Markets: Fixed Income
On Friday, global bonds eked out some good, albeit not extra-ordinary, gains on ongoing weakness in equities that were driven by concerns about the (US) banking sector. The acceleration in the downtrend of EMU (PMI) business confidence was a positive feature too for EMU bonds in the European session. In the US, yields dropped by 4 to 10 basis points flattening the curve, while in EMU, German yields fell by 5 to 8 basis points with the shape of the curve shifting in an erratic way.
Intra-day, the Bund opened stronger on Asian equity weakness and the overnight movement of US Treasuries and was helped later on by a new shift lower in the PMI’s, actually new record lows. This quelled hopes that January’s slight uptick in the manufacturing survey was the harbinger of better news. The rate of decline in output hasn’t stabilized yet. The PMI price indices and the French HICP for January (the lowest since October 1999) showed that inflationary tendencies are receding rapidly. The Bund and US Treasuries stabilized going into the US session. The US CPI was near expectations and a shy attempt to push Treasuries lower failed, whereafter a small rally developed that soon ran into resistance. Equities opened reasonable well but soon hit the wall amongst rumours that Citi and BoA might be nationalized after being stress-tested. The Dow dropped below the cycle lows and the S&P was hit hard too even if the cycle lows weren’t yet approached. Both the Bund and the Treasuries rallied to new intra-day highs on the safety bid. Late in the session the Obama administration let known that “this administration continues to strongly believe that the privately held banking system is the correct way to go.” Equities rallied to about unchanged levels for the day, sending Treasuries sharply lower. Equities couldn’t sustain and fell again modestly lower in the close, but Treasuries didn’t react anymore, sliding lower until the very end of the session.
Intra-EMU spreads in general tightened further with Greece and Austria the outperformers, after Moody’s indicated Austria’s AAA rating isn’t under threat from its bank’s exposure to emerging Europe.
US Treasuries gain on the week, but in fact put down a disappointing performance
Today, the calendar contains no economic data besides the Chicago National Activity Index which is no real market mover. Later this week, we will receive new information on the housing market, durables, consumer and business confidence. Atlanta Fed Lockhart speaks on the economy, but as he spoke already last Thursday on the subject, no changes are expected. After trading, Dallas Fed Fisher will speak on the financial crisis. Fisher dissented a number of times in H1 2008 in favour of a less easy monetary policy at the FOMC meetings, but has recently rejoined his colleagues (has no vote in FOMC deliberations though) and fully supports the current Fed policy. Fisher expressed recently concerns about the deflation risk. On Tuesday, all attention will go to the semi-annual testimony of Fed chairman Bernanke. It is always a key event for markets, as often the longer-term path of policy is discussed. Attention this time will go to quantitative easing and especially whether and when the Fed will start buying longer-dated Treasuries.
Both the NY and Philly Fed showed deterioration in business confidence in February, after the slight improvement in the month before. Although the consensus is looking for an improvement in the Chicago Fed, we expect to see a decline in business sentiment, both in the Chicago and Richmond Fed. Also consumer confidence is expected to have weakened in February. Conference Board’s consumer confidence is forecasted to set a new record low after the worsening in Michigan consumer confidence. If confirmed, these data indicate that both producers and consumers are becoming still more pessimistic.
Last week, both the housing starts and permits plunged to a new record low and also new home sales, scheduled for release on Thursday, are forecasted to continue its downward trend as the large inventories of unsold homes need to be worked off before a significant improvement in the market of new homes is likely. Existing home sales, on the contrary, are expected to show a modest increase in sales after having risen significantly in December. Existing Home sales are supported by… the sale of foreclosed homes (about 50% of all sales recently). Last week, the Federal Deposit Insurance Corporation said the Obama plan on the housing market will start having an impact as soon as in March.
Durable goods orders are forecasted to have remained week in January. The consensus is looking for the fourth consecutive monthly decline, partially due to the automotive shutdowns.
Friday, there were some rumours that the Fed would take some steps to lower the Fed funds rate. This might seem odd. The latter recently traded near the top of its 0- to-0.25% target zone, whereas some weeks ago it traded closer to zero. The rumour seems to have been originated after Bernanke said in his speech last week that the Fed funds rate is nearly as low as it can go. The Fed pays 0.25% on excess reserves but that hasn’t served to put a floor on the funds rate, because some parties (like GSE’s) are not subject to interest payments and thus may have an incentive to trade funds below 0.25%. However, recently that shouldn’t have played a big role anymore. So if the Fed lowers the interest rate on excess reserves, the Fed fund should trade again closer to zero and this would ultimately be an incentive for banks to lend out money. The authority for changing interest on reserves is the Fed Board of Governors and not the FOMC, but it looks likely that if the Fed wants to change the interest paid on reserves it will look for consensus and do it after consultation of the FOMC.
The Treasury will conduct its monthly auctions this week. It will issue $40 B of 2- year, $32 B of 5-year and $22B of 7-year Notes on Tuesday, Wednesday and Thursday. The 2-year Note will raise $22 B in new money, while the 5- and 7-year will raise all new cash. The size of the 2-year Note remains unchanged; the 5-year size is up $2B from the previous auction while the 7-year will be auctioned for the first time since April 1993. The $94B of issuance this week once again put supply in the focus.
