Markets: Fixed Income
On Friday, global bonds showed two faces. In Germany (and still more in the UK), government bonds saw more follow through buying on both a soft ECB press conference and the announcement of the BoE that it will start implementing its quantitative easing policy (Thursday). Bunds and Gilts kept their initial gains and closed near the highs, with both the Bund and the long Gilt future setting new highs (current contract). In Germany, 2-year yields were flat while other maturities dropped between 5 and 9 basis points, the 10-year outperforming. However, at the same time, intra-EMU government yield spreads (versus Germany) widened. The Irish spread widened 12 basis points as now also Fitch put the country rating on negative watch. Austrian, Greek and Belgian spread widened by 9, 8 and 4 basis points respectively.
In the US, Treasuries had a rollercoaster ride but ended the session lower and near session lows, pushing yields up between 6 and 8 basis points in a daily perspective. Intra-day, Treasuries at first rose in sympathy with EMU and UK bonds, but the inability to gain on weak payrolls led to profit taking, also due to the positive reaction of equities. Later on, as equities slid again lower, Treasuries rebounded, but only to ran into resistance soon and fall again lower at a time when also equities were downwardly oriented. Upcoming heavy new supply this week may have convinced traders and investors to lighten their Treasury exposure. A late session rebound in equities was an additional reason to sell.
US Treasuries cannot build out recent gains
Previewing this week’s calendar, attention will go to the massive new supply and the fate of the equity markets. Especially the fortunes of the heavily battered Citigroup and GM might draw a lot of attention. The eco calendar is less enticing. There is also only one Fed speech of which we are aware, notably by chairman Bernanke who speaks on Tuesday on “reforming the US bank regulatory system”. Interesting, but probably not market moving, unless it contains news on the PPIF facility, a hot item that is now centre to any solution that would stabilize financial markets. Of course, more likely it will be the Treasury that might come with a statement. The market worries about the delay in the implementation of the high profile program. Some suggest that the delay is due to the inability to find enough private parties that want and are able to participate in the program. Should there be signs that private money wants to join the government in buying the toxic assets, it might give the hugely oversold equity market a very welcome boost. The equity market indeed will remain jittery as long as there are no signs of stabilization in the banking sector and no hope on a bottoming in the economy. It is disconcerting that the equity market has shown until now no enthusiasm for all those government plans that have been announced in recent months. It shows, we think, that the market expects no recovery whatsoever in Q3 and maybe not even before the end of the year.
Today, there are no eco releases and that essentially remains the case until Thursday when the February retail sales and the inevitable weekly claims are released. In January the retail sales unexpectedly rose by 1% M/M driven by an unexpected rise in car sales, but also electronics, food & beverage and sales at gasoline stations did well, even if often following steep falls in the previous months. Overall sales rose in January for the first time since June 2008, an unprecedented string of losses. For February, the consensus is looking for a renewed decline by 0.5% M/M and for a nearly flat reading for sales excluding cars. Given the exceptional weakness in unit car sales during February, the lowest since December 1981, it is fair to except a steep decline in car sales (in dollar terms). However, part of the weakness might be mitigated by a price induced rise in sales at gasoline stations. The initial claims will most likely hover around recent distressed levels.
On Friday, the eco calendar contains the preliminary March Michigan consumer sentiment survey, the February import prices and the January trade balance. These data won’t be of utmost importance for Treasury trading and shall be previewed later this week.
The Treasury will issue this week $63B of Treasuries. The operation contains a $34B 3-year T-Note auction on Tuesday, a $18B 10-year Note auction on Wednesday and a $11B 30-year Note auction on Thursday. The auctions settle on Monday March 16. The 3-year Note is a new issue, but the 10- and 30-year Note auctions are re-openings of respectively the 2.75% 02/19 and 3.5% 02/39 issues first issued in last month’s refunding operation. This week’s issuance of $63B of Treasury papers is only slightly less than the $66B issued during the quarterly refunding operation in February. However, the dynamics surrounding this week’s auctions are quite a lot more daunting. Indeed, the Treasury will raise $48B of fresh money versus $46B during the refunding operation. However, more important, the Treasury will pay only $1.6B in interest coupon payments versus $25B during the refunding operation. So, the Treasury will have to mobilise more investors’ money that traditionally is not invested in the Treasury sector. Recently, the Treasury succeeded in securing the financing, but only due to some price concessions. The extreme risk aversion is of course a positive for the auctions, but it is clear that supply is an issue too and in this respect it should be noted that e.g. 10-year yields are some 85 basis points above the cycle lows despite ugly eco data and crashing equities.
