Markets: Fixed Income
On Tuesday, global bonds rallied higher and equities sold off, as markets reacted disappointed on the new financial stability plan of US Treasury secretary Geithner (for more details, see below). At the same time, strong auctions both in the euro zone and the US eased investors’ concerns about the massive amount of fresh supply that is flooding the market.
As a result, US yields fell off their recent highs, the belly of the curve outperforming. 5-year and 10-year yields declined by respectively 22.2 and 17.1 basis points compared to 12 basis points in the 2-year sector and 15.8 basis points in the 30-year sector.
In the euro zone, the correction on the recent sharp steepening continued, as the European yield curve flattened for the second consecutive day. 2-year yields bucked the downtrend seen at other maturities and rose by 1.1 basis points. 5- and 10-year yields however declined by respectively 2.9 and 6 basis points, while 30-year yields fell 3.3 basis points.
US Treasuries surge higher as equities tank and 3-year T-Note auction goes smoothly
Today, the calendar contains the December trade balance and weekly mortgage applications. In November, the trade balance showed a sharp narrowing in the deficit (- $40.4B from -$56.7B). For December, the consensus expects to see another decline in the deficit with both imports and exports dropping, which is traditional for periods of recession. A significantly different outcome from the consensus ($-35.5B) will have an impact on fourth quarter GDP. The trade balance report shouldn’t be really influential for trading. Fed speakers on duty are governors Duke on stabilizing the housing market and governor Evans on the economic outlook. More important might be the testimony of Treasury Secretary Geithner on TARP. He will probably be grilled about the new banking plan and the Senator will certainly ask him to clarify a number of issues that sprung up following his speech yesterday.
The 3-year T-Note auction went very well. The auction stopped at 1.419%, well below the WI bid of 1.433% at the moment of the stop. The bid/cover of 2.67 was strong (average 2.39) despite the record size auction. The bidding data showed the buy-side drove the auction, as the Indirect bid was a record high and the Indirect takedown well above average. Today, the Treasury will auction a $21B 10-year Note auction that will raise all new cash at settlement on February 17. The auction is the second leg of the Q1 refunding operation that will be concluded tomorrow by a $14B 30-year T-bond auction. It is not clear that the success of the 3-year Note auction yesterday means the 10-year auction will go smoothly today. On the positive side, the 10-year auctions that are part of the refunding operation in general go smoothly.
Yesterday, Fed chairman Bernanke defended the Fed’s actions in the face of the severe recession and the financial markets crash. He believes that the programs have improved market conditions and eased strains. Bernanke acknowledged that the expansion of its balance sheet could lead to inflation if the Fed failed to withdraw liquidity measures when the economy recovers. He promised more information about the Fed’s balance sheet and credit policy. He played down credit risk from its expanded balance sheet, saying that 95% is extremely safe, while the remainder, lending related to Bear Stearns and AIG “a bit less secure”.
Regarding trading, equities reacted disappointed to the new banking plan, probably because it lacked details and maybe because there is hesitance about whether it tackles the underlying problems with the right measures. However, we wouldn’t conclude at this juncture, as some observers do, that the plan is as worthless as the TARP was in addressing the problems of insufficient capital and the toxic assets. The equity market reaction might have been simply a buy-the-rumour, sell-the-fact reaction. In S&P terms, the sell off brought us back close to the key support area that is situated between 790 (50% decline from top), 768 (2002 low) and 741 (Nov low). So, unless further damage is done, yesterday’s price action doesn’t really change the technical picture (and sentiment). Treasuries staged a strong rebound, which was partly the result of the equity reaction on the banking plan, but partly also the result of an easing of supply concerns after the price concessions made in previous weeks. We aren’t too surprised by the Treasury rally, as the market was oversold and a buythe rumour sell the fact reaction on Geithner/3-year Note auction was always a real possibility. We are a bit disappointed that the technical levels put forward for such a Treasury correction weren’t reached.
So, we don’t all of a sudden become again very enthusiastic on going long Treasuries, even if we won’t go short. The return of some risk appetite apparent before yesterday may return and keep Treasuries from staging a multi-day sustained rally. Therefore we stick to a more neutral positioning on Treasuries at current prices and are looking for more convincing signs before entering the market. While the technicals of the 10- and 30-year didn’t improve, the 5-year yield is again below the neckline of a bearish double bottom, but confirmation of the break is needed.
European bonds rebound strongly
Today, the euro zone economic calendar is empty, but on the supply front Germany will tap its 3.75% Bund Jan 19 for an amount of €6B. And on the money market, the ECB will hold two longer-term refinancing operations one for 3- and one for 6 months. Yesterday’s auctions from the Netherlands and Austria went quite well and sold more than initially announced, while Greece was able to sell €7B of its new 3-year benchmark, albeit at a large premium. Overall, intra-EMU spreads continued to narrow yesterday, which is a positive sign given the increased risk aversion seen in other markets following the announcement of the new financial stability plan in the US. Today, markets will also look out for the shareholders’ meeting on Fortis and the potential implications for the Belgian public finances from the vote. A refusal of the sale of the Belgian banking activities to BNP Paribas may put a burden on the public finances and lead to an underperformance of Belgian government bonds. Ahead of today’s decision, Belgian government bonds however continued to perform in line with their peers.
Overnight, ECB’s Quaden indicated that he has no objections to cutting interest to below the 2% level in case the inflation forecasts would justify such a move. He added however that he’s not in a hurry to go toward zero rates, or close to zero, thereby echoing comments of ECB’s Trichet, who said last Thursday that zero interest rates would be inappropriate in the euro zone. Hence, Quaden’s comments support the current market’s expectations for a 50 basis points rate cut at the next meeting in March, but still don’t expect German 2-year yields to break to new cycle lows. Yesterday’s underperformance of the 2-year sector appears to subscribe this view. This morning, the preliminary GDP figures from Belgium highlighted the arduous state of the economy during the last quarter of 2008, as the Belgian economy contracted 1.3% Q/Q and 0.5% Y/Y. The quarterly contraction is in line with current market expectations for the overall euro zone and shouldn’t therefore have much impact anymore.
At the longer end of curve, the technical picture of the Bund improved, as the Bund broke again above the neckline of the double top formation at 122.54. A sustained break higher would indicate that the recent correction has run out of steam. Indeed, as long as the ECB hasn’t finished cutting interest rates and central banks contemplate more quantitative easing a sustainable uptrend in longer-term yields looks very difficult. Therefore, we would contemplate to install new long positions at the longer end, if the Bund confirms the break higher and 10-year yields would fall again below the 3.30% level.
In the UK, the calendar contains the labour market data (January). The jobless claims are expected to have risen by 89 000 in January, after growing by 77 900 in December. The ILO unemployment rate is forecasted to come out at 6.3% (from 6.1%) in December.
More attention will however go out to the Bank of England inflation report, as investors will scrutinize the report to see how the bank is planning to stimulate the economy now that its official policy rates are rapidly approaching the zero level. Although the MPC decided to cut rates again by 50 basis points in February, the Minutes of the January meeting already pointed to some hesitation to cut rates much further. The MPC may therefore likely focus on the stimulus underway in the economy and the new Asset Purchase Facility to support the credit markets instead of more interest rate cuts.