Regarding trading, Treasuries had a wild erratic ride in last week’s shortened trading, but closed with moderate gains. Yields fell between 2 and 11 basis points, making the shape of the curve flatter. Swap and Agency spreads to Treasuries tightened slightly, but corporate spread widened somewhat. Corporate supply remained healthy suggesting that the market normalized further. The 3 month Libor was virtually unchanged at 1.24/25%, while the liquidity spread rose by 4 basis points to 101 basis points. The eco data were really disappointing and fell in general short to expectations suggestion that the pace of decline in activity hasn’t stabilized yet. Risk aversion was certainly the most important positive factor for Treasuries, but the latter couldn’t fully profit from it. Supply remains a counterbalancing factor and also the technical pictures are neutral more than outright bullish.
Most important, the Obama measures to stabilize financial markets and help the economy are received with ever less enthusiasm. After Mr. Geithner’s speech on the banking plan in the previous week was met with a sell-off in the equity markets, also the house market plan last week couldn’t generate a positive momentum and the Dow closed last week at 7-year lows, while the S&P is testing the very key support area between 790 and 741. Persistent concerns about bank nationalizations are flying high. An article in WSJ over the weekend said Citi and the government are in talks that may lead to the government holding a 40% stake in Citi. A cautious positive reaction is visible in the US equity futures and in Asian equities, but it is way too early to consider it as a sufficient reason to become positive equities at the start of the week. Many questions remain about the fate of Citi and some other banks and about the government intentions, even if the Obama administration late on Friday said it stood behind a privately held banking system.
The technical pictures of the Treasuries remain neutral despite intrinsically Treasuryfriendly factors like dismal eco data and plunging equities. This keeps us cautious at the start of trading. Supply, Bernanke’s testimony, equities and eco data are the four major influences this week. While eco data might again be a Treasury friendly we fear that they might be more or less ignored. Bernanke speech could have a positive effect, if he suggests that purchasing Treasuries is drawing nearer, but recently, signs are that it is too early to expect news on that. Equities dropping below 741 (S&P) should be a positive, but following recent declines there is a decent chance for an eventual rebound, while supply should be difficult to digest. The refunding auctions went reasonable well, but nevertheless the increased size is started to affect the results, with auctions stopping above the bid in the WI trading. So, at the start of the week, we start with a neutral view on Treasuries, but see risks more for a downmove than for an up-move.
Re-iterating, technical the S&P index has entered a critical support area (790-741) which if lost, would signal the market is making itself up for a depression. We have always put this support area as the line in the sand.
German bonds rally higher, but highs in the Bund remain a bridge too far for now
Today, the euro zone calendar is empty, but tomorrow, we will receive the industrial new orders (December) and German IFO business climate indicator. Industrial new orders are expected to show their fifth consecutive monthly decline in December. The consensus is looking for another sharp decline (-5.0% M/M), but the data are rather outdated and therefore no market reaction is expected. The IFO business climate indicator is forecasted to stay broadly unchanged, but the risks might be on the downside of expectations after the weaker than expected PMI’s, released last Friday. Also the European Commission confidence indicators are scheduled for release this week. The market expects to see a marginal deterioration, but we don’t exclude a sharper drop. On Friday, we will receive the euro zone unemployment rate (January), which is forecasted to have risen to 8.1% (from 8.0%) and the final figure of the January CPI.
Over the past week, there has been much divergence within the European bond market, as the intra-EMU spreads widened first, but tightened again towards the end of the week. The difference in performance was mainly related to the exposure to emerging Europe after a report from Moody’s highlighted the vulnerability of those economies in the current financial crisis and warned for downgrades to Western banks that have large operations over there. These warnings led to a sharp underperformance from Austrian and Greek government bonds and raised concerns about what should happen in case an EMU member state would come into trouble. In an effort to ease these concerns, German Finance Minister Steinbrueck and French Finance Minister Lagarde both hinted that the euro zone countries should help other member states that face financial troubles, despite the no bail-out clause in the EU treaty. Over the weekend, the European leaders tried to address the concerns about emerging Europe, as they agreed to support doubling the financial resources to the IMF to $500B so it could act quickly to bail out nations in need. Although this proposal must still be approved at the Group of 20 summit in London April 2, it should contribute to an easing of tensions with regard to the central and eastern European economies and as a consequence ease tensions within the euro zone too. On Friday, Greek and Austrian government bonds were the major outperformers within the European bond market, as Moody’s lead Austria analyst said that Austria’s AAA debt rating is not under pressure from its banks’ exposure to emerging Europe even under stress tests simulating shocks from the banking sector.
On the supply front, Belgium, the Netherlands and Italy will tap the market this week, while there are no redemptions scheduled. Consequently, the net cash flow will again be highly negative. Today, Belgium will tap its 2-, 3-, 5- and 10-year OLOs for an amount of €1.5-2.5B.
On the ECB front, ECB’s Trichet , Gonzalez-Paramo and Nowotny are scheduled to speak. Over the weekend, several ECB council members indicated that the ECB is likely to cut rates again at their meeting in March, but failed to give more insight in the current debate on quantitative easing.
Regarding trading, the German bond market rallied in the first part of the week, but the Bund once again failed to break above the highs at 126.53. This is somewhat disappointing given the huge losses on the equity markets and may indicate that the underlying sentiment is not that bullish. This week supply will again come to the forefront both in the euro zone and the US and this may especially weigh at the longer end of the curve. As such, we don’t front-run on a break higher in the Bund, but prefer a buy-on-dips approach towards last week’s lows at 124.37.
