barclays and some other banks, pushed equities higher. On top of that, the unexpected rise in US Existing Home sales convinced more investors to trim long positions in bonds.
There were some specific developments that complete the above rough picture of trading. Later in the US session, equities lost traction and ended the session only moderately higher. Earlier a sloppy US 20-year TIPS had some, albeit temporary effect.
In EMU, the Bund fell below key support of 122.54, EMU intra-government spreads narrowed, while the 2-year Schatze that held up very well until yesterday got whacked. Ongoing ECB talk that rates below 2% are only possible in special circumstances might at last have unnerved investors and led to profit taking.
US Treasuries correct lower, but arrive now at key levels (10-year)
Today, the calendar is well-filled with the S&P Case Shiller home prices, Conference Board’s consumer confidence and Richmond Fed. Case Shiller house prices are expected to have dropped by 18.4% Y/Y in November, which indicates that the pace of decline is slowing. Nevertheless, a sharper drop is not excluded after the very weak November housing data released earlier. The Richmond Fed manufacturing index plunged to a new record low (-55) in December. For January, a modest improvement is expected (-50), which is in line with the previous released NY and Philly Fed. While it is too early to draw the conclusion that the worst is over, the recent info might be an indication that the pace of slowdown has no longer accelerated. The Conference Board’s consumer confidence index is forecasted to show a marginal improvement in January (39.0 from 38.0). But the risks might be on the downside of expectations as labour market conditions deteriorated sharply and stock prices dropped further. Also the decline in ABC consumer confidence last week might raise fears for a lower outcome.
FT commentator Guha stated in Monday’s edition that whether or not the Fed would unveil new programmes when they meet on Tuesday/Wednesday would depend upon whether it had received risk capital for the US Treasury and had political consent to unveil them. Guha seems to be more optimist than we are about the possibility the Fed will announce new initiatives (or expansions to existing programs) on Wednesday. We thought that the Fed would postpone new initiatives and coordinate it with the expected Obama stimulus and bank rescue program. Another well-known Fed watcher, Steve Beckner, in his column pointed to the divergence of opinions inside the FOMC on the quantitative easing. The expansion of the balance sheet and the Fed venturing in the credit markets led to criticism of governors Lacker who warned that mixing monetary and fiscal policy is fraught with risks, but also Hoenig and Plosser are no unconditional backers of the QE, to say it mildly.
The 20-year TIPS auction was very sloppily bid, as it stopped 11 basis points above the WI bid side. The interest in the auction was quite good though as the 1.92 bid/cover exceeded the average of 1.79. Dealers bid was stronger than average, while the Indirect bid fell a bit shy from average, but not too much. Dealers took down 45.6% while the Indirect takedown amounted to 54%. Today, the Treasury will auction a record $40B 2-year Note. The size was upped $2B from December and has been increased steadily in the last year. The auction will raise approx $20B at settlement (Monday). On Thursday, the Treasury will auction a record $30B 5-year Note, which will raise all new cash on settlement. There are some coupon interest payments but overall the cash flows surrounding the auctions are negative and thus another difficult auction looms.
Regarding trading, the correction in Treasuries continued also yesterday, but losses were modest at the end, as equities receded following a strong advance in early trading. Today, as the Treasuries are at key levels, trading will be very interesting. Indeed, the calendar doesn’t look very Treasury friendly. The Treasury will auction a $40B 2-year Note, the eco data might be conceived as Treasury negative if they are better than expected, or even if they are not worse than expected. In equity markets, earnings results are key, while the nomination of Geithner as Treasury Secretary confirmed by the Senate, the market will eagerly look for the first Obama measures regarding the economy and the banking sector. The technical picture is interesting too with the longer-dated 10-year) Treasuries at crucial levels. So, as the dust settles and the markets are closed, we will have a better view on the outlook for Treasuries. In case of a neat break lower, the risk is for more re-positioning. However, in that case, risks grow that the FOMC announced a program to buy Treasuries.
Bund hard hit, but at last some intra-EMU government spread narrowing
Today, the calendar contains the German IFO business climate indicator (January). The German IFO indicator is forecasted to show its eight consecutive monthly decline in January, coming out at 81.0 (from 82.6). The current assessment is forecasted to worsen, while the consensus expects to see a slight improvement in expectations. The January German PMI, released last Friday, was still down, suggesting that the IFO may show a slight further decline, contrary to situation in a number of other EMU countries. However, fresh business confidence data, albeit in Australia now, show no further decline in January raising doubts on a further decline in the IFO. Even if there is a small decline, it won’t help bonds much if it is due to the current situation sub-index on the condition the more important expectations sub-index improves.
