Markets: Fixed Income
On Tuesday, global bonds hit the skid, as equities staged a mighty rebound on Citigroup announcing strong results for the first two months of the year. The equity market was ready for a rebound as the latest down-leg had reached important targets and was exhausted. The Citi announcement was the welcome trigger on which traders eagerly waited. The big question is now whether there is much follow through buying or better whether the eventual profit taking remains modest and a significant higher low can be put in place. One shouldn’t dismiss the possibility that yesterday’s price action has been simply a dead cat bounce, but overall we would think that the sell-off that started on February 9 and lasted for one month is over. The first hurdles on the upside for the S&P are now 741, the previous eye-catching low and 804 (neckline double top). Only a break of these resistances would improve the picture from a medium term perspective.
The eco data were second tier and couldn’t impact the overall bond market that traded on equities. The US 3-year Note auction and the Dutch 3-year bond auction went well, while the UK 3-year Note was mixed. None of these affected the market though. The Austrian 5-year auction (Oct 14) on the contrary failed, underlining once more the lack of confidence in Austrian bonds and sending the spread with German bonds 9 basis points up (in 5-year segment). Other EMU government bonds outperformed Germany on an improvement of general risk appetite.
In a daily perspective the US curve steepened with yields up between 7 and 15 basis points, while in EMU the belly underperformed the wings, as 2- and 30-year yields rose by 4-to-5 basis points and 5- and 10-year yields added 9 and 6 basis points.
US Treasuries slid lower as risk appetite returns
Today, the eco calendar is almost empty, as it contains the weekly mortgage applications and the February budget statement, none of which is a market mover. The BLS will also release the state employment data for January. While these usually don’t get attention, in the current phase of the cycle, they may include some interesting features, even if no market impact should be expected. The ABC Consumer Confidence index was reported overnight at -48, up 1 point from last week’s -49. Treasury’s Kashkari testifies in the House on TARP.
The $18B 10-year Note auction (re-opening of the 2.5% 02/19) will get more attention. The record-size $34B 3-year Note auction, a new issue with a 1.375% coupon) went pretty well yesterday, given the unfavourable cash flows surrounding the auction (all new cash). Indeed, the auction stopped at 1.489%, below the 1.495% bid in the WI at the moment of the stop. The bid/cover of 2.26 wasn’t bad, even as it was below the 2.41 historical average, but the latter dated partially from before the reintroduction of the 3-year auctions and thus difficult to compare). Indirect Bidding (23.1% of total bid) was solidly above average as was the Indirect takedown (of 40.3%). So also from the side of the participation of the buy-side, the auction should be qualified as a success. The 10-year re-opening is the first of two re-openings of the 2.75% February 2019 that was first issued during February’s quarterly refunding operation. Re-openings in general draw less demand than the original issuance, also because of the absence of maturing issues. The re-openings raise all new cash and are mostly dealer dominated. Historically, the bid/cover for re-openings is about 2.4 and the stop is well above the WI bid at the stop. Indirect bidding is low (less than 10%) as is indirect takedown (about 16%). So, expectations for today’s re-openings are low and the actual results should be compared to these statistics.
Fed Chairman Bernanke urged a sweeping overhaul of the US financial regulations to smooth out the boom-and-bust cycles in financial markets. He defined four key elements of a strategy that should regulate the financial system as a whole, making crisis less frequent and hopefully also less severe. Firstly, authorities should tackle the problem of too big to fail institutions and its undesirable consequences of reduced market discipline and excessive risk-taking. Bernanke thinks about better supervision of these critical firms and a strengthening the resilience of the system to minimize the consequences when such a firm must be unwound. Secondly, the financial infrastructure needs to be improved, amongst other institutions that support trading, payments, clearing and settlement. The CDS, OTC and triparty repo markets were mentioned explicitly as asking for stricter regulation and oversight, while he also asked attention for the fragility of the huge money market mutual funds that caused quite some upheaval after one fund “broke the buck”. Thirdly, Bernanke pleaded to address the excessively pro-cyclical elements in the regulatory system. Capital standards, accounting rules and other regulations often make the cycle excessively pro-cyclical. Finally, he saw a further enhancement of the financial stability via a systemic macroprudential risk authority. In the Q&A, Bernanke said he didn’t support any suspension of the mark-to-market accounting rule, but supported improvements to the rule. He also pleaded for more efforts to provide guidance on the valuation of illiquid assets. On the mark-to-market rule, Reuters reported that according to sources the SEC is not planning to suspend the controversial accounting rule.
Regarding trading, Treasuries traded essentially on equities or otherwise said on a return of risk appetite following positive news from Citigroup. The losses were substantial, but might have been larger given the equity gains. It pushed yields again closer to the recent highs. Equities and supply will again be the drivers today. There might be some profit taking in equities, but if it remains modest, the stage might have been set for a period of less negative/to mildly positive price action in equities. However, the inability of the euro and commodities to gain and the relatively modest losses in Treasuries suggest the equity rebound might not be solidity grounded. For more details on the technical picture of the S&P, see higher. Despite these negatives, we still contemplate re-entering the Treasury market from the long side from a tactical point of view. The 10-year yield has key resistance at 3.05/07/17% (recent high, targets double bottom), the 5-year yield faces resistance at 2.11/15% (previous high/flag top) and the 30-year yield has key resistance at 3.76/86% (recent high/ previous neckline triple top). The above mentioned levels might be used to open long positions. A break through these levels would be a major development and need a reassessment of the situation.
