next report will resume on march 04
Markets: Fixed Income
On Thursday, global bonds traded (sharply) lower, as supply concerns remained on the forefront and offset the ongoing flow of very weak eco data (see news) and struggling equities. These supply concerns were heightened by the sweeping measures taken in the UK to support the banking sector, where the Treasury will inject another £13B in RBS and guarantee £325B of its assets, and the record high deficit of $1750B that results from Obama’s first budget proposal.
Intra-day, the rebound in the European equity markets during the morning session and a disappointing auction result in the UK added to the nervousness of the bond investors. In the US, equities however couldn’t hold on to their early gains and along with the passing of the 7-year Note auction, this offered some relief to the bond markets later in the session.
In the US, there was again a bear steepening of the yield curve with 2-year yields almost unchanged, but 5- and 10-year yields up respectively 8.6 and 6.4 basis points (benchmark change in 5-year). In the euro zone, German bonds underperformed the peripheral markets, as German yields moved sharply higher. 2-year yields were up 9 basis points, compared to 14.6 basis points in the 5-year sector and 13.6 basis points in the 10-year sector.
US Treasuries lose some more ground, but end the session well off intra-day lows
The calendar contains the preliminary Q4 GDP, the February Chicago PMI and the February Michigan consumer sentiment (final) survey. Fed speakers include the regional governors Yellen, Bullard, Plosser and Rosengren. The first two speak about oil price shocks, the latter two on monetary policy.
Q4 GDP will be substantially revised lower from the advance -3.8% reading. Consensus is looking for a 5.4% decline. We have no reasons to distance ourselves from consensus. The downward revision should be driven by negative revision to inventory investment and a wider net export. Changes to other categories should be modest. The Chicago PMI is expected to have stabilized at 33 in February (33.3 in January). It is tempting to put the risks on the downside of expectations, given the deterioration witnessed in a number of other regional manufacturing surveys. However, the index is already at rock bottom low levels with only some lower levels in the depth of the 1980 recession visible on the charts. The Michigan consumer sentiment index dropped in February to 56.2 (from 61.2 in January) according to the preliminary report, only marginally above the cycle low of 55.3 in November 2008. The market expects stabilization (56). The conference Board measure of confidence fell much sharper in February suggesting that the Michigan measure might be revised lower, but the Conference Board measure is closer linked to labour market conditions, while the weekly ABC Consumer Comfort index edged up to -48 from -53 in early February. Therefore, the risks may even be for some modest upward revision of the preliminary figure.
Regarding the Fed presidents, Yellen (FOMC voter) is the governor of the Reserve Bank of California, one of the hardest hit by the housing crash and the recession. She is considered as a moderate dove who currently is more concerned by the downside risks to growth instead of risks to inflation. St-Louis Fed president Bullard endorses the QE policy (like Yellen) and speaks much about financial market stability. Chicago Fed Rosengren dissented in the December 2007 FOMC meeting in favour of an accommodative policy and his position was vindicated afterwards. He should be considered as a dove. Philadelphia Fed Plosser on the other hand should be considered as a hawk. He dissented in H2 2008 twice in favour of a less easy policy than was decided.
The $22B 7-year Note auction didn’t go as smooth, as the 2- and 5-year auctions earlier this week. Indeed, the auction stopped at 2.748%, well above the 2.732% bid in the WI trading at the time of the stop. The bid/cover amounted to 2.11 while the indirect bidders took down 38.7% of the auction. As it was the first 7-year Note auction since April 1993, there is no relevant history to compare the results with. The stop above the WI bid is, of course, a disappointment.
Regarding trading, Treasuries closed the session yesterday with some modest extra losses, but well off intra-day lows. Another batch of really ugly eco data couldn’t bring much support, as investors were spooked by supply concerns. Claims surged to new cycle highs, durable orders plunged while the New Home sales could not find a bottom. Supply concerns were stimulated by the 7-year Note auction and the Obama budget proposal that would result in a huge $1.75T deficit. Today, the eco data will be bad, but maybe not worse than expected. The Central Bankers are interesting to listen to, but we don’t expect much new market moving info as chairman Bernanke testified earlier this week. There might be some end-of-month extension buying supporting longer-dated bonds, while equities are still in a state of heightened alert and little needs to happen to push it below eye-catching obvious key support (741 for S&P). A break would entice safe haven buying. The technical pictures are interesting too.
