Markets: Fixed Income
On Monday, global bonds gained moderate ground, although the manufacturing data provided hope that the worst point in the downturn might have passed for industrial activity. Both in the US, EMU and UK confidence remained at extremely low levels in January, but stood nevertheless slightly higher than in December last year. Equities traded weak during the day, but were off the day’s lows at the end of the session.
This however couldn’t prevent US yields from falling quite substantially in a daily perspective. Although US yields rose on the unexpected rebound in the ISM manufacturing, yields were down 5.5 basis points in the 2-year segment, 13.2 basis points in the 5-year segment and 11.8 basis points in the 10-year segment at the end of the day. Volume was very thin and we would be careful to draw large conclusions out of yesterday’s trading. As long as 10-year yields are still trading above the neckline of a double bottom at 2.60%, the US bond market appears vulnerable.
In Europe, European bonds lagged the up-move in US Treasuries. But also here, yields were down in a daily perspective, except for the ultra-long end of the curve. 2- year yields fell 3.2 basis points, 5-year yields 5.2 basis points and 10-year yields 1.2 basis points, while 30-year yields were up 0.7 basis points. Hence, 10-year yields are still testing the neckline of a double bottom formation at 2.24%.
US Treasuries stage a rebound but without an obvious driver
Today, the calendar is thin as it only contains the pending home sales, vehicle sales and ABC consumer confidence. Pending home sales are expected to have stayed flat in December after surprising on the downside in November (-4.0% M/M). Pending home sales lead Existing Home Sales by one or two months, but are in fact the least important of all housing data (start & permits, New Home sales, NAHB survey, construction spending). Therefore, the markets shouldn’t react too much when the outcome deviates from consensus. Vehicle sales are forecasted to have remained weak in January (10.2M from 10.3M). This indicator is important for eco watchers as it is very timely information and concerns a big ticket item that tells us something about the willingness of consumers to open their wallet. Incentives are often a key reason for monthly swings though. Markets usually don’t react too pronounced because the car sales are reported during the day at different moments by the various carmakers.
Dallas Fed governor Fisher, a hawk inside the FOMC who voted in H1 2008 several times for a less easy policy than the majority, said he is concerned about inflation being too low, though officials should be aware of “baked-in” inflation pressures over the long term.
The January Fed’s Senior Loan survey showed that a majority of banks tightened lending standards, while demand from businesses and households for loans continued to weaken. However, there were signs of some improvement in a number of loan categories. The Fed said that the net fractions of respondents that reported having tightened lending policies over the previous three months remained elevated. However, relative to the October survey these fractions generally edged down slightly or remained unchanged.
The biggest improvement was registered in the supply of consumer loans. On net 15% of domestic banks said they had become either somewhat of much less willing to make consumer instalment loans versus 45% in the October survey. However, demand for such loans remained near its record low. For commercial and industrial lending, the results were only slightly less bad than in October, which is of course very disappointing. Banks cited less favourable eco outlook as a reason for the tightening, while also worsening of industry-specific problems and reduced tolerance for risks played a role. Also here, a pronounced drop-off for C&I loan demand was registered. On residential mortgages, 45% of domestic banks reported a tightening of lending conditions (versus 70% in October), while demand for such loans improved, in fact was substantially less negative. For Commercial real estate loans, 79% of banks reported a tightening of lending conditions and demand for such loans remained dismal (-54.7%), a very high figure that should raise concerns.
The Treasury released its borrowing projections. For Q4 the borrowing amounted to $569B (with cash balance of $300B at the end of Q4). For Q1 2009, the Treasury estimates borrowing at $ 493B (cash balance of $225B at end quarter) up from preliminary $ 368B (projected cash balance of $ 75B), while for Q2 the borrowing is projected at $ 165B (cash balance $45B). These figures are on the low side of most forecasts, that anticipated H1 borrowing needs of about $ 800B, but might subsequently still be revised higher. On Wednesday, the Treasury will announce the details of the refunding package that contains 3-, 10- and 30-year T-paper.
