Markets: Fixed Income
On Tuesday, global bonds couldn’t hold on to their early gains and closed the session somewhat lower in the US or with only limited gains in the euro zone, as the US equity markets staged a powerful rebound from the recent lows. Hence, bonds couldn’t benefit from the very weak eco data, which showed business confidence plunging to new lows in Germany and Belgium. US house prices fell at a record pace in December and US consumer confidence tumbled to a historic low. A strong US 2-year Note auction also failed to prop up the US bond market.
Although the testimony of Fed President Bernanke contained little new info, US equities rebounded strongly in the aftermath led by a 12% surge in financials. As such, the S&P 500 trades still above the key support levels at around the November lows.
In the US, yields were up by around 4-7 basis points in the 2 to 10-year sector, the 30-year sector outperforming with 30-year yields down by 1.4 basis points. In the euro zone, yields were down but this was mainly due to the early official closing, as German bonds tracked US Treasuries lower later in the session in the wake of the rebound on the US equity markets. The intra-EMU spreads widened slightly.
US Treasuries cannot gain on weak eco data, as equities rebound
Today, the calendar contains the existing home sales (January) and weekly mortgage applications. Existing home sales are expected to show a modest increase in sales (1.3% M/M to 4.80M) after having risen significantly in December. Existing home sales are supported by the sale of foreclosed homes (about 50% of all sales recently). Nevertheless, a rise in existing home sales would raise expectations that signs of stabilization are appearing. 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, but we believe it will probably take a few months before the effects of the Obama housing plan becomes visible. The S&P house price index though suggest little improvement as the fall in house prices still accelerated in Q4 of 2009. Besides the eco data, Fed chairman Bernanke will testify before the House Financial Services panel on the economy and monetary policy. It is in fact a repetition of the testimony he held yesterday in the Senate. His text will be similar, but in the Q&A there might be some interesting news.
The 2-year Note auction went well. It stopped at 0.961% firmly below the WI bid of 0.98% at the stop. The bid cover at 2.63 was solid and compares to an average of 2.3. The direct bid and that of Indirect bidders and dealers were all strong, while the Indirect takedown was light at 28.1% (average 34.9%).
The Treasury will auction a record $32B 5-year Note, up $2B from last month. The auction will raise all fresh cash upon settlement, but a $3.7B interest coupon payment associated with the 5-year sector will take place. Last month the 5-year Note auction didn’t go particularly well, even if it came after a successful 2-year Note auction. The bid was not so bad, but given the size of the issue, the bid/cover was disappointing and the auction stopped above the WI bid at the moment of the stop. The 5-year trades currently at 1.88% versus 1.65% at the previous auction. Concluding, while the 2-year auction went well, this is no guarantee that the same will occur with the 5-year Note auction. Yields are a bit higher, which is a positive, but the size and maybe some return of risk appetite are negatives.
Bernanke’s written statement at his semi-annual testimony contained little to no new info. Much of what was said was identical to what was unveiled in the January FOMC Minutes and a recent speech of Bernanke on the Fed’s QE policy. The forecasts of the FOMC (tendencies) were put forward and Bernanke explained the meaning of the LT tendencies for growth and inflation that should be considered as a strong implicit inflation target and the potential growth. With this inflation “target” the Fed wants to quell deflation fears. The chairman also spoke in length about the role of the Fed’s balance sheet in its policy to address financial market stress and help the economy. Interestingly, Bernanke didn’t say anything about the purchase of longer dated Treasuries. It is a tool at the disposal of the Fed, but the Fed doesn’t seem ready to use it. It concentrates on helping specific private credit markets and wants first to evaluate the results of that policy, including the effects of the TALF that will only be operational in the next weeks. This suggests that no near term decision to purchase Treasuries should be expected.
Bernanke’s comments on banks, stress tests and capital injections/nationalization got quite some attention and has been the trigger for a short covering in financial stocks that closed up 11%. Bernanke doesn’t believe any major banks are on the verge of failure, but he left open the possibility some may fall into government hands. “We don’t need majority ownership to work with the banks”, he said, “the goal is to restructure firms, remove toxic assets and return the institutions to profitability, eventually drawing private capital back in.” However, while we don’t doubt Bernanke’s hope that no nationalization is needed, it isn’t clear whether the risk is now off the table. Nationalization is a vague concept. Government may have an increasing stake in some banks without a formal full nationalisation. Bernanke himself painted the path that may happen after the stress tests. “The outcome of the stress test is how much capital is needed in order to meet the credit needs of borrowers. The government would then step in and fill the capital hole. “The federal funds, in the form of convertible preferred shares would initially serve as a buffer against losses rather than outright ownership.” “When losses actually occur, the bank could convert the preferred shares to common stock to ensure it has enough common stock.” “Only at that time, going forward, if those losses do occur, would the ownership implications become relevant” he added. To us, this might mean that it will ultimately be the losses (and the way the economy develops) that will decide whether banks will be nationalized. So, maybe a short term relief for markets, but no strong commitment of Bernanke to resist that nationalization, in the sense that the government becomes a large shareholder takes place.
