Markets: Fixed Income
On Friday, global bonds were generally on the defensive and closed the session mostly down leaving the curve steeper. However, the different technical position of the US (near support) and EMU bond markets (near resistance) meant that the US Treasuries outperformed the EMU ones. Intra-EMU government yield spreads with Germany narrowed a bit further, especially the Italian, Portuguese and Greece ones.
Intra-day, Bonds opened weak in Europe following stronger equities in Asia and comments of the Chinese PM Wen Jiabao who expressed concerns about the security of the Chinese vast Treasury holdings. Bunds and Treasuries weakened further in the European morning session as equities continued to do well. Bonds, both US and EMU ones, bottomed after the US trade deficit was smaller than expected, but especially after US equities sold off in the cash market. This gave bonds support allowing them to erase part of the overnight losses in EMU and even moving into positive territory in the US. However, equities fought back in the second half of US trading sending US Treasuries and Bunds again lower. While the US Treasuries closed with only modest losses (0.4 to 6.3 basis points), the short end even ending up in positive territory (2-year yield fell 4.8 basis points), EMU bonds registered more substantial losses (3.4 to 13.5 basis points).
In EMU, the Italian debt agency sold successfully €7.46 B in BTPs, allowing Italian BTPs (and some other weaker govies) to outperform German bonds.
G-20 statement good on principles, but light on details.
The rift between the US, EMU and China on the G-20 strategy was buried and Finance Ministers did their utmost best to sound conciliatory and stress areas of cooperation ahead of the April 2 G-20 summit of leaders in London. Officials argued that the G-20 is on a twin-track of immediate economic and financial stimulus and financial system repair, alongside medium-term ideas for tougher financial regulation. They pledged to take whatever action is necessary until growth is restored and would ensure that all important financial institutions, markets and instruments are subject to an appropriate degree of regulation and oversight. This translated the wishes of the US (stimuli) and of Europe (financial regulation). The statement contained little details though. Geithner didn’t get his 2% of discretionary stimulus. Leaders agreed that the financial means of the IMF would be upped substantially and that the emerging countries would get more voting weight in the IMF probably from 2011 instead of 2013 onwards. For the full text of the G-20 statement: http://www.ft.com/cms/s/0/3fd02aca- 10ba-11de-994a-0000779fd2ac.html.
It was always overly optimistic to expect the G-20 preparatory meeting of this weekend to come up with a detailed plan to tackle the economic downturn, the financial crisis and the pressure on emerging countries. It looks as if the markets will take the results into stride and concentrate rapidly on the US plan to help banks get rid of its toxic assets.
US Treasuries lose slightly ground on Friday
This week’s calendar is very eventful. The eco dataflow is abundant and interesting. The Fed will hold its two-day meeting on Tuesday/Wednesday, while Treasury Secretary Geithner should announce the detail of its Private/Public Investment facility that would lead to purchases of the bank’s toxic assets. The Treasury will announce the details of its end-of-month issuance of 2-, 5- and 7 year Note auctions, while corporate issuance will probably remain heavy too. The market will start the week chewing on the G-20 decisions taken in the weekend to tackle the financial and economic crisis.
After a rather calm week, the eco calendar heats up today with the NY Empire State manufacturing index (March), February industrial production and March NAHB housing market index.
Last month, the ISM manufacturing index showed a marginal improvement (35.8 from 35.6), while most regional confidence indicators declined further. The NY Empire State index even plunged to a new cyclical low (-34.65). In March, the consensus expects to see a slightly less negative NY Fed (-32). Also the Philly Fed, released later this week, is expected to rise somewhat from its cyclical low of -41.3. Last month, industrial production came out weaker than expected (-1.8% M/M) due to a plunge in the production of motor vehicles and parts. For February, the consensus is looking for a decline of 1.3% M/M driven by weakness in the manufacturing sector. Nevertheless, a positive contribution is expected from the auto industry as GM produced probably more cars than in January. The NAHB housing market index is forecasted to remain unchanged at 9. Later this week we will receive more information on the housing market. In January, both housing starts and permits plunged to a new record low. Housing starts dropped an awful 16.8% M/M (to 466 000), while building permits fell by a more moderate 4.8% (521 000). For February, another drop is expected and also in the next few months no significant improvement in housing starts and permits is forecasted as the large inventories of unsold homes need to be worked off. This week, also the latest inflation data are scheduled for release. While producer prices fell already in negative territory two months ago, consumer prices came out flat last months. On a yearly basis, CPI is expected to remain flat in February, while the monthly figure is forecasted to have risen by 0.3% M/M. In the near future however, inflation is still expected to tumble sharply in negative territory.