From a longer term perspective, the 5-, 10- and 30-year yields need to drop below respectively 1.62%, 2.60% and 3.40% to have enough evidence to requalify the outlook to outright bullish.
Austrian spread widens sharply on disappointing auction
Today, the euro zone calendar remains thin as it only contains the German factory orders (January). In 2008, German factory orders were extremely weak as they dropped in eleven out of twelve months. In the previous four months, German factory orders dropped at a fast pace, but for January, the consensus is looking for a more moderate drop (by 2.0% M/M) after falling by 6.9% M/M in December.
On the supply front, Germany will issue a new 2-year Schatz 1.25% Mar 2011 for an amount of €8B. At the inaugural auction of the current 2-year Schatz, the bids barely covered the amount on offer. However, until now, disappointing German auctions hadn’t much impact on trading afterwards and couldn’t prevent the intra-EMU spreads from widening ever further. Yesterday, the Netherlands sold €2.7B at the reopening of their 3-year DSL 2.5% Jan 2012, which was in the middle of the preannounced range between 2-3B. Austria however failed to sell €1.65B of its 5-year RAGB 3.4% Oct 2014 and had to retain 0.15B. Austrian bonds underperformed in the wake of the disappointing auction result and the spread between German and Austrian 5-year yields widened to a new high at 127 basis points. Other euro zone government bonds however benefited from the improvement in risk appetite, which resulted in a general narrowing of the intra-EMU spreads yesterday.
On the ECB front, the Finnish governor Liikanen will speak on taxation and the economy in a recession. Yesterday, German governor Weber sounded less concerned about cutting rates further than the ECB board members Bini Smaghi and Stark over the previous days. Weber however also chose not to cut rates all the way to zero and put the bottom line again at 1% in which case he would prefer to leave the deposit rate at 0.5%. Weber sounded also very downbeat on the economic forecasts, as he said that ‘negative euro zone growth rates could extend into next year’ and anticipated ‘a more protracted recovery than previously expected’. In line with the comments of Bini Smaghi and Stark, Weber also suggested that the ECB is unlikely to follow the example of the Bank of England and to start buying corporate or government bonds anytime soon. Stark stressed earlier this week that by ‘accepting corporate loans as part of collateral in its regular liquidity operations, the ECB has already significantly contributed to providing funding to nonfinancial corporations and thereby an easing of credit conditions’. ‘Buying corporate debt outright would circumvent the banking sector’, which Weber called ‘not appropriate’. Therefore, ‘we would have to say that the banking sector isn’t fulfilling its role’, which is not our analysis, Weber added. Yesterday evening, ECB’s Mersch said that he is also ‘sceptical’ about the merits of ‘excessively low interest rates’ and added that ‘if things get even worse’ the ECB should look for ‘new non-conventional measures that would go through the banks, because the most important thing is to revive the banking channel’. Based on recent ECB comments, we still expect the ECB to cut rates further, but reaffirm our target of 1% as the lowest point in the cycle.
Today, the ECB will hold its 3- and 6-monthly refinancing operation. By providing unlimited funds at a fixed rate and against an expanded range of eligible collateral in its refinancing operations, the ECB wants to prevent a liquidity crisis and wants to ensure the transmission of their monetary policy decisions through the bank lending channel. The decline in the MFI interest rates charged to households and nonfinancial corporations indicates that this policy is working and that the transmission mechanism of monetary policy isn’t completely impaired.
Regarding trading, German bonds were hit by the strong rally in the equity markets yesterday. As a result, the test of the highs in the Bund failed and 10-year yields rebounded off the all-time lows. Also at the shorter end of the curve, 2- and 5-year yields failed to break to new all-time lows in a sustainable manner. At the short end, the room for correction should however remain limited given the ECB rate cut expectations. At the longer end, the Bund may extend its downward correction, the more as the ECB has signalled that it is unlikely to follow the Bank of England’s asset purchase facility and buy government bonds. First important support is seen at 122.97, but key support stands in the 120.30 area, where we would install new long positions.
In the UK, the calendar contains the January trade balance. In January, the trade deficit is expected to have widened from -£3611 to -£3700 with a decline in both imports and exports. Overnight, the NIESR institute suggested that the contraction of the UK economy is still accelerating, as it estimated that the UK economy has contracted by 1.8% in the three months to February compared to the three months before. This compares with a contraction rate of 1.7% in three months to January and a 1.5% slide in the last quarter of last year.
On the supply front, the Bank of England will hold its first reverse-auction within the framework of last week’s announced Asset Purchase Facility. Therefore, the Bank of England targets to buy £2B of 6 different conventional Gilts with a residual maturity of between 5 and 10 years. The results of the auction will be published as soon as possible after its end. The Bank intends to conduct such auctions twice-weekly, normally on Mondays and Tuesdays, once with a residual maturity of between 5-10 years and once between 10-25 years. The size of the auctions and the Gilts to be purchased will be announced each Thursday at 17 o’clock. Every Friday at 11 o’clock the total amount of gilts purchased will be published.
