Markets: Fixed Income
On Thursday, global bonds moved higher, even though global equities extended their recent rally and the S&P closed higher for the third day in a row, reversing the recent break below last year’s November lows.
Intra-day, European bonds started the day in a good mood following the overnight gains in the US Treasury market and a weak performance of the Asian equity markets. European equity markets opened lower, but bottomed out during the European session and rebounded following better than expected US retail sales. In response to the retail sales and the bounce in the equity markets, bonds fell to the intra-day lows, but rebounded quite easily afterwards. The rate cut of the Swiss National Bank and their decision to start buying corporate bonds pushed bonds again higher in the range. In the US, Treasuries set intra-day highs following a strong 30-year Note auction, but fell again lower afterwards as equities continued to move higher. Overall, bonds closed with good gains both in the euro zone and the US, despite the rally on the equity markets.
In a daily perspective, there was a bull flattening of the US yield curve with yields falling between 0.8 basis points in the 2-year sector and 5.1 basis points in the 10- and 30-year sector. In the euro zone, the belly of the curve outperformed with 5- year yields falling 8.9 basis points compared to 6.8 basis points in the 2-year sector and 6.3 basis points in the 10-year sector. The 30-year sector underperformed, as yields only fell 1.9 basis points. The intra-EMU spreads couldn’t really benefit from the improvement in risk appetite, as the Irish, Italian and Greek spreads widened.
US Treasuries end higher despite rallying equities
Today, the calendar contains the January trade balance, Michigan consumer confidence (March) and the import price index (February). In January, the trade deficit is forecasted to have contracted further. The consensus is looking for an outcome of - $38.0B (from -$39.9B). Both imports and exports are forecasted to have declined again. If confirmed, this will be the sixth consecutive monthly drop in both exports and imports. Last month, Michigan consumer confidence plunged from 61.2 to 56.2, after showing signs of stabilization in the two months before. For March, the consensus expects an outcome of 55.0, which would be a new cyclical low and the lowest outcome since May 1980. We believe the risks are on the upside of expectations after the marginal uptick in IBD economic optimism and ABC consumer confidence. Import prices are forecasted to have fallen by 0.7% M/M in February.
The $11B 30-year bond re-opening (3.50% 02/39) went surprisingly well. The auction stopped at 3.64%, below the 3.685% WI bid at the stop, suggesting aggressive bidding. The bid/cover of 2.40 was above the LT average of 2.16. Buy-side participation was huge, with a high direct bid ($1.28 B). The Indirect bid of $7.22B was the largest since the re-introduction of bond auctions in February 2006. Indirect bid amounted for 27.3% of total bids with an Indirect takedown of 46.2% (17.2% average for re-openings). Concluding, the buy-side saw this auction as an opportunity to enter the long end of the curve and snapped up bonds in an aggressive bid. This is very usual for bond re-openings that are typically dealer-dominated and sloppily bid. This is a strong signal that the upside in yields is capped at about 3.76%, levels reached a few days ago. Market apparently concluded that the QE policy and the eco outlook will prevent yields to rise much higher. 30-year yields bottomed at 2.50% in mid December and climbed since steadily.
Regarding trading, yesterday, Treasuries weathered quite well both stronger-thanexpected retail sales and an ebullient equity rally, that was driven by hopes the banking sector is coming out of the woods. A very strong 30-year T-bond auction eased concerns that investors were churning government bonds because of supply concerns and maybe some long term inflation fears. Also the decision of the Swiss National Bank to start its QE policy by buying Swiss corporate bonds and more questionable by buying Fx currencies against Swiss franc might have been of support for Treasuries. So Treasuries were well bid in Asian and European morning session, came under temporary pressure after the better-than-expected retail sales data, surged after the results of the T-bond auction were published. Later on profit taking occurred, pushing Treasuries off intra-day highs, but leaving them with still moderate gains in the close. The curve shifted in an almost parallel way down by 4-5 basis points with only the 2-year sector lagging.
Today, the eco data probably won’t be of utmost importance. The Michigan consumer sentiment might even turn out to be less negative than expected. The trade balance and import prices usually don’t move the Treasury market much. Overnight, the Chinese PM Wen expressed concerns about the security of the Chinese holdings of Treasuries. He said: “So I hope through you to again call on the US to maintain its creditworthiness, abide by its commitments and ensure the security of China’s assets.” While he was conscience that China had some responsibilities in maintaining the stability of the financial system, our first priority is maintaining our national interest. He also didn’t exclude more fiscal stimulus. Comments like these causes of course some nervousness in the Treasury market and pushed overnight Treasuries down from early gains. The French FinMin Lagarde exposed the rift between the US and Europe ahead of the G-20 talks of the weekend, when she said that the markets had reacted negatively to the US stimulus packages showing that Washington’s calls for more fiscal action by its trading partners like Europe were misguided. Europe stresses more the need for financial market/sector regulation as the main discussion point for the G-20. We suspect the discussion to continue. It is important for bond markets as more stimulus is a negative via supply concerns. In a short term perspective, equities and the risk appetite/aversion factor may be more important. We aren’t surprised that the market turned around earlier this week, but are impressed that the S&P took out so easily the 741 (previous low) resistance. Given the juicy gains of the recent sessions, and ahead of the weekend, we should think that some profit taking could occur. From a longer term perspective, the S&P should move above 804 and even 943 before becoming really more at ease.