Regarding the 2-day FOMC meeting, Fed speakers have been very consistent in their views about the economy, financial tensions and the need to remain extremely loose in their policy settings. So the FOMC statement will continue to stress that the Fed Funds target rate will remain at the rock bottom range of 0-to-25 basis points for a longer period. The Fed will also continue with its Quantitative Easing policy or as Bernanke says their credit easing policy. Following some delay, on March 19 the TALF facility (support of securitized markets) will take off as the deadline for submissions transpires, but the Treasury has already dampened expectations and counts on a slow start. Markets will remain attentive to signals the Fed might start buying longer-dated Treasuries, following a similar initiative of the BoE. However, previously the Fed said it wanted first an evaluation of the impact of the existing credit easing policy before contemplating buying outright Treasuries. Some Fed governors suggested that such an evaluation would take place in spring. As the TALF and the PPIF are still not running, any news about the purchase of Treasuries would be a surprise. There is a bigger chance that the Fed would lower the interest paid on required reserves to push the effective Fed funds rates again closer to the bottom of the 0-to-25 basis points range. Despite some slight decline in recent days to 18 basis points, the Fed Funds rate trades higher than the 10 basis points visible in early January. The Fed might wish to push rates back to those levels. However, overall it wouldn’t make too much difference. So, the FOMC meeting may end without too much market-moving news.
Treasury Secretary Geithner said last Friday that he would soon offer details on his plan for toxic asset cleanup (PPIF). Recently, the delay in announcing these details was seen as due to a lack of private interest in the purchase of these assets. The Geithner plan seems to follow a two track incentive program. It would include incentives for banks to sell the toxic assets on their balance via capital injections and probably also by offering some regulatory relief (participating banks would get more flexibility in the application of the mark-to-market rules). Investors would be lured into the scheme by offering cheap access to federal loans. Banking shares surged last week, albeit from distressed levels, not only because of communications for Citi and BoA that January/February were profitable months and that there didn’t need extra capital from the government, but maybe also on hopes that the PPIF would be successfully launched. So depending on the details Geithner will communicate this week and on the assessment of it by investors, bank shares may react substantially, setting the stage for a strong reaction in Treasury markets too.
Supply has been an item for the market since the government plans to support the financial sector/economy have been published and economic growth succumbed. Last week, the 3-, 10 and 30-year T-Note/bond auctions went very well despite negative cash flows surrounding the auctions. The buy-side showed up massively. Interestingly, this happened when 10- and 30-year yields tested the recent highs at 3.05% and 3.76% respectively. This suggests that these levels might also in the future play their role as strong resistance. The end-of-month funding package of 2-, 5- and 7- year Notes, that will be announced this week, will probably amount to yet again a staggering amount of maybe almost $100B. As only one $18B 2-year Note matures, the Treasury will need to raise again a very high amount of fresh cash. The auctions take place next week and settle on March 31.
Regarding trading, the resurrection of equities was certainly the main event last week. The sell-off started on February 9, when Geithner unveiled his so-called banking plan, which was short on details and considered as a disappointment. It finished on March 6, when a horrible February payrolls report couldn’t push equities any lower and a technical trend reversal signal appeared on the charts. The actual trigger for the rally was an internal note of Citi CEO signalling that the bank had been profitable in January and February. Also the message that no more capital injections of the government were needed (Citi/BoA) helped to cheer up the depressed market. Even an eye-catching downgrade of bellwether GE couldn’t spoil the party. So far so well, but the jury is still out whether it is a bear market rally or whether a bottom is put into place that may lead to a more lasting recovery. A move of the S&P above 804 (previous neckline double top) and actually even above 944 (previous high and potential neckline double bottom) is needed to contemplate the ends of the bear market. The answer to that question is of course of major importance for Treasuries, but we shouldn’t get it this week.