Regarding trading, Treasury yields fell sharply, flattening the curve. The move follows a pronounced run-up in yields and a steepening in the previous weeks. We haven’t a very good explanation of the move when assessing the fundamentals that popped up yesterday. The most important indicator, the ISM was better-thanexpected, but couldn’t keep Treasuries down for long. Equities started weak, but recouped the losses. The Senior Loan Officer survey showed very moderate improvement and the borrowing projections were lower than expected, but they didn’t affect trading. Trading was however very thin and the price action might have been driven by profit taking of shorts. We’ll verify this hypothesis when the open interest statistics are released later today.
However as the technical pictures haven’t changed, we shouldn’t draw too many conclusions from yesterday’s price action. This doesn’t mean we are bearish on Treasuries. We are simply cautious and don’t feel especially confident to take a long position as explained in our previous Sunrise. The Obama administration looks set to come out with a new rescue banking plan soon (including bad bank?) and the stimulus package may follow in a week or two. While many government efforts have passed the revue with apparently not yet really a breakthrough in the financial markets, equities may in a first reaction shoot higher on returning risk appetite and damage for Treasuries, even if at the current juncture a re-test of the lows cannot be excluded either. Supply will be the eye-catcher (see higher) which is a negative. Finally, the technical pictures have deteriorated as a ST lower high, lower low and double top appeared on the March Note contract chart. For today, the Australian Central Bank cut rates by 100 bps to 3.25%, while the BOJ announced purchases of equities (in bank‘s portfolio) for $ 11B, the Irish government announced the birth of a bad bank and the US Senate might vote on the stimulus package with the banking plan waiting in the wings. All these factors might be equity positive and thus maybe Treasury negative, but at least Asian equities aren’t very enthusiast.
Tentative improvement in intra-EMU spreads
The eco calendar remains thin today as its only contains the PPI figures (December). After the CPI inflation (January) on Friday, the PPI data (December) are rather outdated and therefore no market mover. The consensus is looking for a drop of 1.2% M/M in December, but the risks might be on the downside of expectations.
On the supply front, Spain is planning to issue a new 10-year benchmark for an amount of €7B this week. According to the lead managers, the new bond is likely to be priced at 90 basis points over mid-swaps after the order book topped €15B, which would be at the lower end of the pre-announced range of 90-95 basis points. Although the new pricing still offers a huge premium of more than 20 basis points over the previous benchmark July 2018, Spanish bonds in general didn’t underperform yesterday. This may point to an improvement in sentiment on the European bond market with regard to the intra-EMU spreads. Similarly, the spread between German and Irish 10-year yields narrowed yesterday, despite Friday’s downward revision of Ireland’s rating outlook to negative by Moody’s and the higher-than-expected amount needed to recapitalize the ailing banking sector. Later on this week, France plans to sell between €6-7B of longer-term OATs (10 and 30-year segment), while Spain will tap the 2- and 5-year segment.
Regarding trading, European bonds had a constructive session yesterday, as bonds closed higher despite the slight improvement seen in the manufacturing surveys across the globe. It was again the short end of the curve (2-5 year segment) that led the way, as speculation on Thursday’s ECB rate decision and press conference drove 2-year yields again towards the recent lows. Hence, the steepening of the European yield curve continued with the spread between 2- and 10-year German yields closing in towards the cycle highs at 180 basis points. At the longer end of the curve, the technical picture is much less bullish, as the Bund is testing the neckline of a double top formation at 122.54. In yields, this corresponds with 3.24%. Although we had put forward these levels to go long again, we would understand those who want to wait until the market has finally made up its mind. The more as we expect the ECB to keep rates on hold on Thursday, that may disappoint the European bond market and result in more losses. Hence, ahead of the ECB meeting and US Payrolls report, we would be careful to install new long positions unless equities would break below last year lows.
Also in the UK, the calendar is thin with the construction PMI (January), which is expected to fall slightly from 29.3 to 29.0. On the supply front, the DMO will tap its 2- year Gilt 3.25% Dec 2011 for an amount of €3.75B. At the previous auction of the bond in December, demand was very weak resulting in a huge yield tail of 1.4 basis points.
