Markets: Fixed Income
On Wednesday, global bonds again couldn’t really benefit from the weak eco data and the losses on the equity markets. In Japan, exports suffered the steepest year-on-year decline on record, while US existing home sales fell to a record low. In the US, Treasuries ended the session with substantial losses, while European bonds again held up better.
Intra-day, European bonds opened lower following the rally on the US equity markets overnight, but recouped the losses throughout the morning session and build out the gains as US equities opened lower and the US existing home sales disappointed. US Treasuries however turned south after the Existing Home sales couldn’t push Treasuries higher and a rebound in equities caused more damage. A strong 5-year Note auction and the late decline in the US equity market couldn’t offer support, leaving Treasuries at the lows of the session in the close. As such, US Treasuries underperformed European bonds, which closed the session unchanged to slightly higher.
In a daily perspective, there was a steepening of the US yield curve with 2-year yields up 10 basis points, 5-year yields up 11.5 basis points and 10-year yields up 13.1 basis points. German yields closed slightly lower, but this is mainly due to early official closing, as bonds lost most of their gains after the closing. The intra-EMU spreads were mixed, as the Italian spread widened ahead of today’s auction, while the Portuguese spread reversed its recent widening following the issuance of a new 10-year benchmark.
US Treasuries hit the skids
The calendar is well-filled today with the weekly claims, January durable goods orders and new home sales. In the week ended January 21, initial claims are expected to have stayed broadly unchanged (625 000 from 627 000), for the third month in a row. Nevertheless, the figures might be distorted as the week under review included the President’s Day Holiday. Continuing claims, which are reported with a one-week lag, are expected to have risen above 5 million. The consensus is looking for an outcome of 5 024 000 (from 4 987 000). Please note that the claims have been very weak recently and were a good pointer for the monthly payrolls, that were disastrously weak. The durable goods orders are forecasted to show the fourth consecutive decline in January. On a monthly basis, durables are expected to have dropped by 2.5% M/M after falling by 3.0% M/M. We have no clear view on the risks, but aircraft and motor vehicle orders are forecasted to remain weak. In December, new home sales plunged by 14.7% M/M to a record low level of 331 000, while the consensus was looking for an outcome of 397 000. In January, new home sales are forecasted to set a new record low at 324 000, but the risks might be on the downside of expectations after also the existing home sales, released yesterday, set a new record low and the overhang of foreclosed homes on the market weighs on housing prices and thus make the purchase of a New Home relatively less attractive.
The 5-year Note auction went quite well. The auction stopped at 1.985%, below the WI bid generating a solid bid/cover of 2.21 (average 2.13-. and Indirect bidders participated in an aggressive way and took down 48.9% of the auction, well above the average of 32.7% and the highest since September 2006. Following a strong 2-year Note, also the 5-year went very well, contrary to next month when the 5-year Note auction was sloppily bid. This is encouraging for the Treasury (and market) that until now the huge financing needs have been well covered. Despite the encouraging results, it couldn’t give the overall market much support as the sell-off triggered by rebounding equities continued. However, today, the Treasury will conclude its monthly auction with a $22B 7-year Note auction. It will raise all new cash upon settlement next Monday, as it is the first 7-year Note auction since April 1993, when the cycle of 7-year Note auctions was discontinued. So there is little to no valuable historic information available. We have the feeling that the 7-year Note will encounter more difficulties than the 2- and 5-year. Indeed, supply is traditionally more an issue further out the curve and it is a novelty for which there is maybe less of an investor base.
Regarding trading, Treasuries traded sideways, but the inability to generate a positive momentum after much weaker-than-expected Existing Home Sales triggered a selling wave. An intra-day turn higher of equities gave the down-move more momentum, while a strong 5-year Note auction was unable to stop the rot. Attention turned to today’s 7-year Note auction and the supply consequences of Obama’s fiscal and banking plans. Interestingly, the US CDS hit 100 basis points for the first time ever and has continuously increased from less than 20 basis points in September, showing some upped concerns about its solvability.
While the fundamentals aren’t negative for Treasuries, with the exception of supply, the technical pictures are a source of concern. The 5-year yield (see graph) is building a higher high, high low pattern with the yield now testing the previous high at 2.01%. The graph also shows a double bottom with neckline at 1.80% (targets 2.22% and 2.42%) and a bear flag with top at 2.08% today. A distinct break above 2.08% would be a negative development, but we count the bear flag to hold. A similar picture is developing in the 10-year maturity (cf. graph). A move above 3.05% (previous high) would confirm the picture of higher highs, higher lows. A double bottom with neckline at 2.60% and targets at 3.06% and 3.17% is eye-catching. While there are some risks from the technical point of view, one might consider establishing some longs in the neighbourhood of 2.08% for the 5-year yield and 3.06/17% for the 10-year yield. Some stop loss protection is warranted though.
Today’s eco data should again be intrinsically Treasury-friendly, but were recently not really a strong support for Treasuries. It will again be supply (7-year Note auction and Obama’s budget proposal) and equities that will be decisive for Treasuries in the framework of the technical picture as it painted (see higher). Regarding equities, the rebound on Tuesday when the S&P tested the key 741 level was qualified by us as a potential dead cat bounce. It looked yesterday that this might indeed have been such a bounce, but as the losses were ultimately limited, we take on a neutral view and wait for more price action to get a take on the next big move.
