Markets: Fixed Income
On Wednesday, global bonds traded mixed, as US Treasuries rallied higher following the 10-year Note auction in a technical inspired move, thereby recouping the early losses and outperforming the European bond market.
Intra-day, bonds were under pressure for most of the day, as equities held on to their strong gains of Tuesday. Hence, investors once again ignored the weak eco data with Chinese exports plunging 25.7% Y/Y in February and German factory orders falling a huge 37.9% Y/Y in January. The decline in bonds was more outspoken in Europe, where bonds were also hit by profit-taking following the failed test of the highs earlier in the week. In the US, US Treasuries were lower too but reversed course and spiked higher after the 10-year Note auction, as 10- and 30-year yields tested the highs at respectively 3.05% and 3.76%, but failed to break above.
In a daily perspective, there was a bull flattening of the US yield curve, while the European yield curve showed a bear steepening. In the US, yields were down between 1.6 and 10 basis points compared to rises of between 5.1 to 7.2 basis points in Germany. The improvement in investors’ risk appetite resulted in a further narrowing of the intra-EMU sovereign spreads.
US Treasuries slid lower as risk appetite returns
Today, the calendar heats up with the weekly claims, February retail sales and January business inventories. Initial claims are expected to have risen by 6 000 to 645 000 in the week ended March 7 after falling by 31 000 in the week before. Continuing claims, which are reported with a one-week lag, are forecasted to have risen to 5 145 000 (from 5 106 000). We have no clear view on the risks, but expect both initial and continuing claims to remain close to the cyclical highs. In January, US retail sales showed their first improvement after six consecutive monthly declines. The rebound was wide-spread, but it is still unsure whether households started to increase spending or whether it was only a temporary correction driven by discounting after the sharp declines in the last three months of 2008. For February, the consensus is looking for a decline by 0.5% M/M in retail sales, but a weaker outcome is not excluded. Business inventories are forecasted to show their fifth consecutive drop (-1.1% M/M). Treasury Secretary Geithner testifies before Senate budget Committee on the 2010 budget proposal.
Treasury Secretary Geithner made a statement ahead of a G-20 meeting. He said the G-20 meeting had two important agenda items, notably how to ensure recovery and restart growth and how to reform and coordinate the international regulatory and supervisory system. On the first point he clearly pushes the European countries to do more and said that the IMF advice to stimulate the economy to the tune of 2% of GDP in both 2009 and 2010 was a good benchmark. He also pleaded to raise the IMF resources to $500B and attribute more voting rights to EM countries. While also Europe supports the $500B resources, the voting issue may be difficult to resolve. Forceful financial sector actions are critical to rebuild confidence, restore market functioning and get credit flowing, he said. On the second issue, he said the US would take a lead in regulatory reform and promised to put a proposal on the table ahead of the April 2 G-20 meeting. These reforms would include rules to strengthen oversight and regulation of cross border systemic important institutions, strengthening oversight of markets (like CDS), stronger framework of capital requirements that is less procyclical, fight money laundering and crackdown on those that use offshore tax havens. Geithner sees a bigger role for the Financial Stability Forum and also wants the G-20 to address the problem of compensation practices for which there seems to be consensus. He also said that governments should be ready to provide capital to financial institutions if needed and called the removal of problem assets necessary for recovery in the financial sector, but his comments lacked details about how he would do it. Overall, the speech didn’t contain really market-moving news.
The $18B 10-year Note re-opening was sloppy, but participation of the buy-side was OK. The auction stopped at 3.043%, above the 3.031% bid in the WI trading at the moment of the stop. The bid/cover of 2.14 looks weak when compared to the 2.26 average over the last twelve auctions, but given the increased size of the auction, we would qualify demand as solid. Indirect bid was solid at 15.2% of total bids, which is above the reopening average of 9.3% (but below the 19.3% in refunding auctions). The indirect takedown of 23.9% also exceeded the average for re-openings (16.6%). Concluding the auction went reasonable well. The upped size of recent auctions mean that investors ask a price concession (stop above WI bid), but that should in the current climate considered as normal. Demand is still present at the auctions.
The 3-part $63B monthly refunding operation concludes with a $11B 30-year bond re-opening (3.5% 02/39). The auctions will settle next Monday. At the start of the week, we explained that the current monthly refunding would be more difficult than last month’s quarterly refunding operation as the cash flows surrounding the auctions was much less favourable. However, the 3-year Note auction went well and while the 10-year bidding was sloppy, the market took it easily into stride. So the setting for the 30-year bond re-opening is not so bad even if challenges remain. It is the first reopening of a 30-year bond in the month following the original auction. As a consequence, there is little relevant historical data available with which the result to compare. We would expect weaker buy-side participation than for the original auction and sloppier bidding. The bond auctions have always been dealer-dominated and stopped already above the WI stop before the recent decision to re-open the 30-year bonds.