Regarding trading, Treasuries gained at first modestly on another really dismal batch of eco data: House price declines acceleration, consumer confidence collapsing and Richmond manufacturing survey confirming that there is as of yet no improvement in the dire strait of firms. Treasuries sold off sharply when equities rebounded later in the session on Bernanke’s banking comments with a good 2-year Note auction offering no support whatsoever. This left US Treasury yields moderately higher for the day. Today, the Existing Homes sales, Bernanke testimony and the 5- year Note future are the defining factors to look out for. We have no firm view on the Existing Home result, but recently it something surprised on the upside, which was certainly not the case for other housing indicators. The reason is the high number of foreclosed houses, not a positive feature. Bernanke probably won’t bring new info following yesterday’s testimony, while the 5-year Note auction is a hurdle for Treasuries. The main factor will be equities that rebounded nicely yesterday at crucial, obvious levels (S&P low at 741). The trigger, notably relief that there would be no immediate nationalization, makes us a bit nervous as it is far from certain that it will be honoured in a somewhat longer term perspective. The market, when testing these levels was always open to some rebound and the Bernanke comments might have been just a convenient trigger. Asian equity markets seem to be far from convinced that there is scope for more buying through action in the next days.
So, we confirm our neutral view on Treasuries and see risks more for a downmove than for an up-move on the idea that equities might after all try to move higher.
Weber sees lower limit ECB rate at 1%
Today, the euro zone calendar is empty, but on the supply front Italy will tap the market and ECB’s Ordonez and Weber are scheduled to speak.
On the supply front, the Netherlands yesterday sold only €1.005B of its three off-the-run bonds. Although this was only in the midst of the pre-announced range between €0-2B, Dutch government bonds outperformed in the wake of the auction results. Yesterday, Portugal also issued a new 10-year benchmark via syndication for a substantial amount of €4B. The issue was priced at 135 basis points over mid-swaps, which is a substantial premium above the previous benchmark which traded yesterday at 115 basis points. As a result, Portuguese government bonds underperformed their peers. Ahead of tomorrow’s BTP auctions, Italy will today tap two inflation-linked BTPeis in the 10- and 14-year sector for an amount of respectively €1B and €0.75B. Italian government bonds underperformed yesterday ahead of the auctions. Yesterday, Irish bonds underperformed too, after it announced plans to sell 3-year bonds in the near future.
On the ECB front, ECB’s Ordonez and Weber will speak. Yesterday, the governor of the Greek central bank Provopoulos provided some insight in the current debate in the governing council on quantitative easing. He indicated that the council hasn’t discussed to buy government bonds on the secondary market, but pointed out that the ECB is exploring the pros and cons of buying corporate debt. He added that the current considerations were still at a very early stage and said that ECB is unlikely to announce more details at the March meeting. Regarding the intra-EMU spreads, Provopoulos said that ‘we are currently living in an environment of excessive risk aversion’ and expected a decline in the risk premia once things return to normal. In an interview with Die Welt, ECB’s Weber argued that ECB rates could fall as low as 1%. ‘There is still some room to manoeuvre that we can use until we get to 1%’, Weber said.
Regarding the potential bail out of a euro zone member state, ECB’s Weber yesterday said that he didn’t oppose such a move, but added that any aid must have strict rules. ‘If, in an escalation of the situation, targeted aid for individual member states were unavoidable in light of an extraordinary emergency situation, then this would have to be tied to strict demands and conditions’. Yesterday’s rating actions from S&P and Moody’s with regard to the Baltic States and Ukraine highlighted again the downside risks in the region and the risks countries face with a large exposure in eastern and central Europe. The sharp widening of the Austrian CDS since last week’s Moody’s report on the region reflects these concerns. Yesterday, the CDS on Austria is now the second highest of all euro zone member states, slightly higher than Greece, but still below Ireland. However, the CDS of Germany continues to rise too and has doubled since the start of the year. Yesterday, two German federal states, Schleswig-Holstein and Hamburg, agreed to inject €3B of capital and provide guarantees of €10B to HSH Nordbank. This raises some questions whether German bonds should continue to outperform other government bonds and could limit the downside in yields.
Regarding trading, German bonds couldn’t hold on to the early gains, despite the very weak eco data, as US equities rebounded late in the session. This again indicates that the highs in the Bund remain difficult to break above. As such, we don’t front-run on a break higher in the Bund and continue to prefer a buy-on-dips approach towards last week’s lows at 124.37. A break lower in the US equity markets would nevertheless still be a major positive for the bond markets.
In the UK, the calendar contains the preliminary figure of fourth quarter GDP. The consensus expects to see a slight downward revision from -1.5% Q/Q to -1.6% Q/Q, which will be the sharpest quarter-on-quarter contraction since 1980. Today, BoE’s Blanchflower will speak on the UK labour market. Yesterday, BoE’s Sentance gave on overview on the previous recessions and concluded that the current conditions are not that different, although the risks remain on the downside.
