Markets: Fixed Income
On Thursday, global bonds traded volatile as investors chew on the implications of the Fed decision to loosen its policy by expanding its balance sheet in a major way. The objective of the FOMC is to unclog credit markets and reflate the economy or at least avoid the vicious down spiral in growth to stop. However, in the end US investors decided to book some profit after the mighty post-FOMC rally. Weaker equities couldn’t bring support. EMU bonds had the opportunity to react to Wednesday’s eve FOMC decision and booked still good progress, even if they were well off their opening levels. In a daily perspective, the German curve steepened in a bull fashion with yields down between 1 (2-year) and 17 basis points (10-year). In the US, yields actually rose by 5 to 9.7 basis points, giving back small part of Wednesday’s major gains.
Intra-day, US eco data remained very weak, although not weaker than expected, but failed to impact trading. Initial claims fell slightly and the Philly Fed index on manufacturing improved a bit, but at -35 (up from -41.3) remains at distressed levels. EMU eco data were second tier.
The eco dataflow was thin. The US CPI (like the PPI on Tuesday) suggested that deflation fears are a bit overdone or at least a bit premature. Indeed, core and headline CPI were above expectations and suggested that the disinflation process is happening slower than previous reports had suggested.
US Treasuries hit by porift taking after tremendous post FOMC gains
The eco calendar is empty today. St-Louis Fed governor Bullard speaks on monetary policy at a Banque de France meeting. He is the first Fed governor to speak in public following the FOMC meeting of Wednesday. Fed governors Duke and Bernanke will also appear in public but on “Federal and State enforcement of financial consumer and investor protection laws” and on “the financial crisis and Community banking” While we don’t expect Duke and Bernanke to elaborate on for the market hot items, we will closely listen to eventual Bullard’s comments on the bold decision of Wednesday eve.
Yesterday, the Treasury announced the details for next week’s 2-, 5- and 7-year Note auctions. It will issue $40B of 2-year Notes (unchanged), and upped the size of the 5- and 7-year Notes by $2B each (compared to last month) to respectively $34B and $24B. The auctions will be held on Tuesday, Wednesday and Thursday next week and settle on Tuesday March 31. The 5- and 7-year Note auction will raise all new cash, while the 2-year Note auction will raise $22B new cash. The announcement and the auctions itself will keep the supply issue on the forefront.
The Fed announced the expansion of the eligible TALF collateral to ABS backed by mortgage servicing advances, ABS backed by loans or leases related to business equipment and ABS backed by leases of vehicle fleets. The NY Fed announced the results of the first TALF operation. Investors asked for $4.7B of TALF loans out of $200B on offer. There was no demand for student and SBA loans, $9B in auto TALF and $2.8B credit card loans. It is difficult to assess the success. It looks to be a bit sluggish to us, but the Treasury had already dampened expectations by predicting that demand for the financing would only gradually grow. Not all investors that had recently bought AB securities accepted/asked for the Fed financing.
Technically, the 10-year yield fell below 2.60%, neckline previous double bottom post FOMC and it now retesting the level. If confirmed that would again make the technical picture outright bullish. The 5-year yield (now 1.54%) made a technical important move too, dropping below a previous low (1.62%) and breaking below a bull flag (see graph below). This theoretically opens the way eventually for a retest of the cycle lows at around 1.20%, but also here the 1.62% is under retest. The 30-year yield on the contrary tested a similar important technical level at 3.40%, but failed already after the FOMC decision and remains well above these levels. The 2-year yield remains in a sideways range between 0.60 and 1.10%.
Regarding trading, yesterday traders booked some profit on the huge post FOMC gains, but the magnitude of profit taking is no reason for concern. According to some sources, the FOMC decision caused a substantial fall in mortgage rates that are again close to cycle lows. The 3-month Libor rate fell 6 basis points to 1.22% in the wake of the FOMC decision, dragging the liquidity spread (Libor- OIS) down to just below 100 basis points. The market reacted to the Fed statement that said “economic conditions are likely to warrant exceptionally low levels of the federal funds for an extended period of time”.For today, the calendar is extremely thin and uneventful. So it might be a quiet range-bound session with traders starting to look forward to a busy eco calendar and new supply next week. There might be a temptation for pre-weekend profit taking, as the weekly gains have been juicy, even after yesterday’s decline. Equities might be a factor of importance, but following two failed attempts to break above the key 804 resistance in the S&P, also here quiet conditions might reign.
Bund recouped important 122.97 level making the picture again bullish
Today, the calendar contains the euro zone industrial production figures (January) and the Italian unemployment rate. 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 even worse industrial production figure (by -4.0% M/M) after German industrial production plunged by an awful 7.5% M/M and French IP fell by 3.1% M/M. Also the record drop (5.2% M/M) in industrial new orders in December raises fears for a terrible industrial production figure. The Italian unemployment rate is forecasted to have risen to 7.0% (from 6.7%) in the fourth quarter of 2008.
Regarding trading, German bonds rose substantially in the wake of the Fed decision to expand its balance sheet. The curve flattened sharply with the 30-year sector lagging the 10-year though. Indeed, the US program to buy Treasuries is focussed on the 2-to-10-year sector and traders are speculating that the ECB should one day decide to buy bonds it might also focus on that segment. However, we think this kind of reasoning is way out of what the ECB may actual do. Buying of government bonds is probably only a measure of very last resort. Of course, the US decision led to a flattening of the German yield curve. Lower US 10-year yields dragged German ones down via the substitution effect. A factor of importance might become the EUR/USD currency pair. The last the EMU economy is asking for is a strengthening of the euro. It would put more pressure on the ECB to loosen policy further (via non-standardized measures). For today, given the absence of key data of other events, we expect sideways trading.
Technically, the Bund moved again above key support of 122.97, level that was temporarily lost on Tuesday. This makes the picture again bullish, but the topside of the 122.97 to 125.32/63 level looks still difficult to break. Similar picture appears for the 10-year yield that failed already four times to break below the 3/2.90% area. So, the German bond market is a bit blocked for the moment. We still favour to buy on dips, but preferable at yields around 3.30/40% (10-year) and 2.50% (5-year).
Following a substantial narrowing of intra-EMU government yield spreads in previous sessions, there was some widening yesterday. Especially Italy, Ireland and Spain underperformed. The announcement Ireland will bring a new bond might have played a role
In the UK, the calendar is empty today.
On March 25 the BoE announced it would start purchasing corporate bonds. The scheme is designed to provide a backstop offer to purchase small amounts of a wide range of high quality sterling corporate bonds in order to aid secondary market liquidity and thus to facilitate market-making by banks and dealers. Eventually, the BoE is ready to make small purchases of bonds issued by banks under the government’s Credit Guarantee Scheme if market conditions deteriorated.
Regarding, the reverse Gilt auctions, the BoE announced it would buy £6B worth of Gilts next week (Monday-Wednesday in two reverse auctions of respectively £2.5B and £3.5B (6 and 7 different lines).
BoE chief economist Dale was rather optimistic in his comments saying that Britain is already a long way through recession, but hedging his comments by adding that a more prolonged downturn cannot yet be ruled out. He sees the economy begin growing again by the end of the year and expand at normal rates throughout 2010. Asked what the BoE would do if things deteriorated further he replied that it would do more (in terms of quantitative easing. All in all, the interview didn’t contain real new information.