In a weekly perspective, Treasury yields were narrowly mixed (-1.4 bps. to +1.9 bps) which is a surprisingly good result, given the resurrection of equities and the huge Treasury and corporate supply. Regarding the latter, banks are rushing to issue more debt with FDIC guarantees before FDIC will raise the fees on April 1. Corporate deals of BoA, Morgan Stanley, Goldman and GE Capital amount for a total of $26.5B. As a result of the GE downgrading, investment grade spreads widened 13 bps, while the genuine improvement in the banking/overall equities was better reflected in a narrowing of the high yield spread by 37 bps. Swap spreads were tighter across the board.
The technicals played a role in the relative encouraging performance of Treasuries. Indeed, Treasury yields bottomed at the end of December at 2.02% for the 10- year and 2.50% for the 30-year. Since, they rose to respectively 3.05% and 3.76%, levels that were tested three times recently, but always held. This might be an indication that the upside in yields is blocked for the moment. With ongoing eco weakness, zero Fed fund rates and QE in place (prospect of Fed purchases of longer-dated Treasuries still lingering), it isn’t surprising the market is currently unwilling to push Treasury yields much higher. Supply is evidently a negative. While many events may surprise this week, we would start the week with a positive bias for Treasuries. A sustained rise above the 3.05% and 3.76%, difficult we think, would cause us nevertheless to re-assess the situation. From a technical point of view, yields may fall to 2.60% and 3.40% before key levels loom.
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.
Bund corrects lower
The eco calendar is rather light this week and probably won’t be a major factor for bond trading. Today, the euro zone calendar contains the final figure of euro zone CPI (February) and the fourth quarter employment data. According to the flash estimate, euro zone CPI rose from 1.1% Y/Y to 1.2% Y/Y in February, while a slight drop was expected. Today, the final figure is expected to confirm the first estimate of 1.2% Y/Y. The driver behind the unexpected rise in inflation might have been oil prices as they increased somewhat in February. Therefore core CPI, excluding food and energy, is forecasted to remain unchanged in February (1.6% Y/Y). Later this week, the calendar contains the German ZEW survey, euro zone industrial production and the trade balance. Tomorrow, the German ZEW index is forecasted to show a marginal decline (-6.5 from -5.8) after four consecutive increases. From July 2008 the headline index rose from a low of -63.9 to -5.8 last month, losing much of its correlation with other confidence indicators, which remained close to their record lows. Last year, euro zone industrial production dropped in ten out of twelve months with a record drop (-2.6% M/M) in December. For January, the consensus is looking for an awful industrial production figure (by -4.0% M/M) after the terrible German and French production data last week. The trade balance on Friday might be less interesting for trading.
Government bond auctions include Slovakian Jan 2015 floating rate today and more important German Bund (€5B Jan 2019) and Spanish 10-year on Wednesday.
France BTAN auctions (€6-7.5B July 2011, Jan 2012 & Jan 2014) take place on Thursday. France also holds inflation-linked OAT auctions on Thursday. Recently, the German auction didn’t go well, obliging the Bundesbank to retain sometimes a large amount of the auctions on its books. Investors were not enticed by the very expensive German papers and preferred higher yielding peripherals like the Spanish bonds. The Spanish 10-year spread narrowed nicely to 100 basis points from a top of about 125 bps one month ago.
ECB speakers of which we are aware include this week Trichet (Monday/Tuesday) end Weber (Tuesday/Friday). So, there are a fairly limited number of speeches scheduled. On Thursday, the ECB holds its monthly non-monetary policy meeting. We suspect that the internal discussion on how low interest rates may fall and on eventual expansion of the so-called non-standardized measures will continue. In this respect, it will be interesting to hear whether the tone of the talk makes a switch following that meeting. However, at this point it seems that only ECB Weber will take the stage on Friday. With the forward eonia trading at about 0.70%, it is obvious that the room for decline has become very limited, even if the ECB cuts its official repo rate to 1% in early April, as we expect.
Concluding, we suspect that the EMU bond market will be dominated this week by events in the US (see US part) and particularly by the fate of the private/public investment plan to buy purchases of which the details will be released this week. Will it allow equities to continue their resurrection this week? Besides these, the technical pictures retain all our attention. Last week, on Monday the Bund tried to move above the contract high, but failed to do so and reverted back lower in the range. It didn’t however damage the technical picture. Only a sustained drop below 122.97 would be more negative as it would paint a double top on the charts and open the road for a retracement towards the key support zone at about 120.90. So, overall, the market is a in a bind in a broad sideways range that developed since early December. Both the downside and the upside of this range has been tested and rejected (see also graph 10-year yield). Therefore, we start the week with a neutral bias.
