Markets: Fixed Income
On Monday, global bonds remained under pressure, as the return of risk appetite, already visible last week, drove risky assets like equities initially higher, now already for the fifth consecutive session. However, bonds failed to turn around when equities were hit by a late session bout of profit taking. At the end of the session, German yields were up between 2 and 8 basis points, the curve steeper, while US yields increased between 4 and 8.5 basis points.
The eco dataflow was very weak, but unable to affect markets. Indeed, the NY Fed manufacturing index disappointed setting a new cycle low in March, US industrial production was very weak too, but in line with market expectations despite an (expected) rebound in car production. In the EMU area, inflation was confirmed at 1.2% Y/Y in February, up from 1.1% Y/Y in March, but the core CPI disappointed showing an unexpected rise to 1.7% Y/Y from 1.6% previously. However, it doesn’t endanger the expected further decline in both headline and core inflation.
The G-20 meeting, while short on details, couldn’t really help market sentiment, but at least didn’t affect sentiment negatively. Bernanke’s appearance in a US talk show in the weekend, that escaped our attention, on the contrary didn’t go unnoticed. He said that depression risks has been averted and eco weakness now should be followed by a recovery in 2010. It is obvious that such comments combined with hopes that the soon-to-be announced details of the toxic asset cleanup will thaw markets buoyed equities. Bernanke’s comments were conditional on the healing of the banking system.
US Treasuries remain under downside pressure
Today, the calendar contains the February PPI figures and housing starts and permits. 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. Housing starts are forecasted to have dropped to 450 000 (from 466 000) and building permits are expected to have declined to 500 000 (from 531 000). Also in the next few months no significant improvement in both housing starts and permits is forecasted as the large inventories of unsold homes need to be worked off. Two months ago, the year-on-year PPI figure fell in negative territory. For February, the consensus is looking for a further decline (-1.4% Y/Y from -1.0% Y/Y), while the monthly figure is forecasted to have risen by 0.4% M/M.
The FOMC starts its 2-day meeting that will result in the publication of a statement tomorrow evening. 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 longerdated 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. However, there is still some speculation in the market that the Fed might already now start the purchases of Treasuries. Other market participants count on an expansion of some existing QE measures like the purchase of Agency or Agency MBS debt. 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 marketmoving news and maybe some disappointment.
However, the market might get good news from Treasury Secretary Geithner. He should announce the details of its Private/Public Investment facility that would lead to purchases of the bank’s toxic assets, somewhere this week. The Treasury yesterday pledged to directly buy $15B in SBA-backed loans to help unfreeze the secondary market of Small Business loans. The program starts at the end of March and targets such existing loans that were originated as of last July and new ones through the end of 2009. The guarantee on these loans is reached to 90% and the SBA loan fee is eliminated.
Regarding trading, the resurrection of equities continues to affect Treasuries negatively, but until now it didn’t harm the technical pictures. These show Treasuries blocked in a fairly narrow range, but closer to the bottom of the ranges (in prices). In yield terms the 3.05% for the 10-year and the 2.78% for the 30-year played in recent weeks role of resistance, making us optimistic that the upside in yields was well protected, especially as the 10- and 30-year auctions went very well. However, our optimism might have been a bit premature as the 30-year yield is severely testing the top of the range and the 10-year yield remains within striking distance. The ongoing strength of equities is the main culprit, even if the rally ran yesterday into profit taking. Hopes on Geithner’s PPIF and on the Fed expanding its QE, are supporting equities and therefore, the FOMC decision and Geithner’s PPIF will be instrumental thin giving equities guidance short term. The eco data should be weak (housing) but most likely not a very important item today.
Bund tests first key support level
Today, the calendar contains the German ZEW survey (March). In Germany, the ZEW index is forecasted to show a slight decline (-8.0 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. For this reason, we have no clear view on the risks, even if the decline in equities, until very recently, and February’s strong advance suggest the index may drop lower again. ECB appearances include a testimony of Governor Draghi, a speech of president Trichet and after trading another speech of Governor Weber.
In an interview with Handelsblatt, ECB board member Stark repeated that the ECB still has some wiggle room with regard to rates, though warned too that the lower threshold is not far from current rates. Too low lending rates may spur ill-advised lending. He criticized a policy of credit easing (the US form of QE) saying that it may distort industry competition and added that zero rate policy may cause problems on the money market, but added that discussions on QE are at an early stage. He clarified his position by stating that the situation is not at a point where QE should be pursued. Overall, his remarks didn’t change much from what he said back on March 9, when he also said that current ECB policy anticipates weak economic data in Q1, that weak data is already accounted for in policy and would not lead to policy change. ECB president Trichet offered little new in his speech where he said the ECB is committed to preserve the euro as an anchor of stability.
We interpret the comments as signalling that one more rate cut (to 1%) is very likely. QE policy in the sense of the US (credit easing) is unlikely to be implemented in EMU, but other so-called non-standardized policy measures (the ECB variant of QE) are under study.
The renewed risk appetite continues to drive intra-EMU yield spreads versus Germany lower. The movement was general yesterday, with even Greece and Ireland the laggards joining other sovereigns. The outperformers were Portugal, Italy and Belgium in the 10-year segment. So the rise in German yields is for a large part offset by incoming spreads.
Regarding trading, German bonds are in the defensive as upped risk appetite convinces investor to shift some investments from the safe-haven government bonds towards more risky assets like equities. The Bund future tested the contract highs on Monday 09 March (125.63), but couldn’t sustain and has lost ever more altitude since setting an intra-day low at 123.02 yesterday. From a technical point of view that didn’t affect the picture. However, that may change should the contract drop sustainable below 122.97, a previous low and neckline potential double top formation. It would put the contract back in the lower part of the broader sideways trading range with bottom at 120.37 and top at 125.63. So trading will become interesting now.
Today, the EMU calendar is a bit light with the March German ZEW economic sentiment index as the sole indicator to be released. The ZEW surged higher in recent months, but its move wasn’t replicated in the more reliable business confidence data, like the PMI’s or the German IFO. We don’t expect it to have much impact. Also the speeches probably won’t bring new info, as the non-monetary policy meeting takes place on Thursday, where discussions about future policy will continue. Speeches after that meeting might become more interesting again. We suspect that risk appetite/ risk aversion pair will again be the main driver for the market together with technicals (support). Asian equities are trading strongly, despite Wall Streets’ late session decline, which could immediate test the nerves of the Bund bulls, as the key support will be under test.
In the UK, the BoE quarterly bulletin contained an article on deflation in which the BoE said that prompt and decisive policy action could prevent deflation from getting engrained. The recent move to quantitative easing could be seen as an attempt to learn the lessons of history when policy had too often been seen to respond inappropriately added the article. There would be no “genuine” deflation in the UK, as temporary falls in the price level, as seen in early 1960 were no great cause of concern. The biggest disadvantage of deflation would be a rise in the real debt burden and higher real interest payments.
The BoE organized its second reverse auction of Gilts with 6 issues targeted in the 2020 to 2032 sector for a total amount of about £2B. The cover ratio amounted to 3.36, which was substantially less than the cover of its first operation last week. The market sold off after the auction results were published. In the weekend, there were already rumours that pension funds and insurers weren’t very keen in participating in these reverse auctions as they might wanted to keep their Gilts. It is too early to appreciate the appetite of the market for the reverse auctions. The UK calendar is quite empty today with house prices and details of the March 25 and 26 Gilt auctions. BoE King speaks after closure of markets. Global factors will drive the price action.
