Markets: Fixed Income
On Thursday, global bonds sentiment soured further, as bonds couldn’t profit from awful eco data and equity weakness. The inability to generate a positive momentum on bond-friendly factors led to a sharp sell off later in the US session. Treasury supply (a sloppy 5-year Note auction) and huge corporate supply weighed and when also an important technical level was broken (123-09 in March Note future), the weakness turned into a rout. Disappointment about the Fed not committing itself towards buying longer-term Treasuries on Wednesday evening lingered on. In EMU, German yields were mixed with 2- and 30-year yields still down 4.7 and 13.7 basis points, while 5-year yields were little changed and 10-year yields were up 2.6% basis points. In the US, yields rose by between 5.5 and 19 basis points, the curve much steeper on the day.
The eco data were indeed universally weak injecting again a dose of pessimism in the markets. It started with awful Japanese retail sales, but European data weren’t any better. EMU economic sentiment deteriorated in January, albeit from an upwardly revised December figure. M3 money supply slowed sharply, which was also the case for lending to households and firms. German unemployment, barely rising until December, surged higher in January indicating that the German labour market is now fully hit by the recession. This might impact government policy. In the US, claims edged marginally higher from last week and are at cyclical highs. Durable orders fell steeply in December and the November figure was revised sharply lower, while New Home sales sank to the lowest level since at least 1963.
US Treasuries tank on supply concerns and despite weakness in equities
Today, the calendar contains the fourth quarter GDP figures, Chicago PMI and final figure of U. of Michigan Consumer Confidence.
Fourth quarter GDP is expected have contracted by 5.5% Q/Q (annualized) after an annualized -0.5% Q/Q figure in the third quarter. If confirmed, this will be the worst performance since the first quarter of 1982 when it declined by 6.4% Q/Q. Weakness is expected to be broadly based. Consumer spending is expected to post its second consecutive monthly decline and also residential investment is forecasted to remain weak as the housing crisis deepened in the fourth quarter of 2008. As demand weakened, the pace of inventory liquidation might have a negative impact and also the US net export deficit is forecasted to have widened. Economic growth is expected to remain weak in the coming quarters. Last month, Chicago PMI showed a modest recovery (35.1 from 33.6) and for January, a marginal worsening is expected (34.9). After the upward surprise in the other regional business confidence surveys, we see the risks on the upside of expectations. The final figure of January University of Michigan consumer confidence is expected to confirm the (slight) recovery in the first release (61.9).
The $30B 5-year Note auction did not go well. The auction stopped at 1.82% well above the 1.795% which was bid in the WI at the moment of the stop. The bid/cover at 1.98 was below the 2.14 average over the last twelve auctions, but the record size of the issue need to be taken into account. The dealer bid was solid at $47.3B, while the Indirect bid at $11.6B was down from the previous month’s $13B, but certainly not weak compared with average bid size.
Regarding trading, the sell-off in post FOMC trading got another leg on Thursday. The intra-day price action shows the extent to which sentiment has soured. Indeed, awful eco data and equity weakness never could initiate a positive momentum and later on investors threw the towel in. Supply concerns came to the forefront with a lot of corporate supply, including issues of Goldman, AT&T, ConocoPhillips and General Mills, and a 5-year Note auction that didn’t go well. All this happened against the background of disappointment over the Fed’s reluctance to buy longer-dated Treasuries. The technical pictures of both the March Note future and the 10-year yield have become negative. The 30-year T-yield has now risen by slightly more than 100 basis points since the start of the year. This has also pushed mortgage rates up, which risks hindering the Fed’s efforts to bring market rates in a number of key markets like mortgages, consumer credit and other down. The Fed last Wednesday showed itself reluctant to start buying Treasuries, even if it opened the door for such purchases a little bit further. A showdown between the Fed and markets has started against concerns about the avalanche of Treasury supply that is flooding the market. The Fed probably cannot wait too long to intervene or the sell-off ends in a rout.
Today, the eco data will be again weak, but we aren’t convinced they will be weakerthan- expected. Given the current worsening sentiment, the bond market may react negatively in case of upward surprises, while weakness is already well discounted. On the other hand, the sell-off has gone far this week leaving the market oversold, while some month-end extension buying might still have to be done. Earnings results of Procter & Gamble, Honeywell and Chevron/Exxon could set the tone for equities. So, all in all while a prolongation of the decline is possible, there is scope for some pre-weekend profit taking of shorts that would give Treasuries some relief. The Fed intervening by buying longer-dated Treasuries is a wildcard.