The 5-year yield is building a higher high, high low pattern with the yield now testing the bear flag top at 2.09% today. The graph also shows a double bottom with neckline at 1.80% (targets 2.22% and 2.42%). So while the picture is rather bearish, very short term traders might buy into the 5-year at current levels. A distinct break above 2.09% would however be a negative development, but we count short term the bear flag to hold for now. 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 3.06/17% for the 10-year yield. Some stop loss protection is warranted though.
European bonds caught between supply concerns and weak eco data
Today, the euro zone calendar contains the final inflation data for the month of January as well as the unemployment rate. The inflation rate is expected to confirm the flash CPI at 1.1% Y/Y while the core inflation rate is seen unchanged at 1.8% Y/Y. Inflation is currently not a major item for the markets, as the sharp recession will drive inflation lower in the coming months. The first inflation data from Germany for February nevertheless disappointed slightly pointing to a 0.6% M/M increase compared to an expected 0.3% M/M. This however comes on the heels of several months of downward surprises in inflation. In Belgium, the annual inflation rate nevertheless continued its downward trend from 2.3% in January to 1.9% this month. A first estimate of the euro zone inflation rate in February will be published on Monday. Regarding the labour market, the euro zone unemployment rate is expected to continue its uptrend from 8.0% in December to 8.1% in January. The labour market is a typical lagging indicator in the business cycle and as such markets shouldn’t pay too much attention to this kind of data.
On the supply front, Italy yesterday sold €8.5B of its conventional BTPs. Although the bid/cover was rather low, the bonds outperformed in the aftermath of the auction. Italian government bonds had however cheapened quite substantially in the run-up to the auction. Overall, the intra-EMU sovereign spreads narrowed yesterday. To facilitate the sale of the ever rising amount of government bond issues, German Chancellor Merkel yesterday proposed to coordinate global bond issuance. The issue had been discussed on the meeting of European leaders in Berlin last Sunday and is likely to be put on the table of the G20 meeting in London within a few weeks. The measures should help to ease investors’ concerns about supply.
On the ECB front, a lot of ECB council members are scheduled to speak today. Markets will focus on comments related to the floor for ECB interest rates and which quantitative measures the ECB may is thinking about. During the week, ECB’s Weber has hinted towards a 1% limit, which was echoed later on by ECB’s Nowotny. Weber and Nowotny will speak today too. Nowotny, the Austrian central bank governor, will speak on the impact of the financial crisis on central and Eastern Europe. Since the critical report of Moody’s last week, the exposure of euro zone countries and their banking sector to this region has come under increasing scrutiny and has resulted in sharp widening of the CDS of Austria as well as an underperfomance of the Austrian government bonds. In an interview, Nowotny suggested that the ECB could support some individual countries through repurchase agreements with the ECB. Yesterday, ECB president Trichet urged the euro zone governments to restore their competitiveness, especially for those countries that have witnessed a long period of strong domestic demand based on overly optimistic income and profit prospects, like Ireland. Such a situation can stoke inflation and bring cumulated losses in competitiveness, lower export performance and a high current account deficit, which in a monetary union must be corrected through lower unit labour cost increases relative to the average of the union. Within the EMU, Greece, Spain and Portugal do have largest current account deficits of around 10% of GDP, while the Netherlands, Germany and Finland do have the largest surpluses.
Regarding trading, German bonds sold off yesterday on supply concerns and the rebound in the (European) equity markets. The short end again outperformed, but was nevertheless also hit quite sharply. At the longer end of the curve, the Bund tested last week’s low and neckline of a potential double top formation at 124.37, but failed to break below. This may signal that we now have entered a sideways range between last week’s low and the recent highs at 126.01/05, as investors are caught between concerns about supply and the ongoing weakening of the economic outlook.
In the UK, Gilts were sold off yesterday following a weak Gilt auction and the government’s agreement to guarantee £325B of assets from RBS. At the same, the UK government also subscribed to £13B of new preference shares in the bank. Today, Lloyds banking group will decide whether it will also participate in the asset guarantee scheme. The enormous amounts injected in the banks and the huge liabilities born by the government raise concerns about the solvability of the UK (the CDS however surprisingly declined) and how markets will digest the ever growing amount of supply. Although the Bank of England is likely to buy outright Gilts when it starts its quantitative easing policy, there is no idea yet about the amount of money concerned. Yesterday, the new 13-year Gilt auction failed to impress investors with a very low bid/cover of 1.36 and a large tail of 2 basis points. Accordingly, the longer end underperformed leaving the curve steeper.