ECB Executive Board member Gonzalez-Paramo said that the ECB is comfortable with rates at 2% and exceptional reasons will be necessary to lower them further. Excessively low rates can create obstacle to the smooth functioning of markets. At the January press conference, Trichet signalled that 2% wasn’t necessarily a floor for rates. Gonzalez-Paramo didn’t say anything fundamentally different, but from his comments and those of some others like Mersch over the weekend and Bini Smaghi late last week, one cannot but conclude that the ECB is trying to temper markets expectations regarding the room for more rate cuts. Paramo called inflation risk balanced and deflation a very far off risk. However, the comments of ECB Weber, a hawk, late yesterday, were interesting. The German Central Banker is downbeat on growth saying that the 2.25% contraction of growth in 2009 for Germany is realistic and sees only a slight recovery in 2010. Weber doesn’t see deflation and added that future monetary policy decisions would be data-dependent. That looks more dovish talk to us than that of the Executive Board members like Gonzalez and Bini Smaghi recently, who put the hurdle for eventual rate cuts below 2% quite high.
According to ECB data, banks parked nearly $200B at the ECB deposit facility over the weekend, up from €110B on Wednesday. Following the implementation of the decision last week to widen the band around the re-fi rate to 1% on each side, banks had trimmed the money put in the deposit facility. The latest ECB figure suggests that this development has reversed. We don’t draw too rapidly conclusions about renewed increased tensions in funding markets though. The rise in the amount is linked to a drop in the overnight rates to levels slightly below the deposit rate. In this respect, it is rational behaviour to put the money at the deposit facility instead of lending it out. The more strange development is that banks continue to ask more money than they need at the ST refinancing operations that are conducted at fixed rate (2%) and fully allotted, especially as the penalty is now higher in case of surplusses (1%). Part of the obtained CB money is clearly excessive and lend out in the money market (overnight) or put at the Fed (deposit facility), if the deposit rate is higher than the overnight rate.
The Belgian Treasury successfully sold €2.385B of bonds in different OLO lines with bid/cover between 2 and 3 for 2011/2014 maturities and 8.39 for the 2028 OLO on tap. The latter however was for a very small amount. The Dutch debt Agency taps today the 5% July 2011, the 4.25% July 2013 and the July 2015 for an amount of up to €2B maximum. Yesterday, spreads between Germany and the other EMU sovereigns narrowed, as Germany sold off. Blackrock said it had taken spread narrowing positions, as it called the current wide spreads ridiculous. The message got quite some publicity and might have been replicated by others in the markets or convinced some to unwind spread widening positions. The market is currently still thinly traded and order driven. Second potential hypothesis for the spread widening is the sharp sell-off in Germany that in a thin market leads the reaction in other EMU government bond markets. If that should be the case, these peripheral markets might catch up today.
Regarding trading, the market corrected sharply lower, the curve bear flattened, contrary to Friday when the curve bear steepened. Increased risk appetite certainly played a role, as did the technicals, but the consistent message out of the ECB Executive Board that it is reticent to cut rates below 2%, unless some very strong reasons, might have been the straw that broke the camel’s back and unnerved investors at the short end of the curve. The market discounted an ECB official floor rate for the cycle closed to 1%, which was an ideal level to book some profits. At the longer end of the curve, the Bund future fell in the wake of….the US eco data below the key 122.55 support level and when the US Treasuries recovered, the Bund showed no appetite to struggle back, but on the contrary lingered on close to the intra-day lows.
Today, the eco data (IFO) might be neutral for markets, but an unexpected rise would in the current scenario probably lead to more losses. The return of risk appetite has maybe also somewhat further to go. The Nikkei is sharply up on a government plan to support Non-financial companies by amongst others a $16.7B scheme to buy shares. Also the official nomination of Mr. Geithner as the next Treasury Secretary and his promise to act rapidly underpins the more positive sentiment on equity markets.
The technical pictures of the Bund and the 10-year yield are deteriorating. The Bund fell below 122.55 and the 10-year yield rose above 3.30%, painting bearish double top/bottom on the respective charts. The moves need to be confirmed today to make the MT pictures bearish. If that’s the case, next levels are 3.55% for the 10- year yield (38% retracement) and 121.33 for the Bund. The targets of the configuration are still much further away.
Yesterday, we advised that the longer end of the curve had reached interesting entry levels for longs. The levels were broken though, but we wait today’s trading to see whether the idea of going long should already be left. The break should be confirmed and a similar configuration of double top in the March Note future is under test, but the neckline isn’t broken yet. In the Bund, the line in the sand is 121.23 (Dec 12 low).
For the shorter end of the curve, we advised yesterday to go long, but only after a more pronounced correction, as the low levels reached didn’t offer value. Yesterday’s rise by 22 basis points (1.66%) of the 2-year German yield makes the idea of going long more interesting, but given the steep correction it might be better to wait for signs the underlying bullish sentiment hasn’t been fatally hurt.
In the UK, the calendar contains the January CBI distributives trades report. In December, the CBI distributive trades report deteriorated from -46 to -55 and a further decline is expected in January. Yesterday, Gilts outperformed Bunds on the back of dovish comments of MPC member Blanchflower that rates should fall to US levels.