Regarding trading, last week, Treasury yields fell while the shape of the curve flattened. In a week-to-week perspective yields dropped between 2 and 15 basis points. However, these gains should still be qualified as disappointing, given the horrendous eco data and crashing equities. Indeed, the S&P broke through the eye-catching 741 level, suggesting that the market is seriously contemplating the economy has entered a depression. The risk for such a development has clearly risen. During the week, Treasury trading was erratic and volatile with the ebbs and flows of risk aversion at work. However, when one sees equities at multi-year cyclical lows, Treasury yields are 85 to 105 basis points above cyclical lows (10 and 30-year). The technicals haven’t improved a lot. The 5-, 10- and 30-year yields need to drop below respectively 1.62%, 2.60% and 3.40% to have enough evidence to re-qualify the outlook to bullish. The June Note future closed Friday marginally above the bull flag, but needs to recapture on a sustained basis the 122-28+ level (previous high/neckline double bottom) to justify hope that the upside is unlocked. The inability to do would put the bears again in the driver’s seat and lead to more losses, pushing yields eventually to recent highs. So, this week might be important for the longer term outlook. If equities find their composure and some technical elements (doji, 2e target double top neckline at 665 is reached & so is the Irreg.B at 663 ) do suggest that the market might be exhausted and ripe for some rebound, maybe as a result of some communication on the PPIF, and also the auctions wouldn’t go well, selling may re-appear. We still think of the Treasury market as a buy-on-dips one. Should yields re-approach 2.16%, 3.06% and 3.76% for the 5-, 10- and 30-year, we would contemplate setting up long positions, but at current levels, we are at most neutral.
Bund continues to benefit from the BoE’s quantitative easing policy and tests the highs
Today, the calendar is empty and will remain rather thin this week. Nevertheless, on Friday, we will look out for the euro zone retail sales. In the fourth quarter of 2008, household consumption dropped by 0.9% Q/Q, while only a modest decline was expected (-0.2% Q/Q). In the first part of 2009, household consumption is expected to remain weak. For January however, the consensus is looking for a rise by 0.2% M/M, but the risks might be on the downside of expectations after the weaker than expected German retail sales.
On the supply front, Austria and the Netherlands (Tuesday), Germany (Wednesday), Italy (Friday) will tap the market this week. Supply will centre on the short end of the curve, as Germany will issue a new 2-year Schatz (8B), while the Netherlands will tap its 3-year benchmark (2-3B) and Austria its 5-year benchmark (1.65B). Only Italy will tap the 30-year sector, besides a tap of a 4-year BTP. The amounts for the Italian taps will be specified on Tuesday. On Friday, the intra-EMU spreads widened again sharply with Ireland, Greece and Austria hit the hardest. Ireland was put on negative watch by Fitch, while Greece announced it will tap its 3-, 5- and 10-year benchmarks via syndication in the course of this year. Austria on the other hand continues to suffer from its banks’ exposure to Central and Eastern Europe. On Friday, the Austrian ECB governor Nowotny again tried to ease investors’ concerns saying that ‘there is no risk that cannot be handled with the measures already implemented’ and pointed out that Austria’s debt equals about 60% of GDP and is about the European average, Italy’s for instance is about 100% and Germany at about 65% of GDP. On the CDS market, the CDS of Austria is currently the second highest, below Ireland, but higher than Italy.
On the ECB front, the central bankers will meet today in Basel for the bimonthly meeting of the BIS, while ECB’s Stark will speak in Luxembourg. On Friday, ECB’s Bini Smaghi warned on cutting interest rates close to zero, unless the economy is really on the verge of persistent deflation. ‘Cutting rates to a very low level, even to zero, just to insure against the worst case scenario can have deleterious effects in both the short and long term’. Bini Smaghi warned that this could lead to a next bubble and unleash a new crisis, as well as driving financial intermediaries, like money market funds, out of business and trigger a disorderly unwinding of investment in certain securities. Bini Smaghi also questioned whether low policy rates would be effective if the economy may be facing a lending crisis, as low rates could discourage investors to hold risky long-term assets to finance the banking system and the real economy. In such circumstances, Bini Smaghi warned that a policy of extremely might be counterproductive. Over the weekend, these comments were echoed by ECB’s Stark who warned that rate cuts won’t solve the crisis and could actually be self-defeating. Although, there may be good reasons why the ECB should be cautious in cutting interest rates much further, Thursday’s comments of ECB’s president Trichet have indicated that 1.5% won’t be the bottom of the cycle. For now, we hold on to our target of 1% for ECB rates this year.
Regarding trading, the decision of the Bank of England to start its quantitative easing policy continued to support the German bond market too. Although the ECB isn’t likely to follow soon, the decision of the Bank of England to buy government bonds has indeed eased investor’s concerns about supply, which has been the major factor why bonds couldn’t gain further ground despite the worsening economic outlook and the sell-off in the equity markets. On Friday, the Bund even tested the contract high at 125.30, but failed to break above in a sustainable manner. As such, we hold on to our long-standing strategy not to front-run on a break higher, but to buy on dips. Therefore, we look to the recent lows at around 122.97.
In the UK, the bull flattening of the yield curve continued, as 10- and 30-year yields dropped again 30 basis points lower. This morning, BoE’s sounded confident that the quantitative easing policy will help to end the economic decline ‘sooner rather than later’.