We stick to our strategy of re-entering the Treasury market from the long side from a tactical point of view. The 10-year yield tested 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 tested key resistance at 3.76/86% (recent high/ previous neckline triple top). The above mentioned levels held and set the stage for a modest rally in Treasuries, which might not have finished yet.
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. Shorter term traders/investors might consider taking profit on existing longs when approaching these levels.
30-year Italian spread at the highs ahead of today’s BTP auctions
In the euro zone, the calendar contains the January 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). Household consumption is expected to remain weak in the first quarter of 2009. For January however, the consensus is looking for a rise by 0.2% M/M in retail sales, we have no clear view on the risks as French consumer spending rose by 1.8% M/M in January, while German retail sales disappointed, falling by 0.6% M/M.
On the supply front, Italy will tap the market today. Italy will tap four different BTPs in the 4-, 7-, 25- and 30-year sector for a total amount of €5-7.5B. In the run-up to today’s auction, the 30-year segment underperformed with the spread over Germany widening to its highest level at 176 basis points.
On the ECB front, ECB’s Stark will speak on financial regulation. Earlier this week, Stark’s warning that too low interest rates could be counterproductive resulted in an upward correction in the German 2-year yields. Yesterday, ECB’s Trichet however repeated last week’s comments that the ECB governing council ‘had not decided ex-ante that the present level was the lowest’, thereby hinting at a further easing in monetary policy. Trichet and Nowotny spoke at a conference of the Russian central bank on the Central and Eastern European economies. Both speakers stressed that this is ‘no homogenous region’ and that one has to ‘take into account the real situation of each particular country’. Therefore, Nowotny said that ‘adding up the exposure of these countries is misleading’ and added that ‘he’s glad to observe that even some rating agencies have got this message’. In February, a Moody’s report on the banking exposure to Central and Eastern Europe caused a ravage in the regional currencies and resulted in a huge spread widening of Austrian bonds over Germany, as Austrian do have a large exposure to this region. On Wednesday, Moody’s however tried to ease concerns as they nuanced their message. In response to their comments, Austrian bonds yesterday outperformed on the European bond market.
In an interview with the FT, French governor Noyer pointed out that the ECB’s measures in the money market to provide unlimited liquidity at all maturities up to six months at a fixed rate against a widened range of collateral in fact is some sort of quantitative easing. Although Noyer didn’t want to confirm that 1% is the bottom for ECB interest rates, like Weber hinted, he admitted that the room for further interest rate cut has become very limited and that the impact will also decline. Regarding buying corporate or government bonds, Noyer kept all options open, but indicated that ‘there are signs that the transmission mechanism in terms of interest rates in almost all segments of the credit market works relatively well’ and that the ‘objective of so-called additional measures would be to act where parts of the credit market are not working’.
Regarding trading, German bonds proved quite resilient in the face of the equity rebound yesterday. This morning bonds are however sharply lower, as the rally on the equity markets continued overnight in the US and Asia. The break above the November lows in the S&P500 may indicate that the rebound is more than a dead, cat bounce. The improvement in sentiment may continue to weigh on the bond markets in a short term perspective in spite off recent awful industrial production data and the quantitative easing policy measures taken by the Bank of England last week and the Swiss National Bank yesterday. This nevertheless remains a buy-on-dips market with first important support seen at 122.97, but if broken key support stands in the 120.30 area.
In the UK, Gilts continued to outperform the European bond market, as longerterm UK yields dropped again more than 10 basis points. Consequently, UK 10- year yields test again at the all-time lows at 2.95% and fell below their German counterparts for the first time since the beginning of 2002. Yesterday, the Bank of England announced that it will buy £5B of conventional Gilts next week. In the first reverseauction on Monday, the Bank will buy 2B of Gilts from the 10 to 25-year sector and in the second auction on Wednesday the Bank will buy 5B of Gilts from the 5 to 10-year sector.
Yesterday evening, BoE’s Barker defended the Bank of England’s quantitative easing policy.