Regarding trading, Treasuries tested the downside ahead of 10-year re-opening, before surging higher and closing the session with substantial gains. The longer end of the curve outperformed. It is tempting to point to the auction as the trigger for the rebound. However, we shouldn’t draw too much conclusions from that auction. It went reasonably well, but was far from a blockbuster. Nevertheless, technicals kicked in. The 10- and 30-year tested the recent highs at respectively 3.05 and 3.76%, which was always an obvious resistance where new longs could be placed. The recent selloff had also created the room for short covering. We sifted through the speech of Geithner that flashed on the screens at exactly the same time as the auction results and the rebound of Treasuries, but found no obvious trigger that might have explained the rebound. Today, the claims and retail sales should be weak, but we have no reasons to expect them weaker than forecasted. The 30-year bond re-opening is a challenge, but yesterday’s reaction on the 10-year re-opening shows that it isn’t as suhch a negative. Following the auction, the market may even be relieved that supply is off the table (at least in the very short term). Geithner will speak on the budget which is potential a dangerous cliff for Treasuries, but we don’t expect Geithner to stoke supply fears. Re-iterating our strategy, we contemplated re-entering the Treasury market from the long side from a tactical point of view for the following technical reasons. 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 still be used to open long positions.
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 re-qualify the outlook to outright bullish. Of course, shorter term traders/investors might consider taking profit on longs when approaching these levels.
Swiss National Bank the next to start a QE policy?
Today, the calendar contains the German industrial production figures (January) and euro zone PPI (January). In December, German industrial production showed its largest monthly drop since May 1989 and for the third quarter of 2008, industrial production was down by 6.8% Q/Q. An improvement is not yet expected as the consensus is looking for a decline by 3.0% M/M in January. In the coming months, industrial production is expected to remain extremely weak as yesterday’s factory orders were again awful. The euro zone PPI data are rather outdated and therefore, no market impact is expected. On a monthly basis, the consensus is looking for an outcome of - 0.2% M/M and the yearly figure is forecasted to head closer to zero (0.5% M/M).
Outside the euro zone, the Swiss National Bank will hold its three-monthly monetary policy assessment. In December, the Bank decided to lower the target for the three-month Libor by 50 bps to 0.5%. Today, markets expect another cut to the low of 0.25% reached in the 2002/2003 recession. It will also be interesting to see whether the Bank will take more unconventional measures now that rates have fallen close to zero. Therefore, it could further extend the maturity of its repo operations or start buying government and/or corporate bonds. The Bank is also likely to signal its concern about the strength of the Swiss franc. If the Bank would effectively decide to start buying longer-term bonds, this would have spill-over effects on the European bond market too.
On the supply front, there are no auctions scheduled for today. Yesterday, Germany sold €6.325B of its new 2-year Schatz 1.25% March 2011. Demand was strong with a bid/cover ratio of 2.1, the highest ratio since July last year. The bidding was however not very aggressive, as the tail was rather high and the Bundesbank retained a large €1.675B for its own market operations.
On the ECB front, ECB president Trichet and Austrian governor Nowotny will both participate at a conference of the Bank of Russia in Vienna, while Luxembourg governor Mersch will present the Central Bank Bulletin. Yesterday, ECB’s Liikanen indicated that the ECB has more room to cut rates if needed. His comments contrast a bit with earlier comments from Bini Smaghi and Stark, who both warned that too low interest rates could be counterproductive. ECB’s Mersch also said that he’s sceptical about excessively low interest rates, while Weber signalled that he doesn’t support rates falling below 1%. All however appeared to agree that more unconventional measures should first focus on the regular refinancing operations before more aggressive actions in the form of asset purchases should be considered.
Regarding trading, German bonds fell further off the highs tested earlier in the week, as equities held on to their strong gains of Tuesday. Overnight, US Treasuries however moved sharply higher, as US longer-term yields tested but failed to move above key resistance levels. This resulted in a higher opening of the European bond market this morning, the more as the decline in the Asian equity markets points to a lower opening of the European equity markets too. Overall, we still favour a buyon- dips approach in the Bund. First important support is seen at 122.97, but if broken key support stands in the 120.30 area.
In the UK, Gilts outperformed the European bond market. Yesterday, the BoE started its purchases of Gilts with the reverse-auction of 6 conventional Gilts for a total amount of £2B. Notwithstanding some volatility around the time of the publication of the auction results, the results themselves had no visible impact on trading.
Today, the BoE’s Barker will speak on deficits, debts and monetary policy. Barker will be the first member of the MPC to speak following last week’s meeting.
On the supply front, the UK will tap its 25-year IL Gilt 1.25% Nov 2032 for an amount of £1.1B. It will be interesting to see whether investors’ appetite for linkers has declined in the wake of the BoE’s decision to buy only conventional Gilts in their asset purchase programme, as linkers had the tendency to underperform conventional Gilts since.
