Markets: Fixed Income
On Wednesday, global bonds, at first, showed quite good resilience despite risk appetite improving further on the back of the progress the Obama stimulus package makes in Congress and on hopes a bad bank will soon put into place, allowing banks to get rid of their toxic assets. Equities surged higher led by finan-cials, but also cyclical sectors performed well. In such a climate, one expects bonds to lose ground, but hopes the Fed would start buying Treasuries kept bonds well underpinned for most of the session.
However, the Fed refrained in its statement from announcing such an initiative, even if it made the opening for such purchases of Treasuries a bit larger. The market was clearly not satisfied and sold off, steepening the curve sharply. The European cash bond market was already closed at the time the FOMC statement was released. Therefore, German yields still showed a decline on a daily basis of 2.7 to 7.6 basis points, the wings outperforming the belly of the curve. In the US, yields rose by 9.8 basis points at the 2-year sector (partly the result of a benchmark change) to 18 basis points in the 30-year sector, steepening the curve sharply.
The eco calendar was thin yesterday, but the Spanish Central bank released very bad Q4 GDP figures, while Italian business confidence bucked the trend seen in other countries by showing some further deterioration in January. German inflation fell to 0.9% Y/Y and was below expectations confirming that the downtrend trend in inflation is still well in place. In the US, the mortgage applications fell sharply in the week under review, after already been very soft in the past 4 weeks. This is discon-certing as it suggests that the Fed’s policy of buying MBS securities, announced in November and implemented in December hasn’t revived the mortgage and housing market yet.
For full coverage of the FOMC decision see our flash report (https://multimediafiles.kbcgroup.eu/ng/published/KBC/PDF/MARKTENZAAL/marktenzaal_flash_fed_29012009.pdf)
Treasuries sell off following FOMC statement
Today, the eco calendar is well-filled with the durable goods orders (December), new home sales (December) and weekly claims.
In November, durable goods orders dropped by 1.5% M/M after a plunge of 8.5% M/M in October. The consensus is looking for a decline of 2.0% M/M in December. We see the risks on the downside of expectations after manufacturing PMI showed another plunge in new orders and also orders for motor vehicles are expected to have declined sharply. Civilian aircraft is forecasted to have a mitigating impact as Boeing orders rose sharply after the ending of the strike. After the upward surprise in existing home on Monday, new home sales are expected to have plunged in De-cember to the lowest level since July 1982. The consensus is looking for an outcome of 397 000 (from 407 000), which would indicate that new home sales dropped by another 2.5% M/M in December. But we see the risks on the upside of expectations. Last week, both initial and continuing claims surprised on the upside which was at least partially due to the automotive shutdowns. Initial claims rose to 589 000, the highest level since 1982 and continuing claims climbed to 4 607 000. For the week ended January 24, initial claims are forecasted to have dropped by 14 000 (to 575 000). But the figures might be distorted as the week in question includes the Martin Luther King holiday. Continuing claims, which are reported with a one-week lag, are forecasted to have risen to 4 620 000.
Summarizing the FOMC statement (for full coverage see our flash report), the Fed downgraded the economic outlook and hinted that deflation was a risk going forward, without using the D word though. The credit-based policy of quantitative was con-firmed, but there were no specific details about eventual new initiatives, timings or quantities. In general terms the Fed said it might expand its operations and target other markets. Interestingly, the Fed signalled that its credit-based quantitative easing policy primed on the pure theoretical quantitative easing policy that is based on the purchase of Treasury securities. Nevertheless, the Fed added that it is also pre-pared to purchase longer-term Treasury securities if evolving circumstances indi-cate that such transactions would be particularly effective in improving condi-tions in private credit markets. So not yet an unconditional go ahead for buying Treasuries. We explained in previous Sunrises that in a context of supply concerns, the market was very sensitive to the subject. The small additional step the Fed made towards such purchases was deemed disappointing by market participants and re-sulted in a steep sell-off after the statement was released. The 30-year yield is at a 2-month high of 3.44%.