Italian government bonds underperform ahead of today’s auction
Today, the euro zone calendar is interesting with the M3 money and credit growth data (January), the European Commission confidence indicators (February) and the first German inflation for February as well as the German unemployment data.
In December, M3 money growth slowed more than expected and both lending growth to the private sector and households slowed significantly. In January, M3 money growth is expected to come out at 6.9% Y/Y (from 7.3 Y/Y). Lending to households and companies are forecasted to have declined further due to the economic crisis and tight lending conditions. In a speech earlier this week before the EU parliament, ECB president Trichet warned for the first time for a credit crunch, as he saw signs of falling credit flows. In December, outstanding loans to non-financial corporations contracted for the first time, while lending to households has slowed sharply. In January, European Commission economic confidence showed a more moderate drop than was expected. For February, the consensus is looking for a slight improvement (from 67.1 to 68.5), but the risks are on the downside of expectations after the weaker than expected PMI figures. Overall, the confidence indicators tend to lag the PMI indicators and therefore are considered less important. In Germany, the first inflation data for February are expected to point to a further drop in the annual inflation rate to 0.7% from 0.9% in January. Unemployment in Germany is forecasted to show its fourth consecutive rise. In February, unemployment is forecasted to have risen by 60 000 and the unemployment rate is expected to come out at 7.9% (from 7.8%).
On the supply front, Italy will tap two BTPs in the 3- and 7-year sector, as well as a 4- and 6-year CCT. Ahead of the auction, Italian government bonds underperformed their peers. Yesterday, the Irish spread over Germany widened again following the issuance of a new 3-year benchmark (€4B) at a huge premium of 170 basis points over mid-swap. This compares to a spread of 246 basis points over Germany. As such, the yield differential between Irish and Greek bonds, which yield the highest in the euro zone, has narrowed to 10-15 basis points. In the CDS market, the CDS of Ireland is already the highest, despite its AAA rating (negative outlook). This is mainly due to rising concerns about the state of Ireland’s banking sector and the impact this may have on Ireland’s public finances. Since the beginning of the financial crisis, Ireland has already injected €12.5B capital in its banks and guaranteed 400B in bank lending, which compares to an exposure of 216% of its GDP. This compares to only 12.3% of its GDP in Greece. Yesterday, Moody’s nevertheless lowered the outlook on Greece from positive to stable. Greece currently has the lowest credit rating in the euro zone at A1. Spain yesterday announced that it plans to sell a 3-year bond in USD. Last year, Spain has already issued two dollar-denominated bonds in the 2- and 5-year sector, each for an amount of $2B.
On the ECB front, ECB’s Trichet, Nowotny and Gonzalez-Paramo are scheduled to speak. Trichet will speak on competitiveness in Ireland, while Gonzalez-Paramo will comment on regulation following yesterday’s de Larosiere report. Yesterday, ECB’s Ordonez from Spain indicated that the ECB is likely to cut rates by 50 basis points at their next meeting in March, but added that he thinks rates shouldn’t go to zero. ‘I am among those who think that perhaps we shouldn’t go to zero as there could be stability problems for some financial entities, like investment funds or others. Earlier this week, ECB’s Weber hinted at a lower limit of 1% for ECB rates. Ordonez also added that the ECB is ‘obliged’ to study non-conventional measures but declined to give details. On Tuesday, ECB’s Provopolous indicated that the ECB is looking towards the corporate bond market and has no plans to buy longer-term government bonds.
Regarding trading, German bonds again couldn’t really benefit from the weak eco data and the losses on the equity markets. The short end outperformed on the back of the comments of ECB’s Weber, but the Bund still trades below the contract high at 126.53 despite the recent sharp losses on the equity markets. We consider this as a rather disappointing performance of the Bund, which supports our buyon- dips approach towards last week lows at 124.37 and not to front-run on a break higher.
In the UK, the yield curve steepened, as longer-term yields increased compared to a slight decline at the short end. Today, the Chancellor Darling is expected to detail its bank loan guarantee program, which may guarantee up to £300B assets of RBS and 250B of Lloyds. This morning, the Nationwide house price index showed house prices falling for the sixteenth consecutive month in February. The decline was slightly higher than expected, as prices fell 1.8% M/M and 17.6% Y/Y.
On the supply front, the DMO will issue a new 13-year Gilt for an amount of GBP2.75B. It will be interesting to see how strong demand for Gilts is given the increasing risk on a downgrade of the UK’s AAA status. On the CDS market, the UK ranks just below Italy, but above Spain, Belgium and Portugal.
Yesterday evening, BoE’s Blanchflower, the ultra-dove, painted a gloomy picture of the UK economy, as he said that the UK recession may intensify ‘significantly’. As such, he defended his vote for a rate cut to 0.5% and called current monetary policy ‘overly restrictive’. Within the MPC a debate is going on how low interest rates should fall and how a quantitative easing policy should work. Blanchflowers’ comments were more pessimistic compared to Sentance. Today, BoE’s Governor King will testify on the banking crisis.
