Markets: Fixed Income
On Tuesday, global bonds couldn’t really shrug off the negative sentiment that reigned already a few days, especially in Germany, as risk appetite continued to rise resulting in a strong gain for equities. So intra-day, the driver for bonds was clearly equities (see graph). The technical picture of the US Treasury markets hasn’t yet been damaged, except for the 30-year that saw its yield move above the key 3.76%. In EMU, the Bund future fell through an important key support level (122.97), which if confirmed, downgrades the picture from bullish to neutral. In a daily perspective, US yields were up 3.3 to 6.7 basis points leaving the curve steeper. In EMU, yields increased by 4.6 to 6.3 basis points, the belly slightly outperforming the wings of the curve.
The eco dataflow was interesting and encouraging. The US housing starts data offered a glimmer of hope that a bottom may be near, supporting homebuilders’ equities, but also other cyclical equities. Especially, the rise of the less volatile and less weather-dependant housing permits points to such a possible bottoming. Equally interesting, the core PPI was up 0.2% M/M, slightly above expectations, but more importantly producer prices, the most vulnerable to cyclical influences, show of yet no imminent sign of deflation. In EMU, the ZEW rose modestly, but already for the fifth consecutive month. The survey isn’t very reliable, but altogether we get the impression that the global dataflow has become somewhat less negative than recently.
Whereas in previous days the rally in equities didn’t bolster commodities, this changed yesterday. The CRB at last gives some signs of life, even if no decisive break higher has yet been reported. Also oil is doing again better, now approaching the $50/barrel level.
US Treasuries correct moderately lower
Today, the eco calendar contains the February CPI figures, Q4 current account and weekly mortgage applications. 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. We believe the risks are on the upside of expectations as the unwinding of strong discounting in December might still be visible and a positive contribution may also come from oil prices. In the near future however, inflation is still expected to tumble sharply in negative territory. In the current context, more attention may go towards core CPI that will allow markets gauge chances on deflation. Core CPI slowed sharply in Q4 when core CPI rose just 0.1%. Given the steepness of the crash in demand, there should be downward pressure on underlying prices, but recent readings in PPI suggest that underlying inflation is not collapsing. Will this be confirmed in the CPI report?
The FOMC concludes its 2-day meeting that will result in the publication of a statement in the 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 start already now 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, but as the Fed hasn’t yet exhausted the target amounts there is no urgency to announce an upped amount of purchases. There is a 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 and maybe some disappointment. Otherwise, the Fed may try to tweak its statement in such a way that the disappointment about real new measures is mitigated. Will governor Lacker continue to dissent?
However, the market is still waiting on 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. For equity markets this is a key event that might as a consequence impact Treasuries too.
Regarding trading, Treasuries continued to correct lower as the theme of risk appetite remains the driver of the price action in equity and Treasury markets. Technicals for the 5- and 10-year haven’t changed much recently and are still neutral, with 2.04/11% and 3.05% still the major support levels. The targets of the double bottom in the 10-year yield stand at 3.17%. The situation for the 30-year yield is changing, after it broke above 3.76% yesterday. While confirmation of the break is needed, there is still key support immediately above, at 3.86%, the previous neckline of a triple top.
We suspect today subdued trading ahead of the FOMC statement, even if the CPI release might cause some temporary volatility. If the FOMC completely disappoints markets (no hint of the purchase of long-dated Treasuries and no increased support for other credit markets) Treasuries might be disappointed, but the reaction should be influenced by equities. How will these react on such a FOMC statement? Is it a trigger for profit taking following the juicy gains of recent or will they consider it as a signal the Fed isn’t too worried and thus be equity friendly? To be honest, we have no real good feeling on how the market will take the FOMC statement.
Bund falls below 122.97 support as equities make more advance
Today, the euro zone eco calendar is empty, if we disregard Italian industrial production for January, no market mover. There are no ECB speakers scheduled either.
Yesterday evening, ECB president Trichet confirmed that the ECB was studying the possibility of further non-conventional measures if needed, but offered no new info on the subject. In other comments, he discussed the causes of the current financial crisis (securitization, compensation systems, global imbalances) and defended the current ECB stance by underlying that 6 month and 1-year rates are lower in EMU than in the US. He pointed to the different structure of the US and EMU economies as the reason why the strategies of the central banks differed. Trichet pointed to a fast retreat of inflationary pressures, but repeated that the risk of deflation in Europe is not substantiated. Yesterday, Nobel price winner and NYT columnist Krugman said Trichet “weirdly” complacent about such deflation risks. Trichet also defended the unity inside EMU area and underlined that no country wants to leave the union and no country can imagine another country would leave. Interesting comments, but from a market point of view, they contained no new info.
ECB Weber also said that concerns about potential default by euro zone countries are unfounded. He defended the “no bail out” rule as indispensable instrument for preventing moral hazard behaviour. If help is needed for member states in case of extreme urgency, it would be conditional. He warned also against loosening any entry requirements for potential new EMU member states. Also his comments haven’t any immediate effect on the overall market.
The market will closely look to the results of the German auction of the 3.75% July 2019 Bund, (€5B) and Spanish a 4.60% July 2019 bond and a 4.90% July 2040 bond auctions(€4.6B). Together with the syndicated issues of Belgium and Finland, the market is facing more than €29B of gross issuance this week. There are no redemptions scheduled and only €3B of coupon payments. So the cash flows surrounding the auctions are unfavourable. The Bund auctions of recent went difficult, as investors shun the expensive German Bunds at auctions and dealers were reticent to snap them up. As a result, the Bundesbank recently retained a large chunk of the issues. Will this be also the case today? The Spanish auctions did better recently. The spread narrowing of recent will allow us to verify whether this remains the case. Belgium issued a new benchmark 5-year OLO (3.5% March 2015) for an amount of €5B. The book (€7B) exceeded the amount on offer. The issue was priced at 72 basis points above mid-swaps or 112 basis points above DBR 3.75% 2015. The issue attracted good demand, also because the 5-year sector was relatively cheap when compared to the wings.
The intra-EMU yield spreads showed little movements. Only Greece (-12 bps) and Italy -5 bps) showed a spread narrowing. Other government yield spreads were flat to 1 basis point higher versus Germany.
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, but also other EMU government bonds, albeit that this wasn’t very visible in yesterday’s trading. The technical picture of the Bund deteriorated after the drop below 122.97 (need confirmation) brought the Bund again in the lower part of the broader sideways trading range with bottom at 120.37 and top at 125.63. While the Bund opened slightly negative this morning, the dearth of eco data or other events together with oversold conditions point to more sideways trading pattern. We suspect that traders and investors will also be largely sidelined ahead of the FOMC statement to be released late today.
In the UK, the calendar heats up with the BoE minutes and February unemployment data. Earlier this month, the BoE decided to cut rates by 50 basis points and announced a programme of asset purchases. It will be interesting to see whether the decision to cut rates and start asset purchases was unanimous. Regarding unemployment, the jobless claims change is forecasted come out at 84 800 and the ILO unemployment rate is forecasted to have risen to 6.5% in January.