The $30B 5-year Note auction will be in the focus after the Fed in its statement didn’t commit itself (yet) to purchase Treasuries. Supply is an issue and markets think that Fed intervention is needed to absorb that mountain of new debt. So, it tries to force the Fed’s hand. We suspect that the Fed won’t wait too long before throwing in the towel and start buying Treasuries, but where is the pain threshold for the Fed? A bad auction would of course be an important event. The 2-year Note auction, also of a record size, on Tuesday went surprisingly well. However the 5-year might be more difficult. The auction will raise all new cash upon settlement and last month’s auction went poorly. On the other hand, yields have gone up and at 1.70% aren’t so unattrac-tive, given the prospect of 0% Fed funds rate for a long time.
Regarding trading, the sell-off in post FOMC trading shows that the sentiment that deteriorated in mid-January is still bad. We were/are looking for signs the correction is over, but the environment doesn’t give us confidence the correction is over. The technical pictures of 10 and 30-year yields have deteriorated with a double bottom in place in the 10-year (but not yet confirmation in March Note future). Next support is at 2.80%. The picture of the 5-year is still positive, with key supply at 1.80%. Negative factors are a revival of risk sentiment that we expect to continue in the next sessions with the Obama stimulus and bad bank packages taking centre stage. Supply con-cerns won’t dissipate soon. The big unknown factor is when the Fed intervenes and starts buying Treasuries. The eco data should be again weak, but for reasons ex-plained above, they might be mixed compared to expectations. Together with the 5-year Note auction and the aftershocks of the FOMC decision, the environment is difficult for Treasuries.
European bonds follow US Treasuries lower at start of trading
Today, the calendar is well-filled with the European Commission confidence indica-tors (January), M3 money supply and credit growth data (December), German unem-ployment figures (January) and Belgian CPI (January).
Last month, euro zone economic confidence deteriorated sharply, while the con-sensus was looking for a modest decline. Broadly based weakness pushed the head-line index lower from 74.9 to 67.1. For January, a modest worsening is expected (65.4), with all sub-indices deteriorating. We anticipate on a less negative outcome after the upward surprise in PMI business confidence and the German IFO indicator. Yesterday, also French consumer confidence unexpectedly improved. In December, German unemployment showed its first increase since January 2006, after holding up rather well. The number of people unemployed rose by 18 000 after falling by 4 000 in November. In January, unemployment is expected to have risen by 30 000 and the German unemployment rate is expected to have grown to 7.7%. In the com-ing months, unemployment is forecasted to rise further. Euro zone M3 money growth is expected to fall back to 7.6% Y/Y in December (from 7.8% Y/Y in Novem-ber).
ECB member Constancio, a dove inside the ECB, said there could be negative in-flation rates in the middle of the year, but that won’t signify deflation. He said every-thing should be done to avoid a prolonged decline in prices. We don’t think that these comments bring anything new to the outlook for rates.
Regarding supply, the market will eagerly look at investor’s appetite for Italian BTP’s. The Treasury will re-open the 4.25% Sept 2011 and the 4.50% March 2019 (from amounts of €2.5 to 3.25 each). The Treasury will also issue a CCT (floating rate) Sept. 2015. Intra-EMU government spreads versus Germany, narrowed a bit in recent days following a sharp widening after the downgrading of some sovereigns.
Yesterday, bonds held up quite well with an outperformance of the 2- and 30-year sectors. At the start of trading, the market needs to digest the FOMC decision and the negative reaction on the US Treasury market (see US part).The European data are interesting, but probably not very influential for trading. Equities and the general risk sentiment will probably drive the markets. The Obama stimulus package and the bad bank plan are key focus with the wild card the Fed’s attitude towards buying Treasur-ies. Yesterday, they still seemed reluctant to go in that venue but in case of a further sell-off at the longer end, they might have little options than expand their asset pur-chases to Treasuries. The Italian auction is a wild card, but sentiment regarding non-German sovereigns improved recently and after the price concession the auction may go okay. The technical picture of the Bund is still positive but the ongoing test of the key 122.54 level is a concern. A neat break lower might trigger follow through selling. We advocated recently to buy on dips towards the 122.54 and as long as there is no firm break of that level, we would stick to that point of view. We would understand those who want to wait until the market has finally made up its mind.