Bund trades sideways in regular session, but drops in sympathy with US Treasuries afterwards
Today, the calendar contains the first estimate of euro zone HICP inflation and the December unemployment rate. In December, euro zone inflation fell below the ECB medium-term price stability target of 2%. Euro zone inflation dropped from 2.1% Y/Y to 1.6% Y/Y and core CPI, excluding food and energy, showed its first decline after staying flat in the four previous months. For January, the consensus is looking for further decline (to 1.4% Y/Y). Especially prices of clothing are likely to have dropped significantly on the back of the January sales. On Wednesday, German inflation fell to 0.9% Y/Y, while an outcome of 1.1% Y/Y was forecasted. Therefore, we anticipate on a lower outcome for euro zone HICP and are looking for an outcome of 1.3% Y/Y in January. For the months to come, we expect to see further downward pressure on prices as the recession in the euro zone is expected to intensify. Unemployment is forecasted to have extended its upward trend in December. The consensus expects to see a figure of 7.9%, clearly above the cycle-low of 7.2% at the start of last year.
ECB president Trichet repeated yesterday that the ECB doesn’t exclude cutting rates below 2% and pointed to the important rendezvous in March. He also repeated that the ECB could take more unusual measures to fight the economic slowdown, but added he pre-announced nothing. While these comments were not different from these uttered at his press conference after the January rate cut, it pushed short term rates temporarily lower. Later on, short term yields fell more sustainable, but this time driven by falling equities.
The intra-EMU spread narrowing versus Germany continued with the weakest credits, Greece, Ireland and Italy narrowing the most. Also Belgium, Portugal and Spain registered a nice narrowing of their spread. The Italian Treasury was able to distribute €3.24 B of its 4.25% Set 2011 BTP, at the top of the indicated range for a bid/cover of just 1.363. The pricing was not very aggressive. The 4.5% March 2019 was more aggressive bid and €3.065B was sold for a bid/cover of 1.49. We would consider the auction as ok, but not spectacular. The market was happy the supply was off the table allowing Italian spread to narrow versus Germany. The debate on the future of the EMU zone continued yesterday. On Wednesday eve, ECB president Trichet said that the recent widening of risk premia in the euro area posed no threat to the future of the single currency, even if he asked governments to take responsibility for restoring confidence in their fiscal policies. Yesterday, Soros, the well-known investor, in an Australian newspaper would have said that the euro may not survive without the EU plan to deal with toxic assets. The international news agencies brought the news only late on Thursday. So, we are eager to see whether it impacts the spreads during today’s session, but all in all, we don’t buy into Soros’ story.
Yesterday, bonds traded mixed with the belly underperforming the wings. The Bund opened weak catching up with the post FOMC performance of Treasuries. An initial attempt to rally faltered, but all in all bonds kept a more sideways trading profile. A second attempt to rally in the US session, driven by equity weakness and eco data failed miserably leading the Bund to close at 122.89, a loss of 17 ticks versus the previous close but up on Thursday’s opening levels. In after-market trading, the Bund in sympathy with US Treasuries fell quite sharply, a movement that was continued in today’s opening. Also here, the technical pictures are showing some cracks, even if there is no clear break of the 3.30% (10-year Bund yield) or 122.54 (Bund future). Overnight, Japanese eco data were very weak and equities down, but just like yesterday these bond-friendly factors cannot prevent bonds from going lower. The EMU data, inflation and unemployment should be bond-friendly too, but probably won’t turn the sentiment for the better, except for the short end that may profit from a lower-than-expected inflation data. We suspect that trading in US Treasuries will set the tone for the EMU bond market too, with oversold conditions and month-end extension buying the only elements that might give the bonds some relief today.
The technical picture of the Bund is still positive but the ongoing test of the key 122.54 level is a concern and the picture looks heavier every session. A neat break lower might trigger follow through selling. We advocated recently to buy-on-dips towards the 122.54 (with stop loss at 121.33 Dec low) and as long as there is no firm break of that level, we would stick to that point of view. However, we would very well understand those who want to wait until the market has finally made up its mind before contemplating to enter the market from the long side.
In the UK, the calendar contains the December lending data. This will give us an indication whether the guarantees offered by the government will have encouraged the banks to lend.
