Markets: Fixed Income
On Friday, US Treasuries were hit by ongoing mild profit taking, a reaction on the huge post-FOMC gains. There were no eco releases and comments by Bernanke didn’t contain new info. So, in thin trading, the overnight gains evaporated during the US session and sliding equities brought no help. In a daily perspective, the 2- and 5- year yields were little changed, while the longer end, 10- and 30-year yields went up by 3 basis points.
EMU bonds showed a completely different trading pattern. Sideways trading in the morning session gave way to a rally in the afternoon session that left bonds with good gains. In yield terms, the 2-, 5- and 10-year fell by 7.5, 6.4 and 7.1 basis points, while the 30-year yield shed 5.7 basis points. The trigger for the rally was comments from ECB Weber and ECB Wellink who both clearly indicated that the ECB has room to cut rates. Weber also suggested that the ECB could ease policy further by lengthening the duration of its repo-operations beyond the 6-month that is currently the longest maturity. Also in EMU, trading was thin though.
In EMU, the intra-EMU government bond yield spreads narrowed with Greece (-14 bps) and Ireland (-8 bps) the eye-catchers. The narrowing occurred despite the ECB denying that there was an emergency plan to help governments that would face severe financing needs.
Treasuries corrected mildly lower on Friday, still digesting post FOMC gains
This week, the calendar is extremely well filled. There are a number of interesting economic reports scheduled to be released, while Fed speakers will address the markets following last week’s surprise FOMC decision to expand its balance sheet in a fairly aggressive way. Besides these, supply remains in the focus with the Treasury issuing 2-, 5- and 7-year Notes for a considerable amount. Last, but not least, Treasury Secretary Geithner will unveil its plan to purchase toxic assets in collaboration with the private sector.
Regarding the economic reports, today, the eco calendar contains only the Existing Home Sales (February) and the Chicago Fed National Activity Index for February. In January, Existing Home Sales surprised on the downside of expectations, as they dropped by 5.3% M/M (to 4.49M) after showing an unexpected rise in the last month of 2008. In February, Existing Home Sales are forecasted to have dropped by a more modest 0.9% M/M (to 4.45M), but the risks might be on the upside of expectations after the better than expected housing starts and permits last week. However, one should take into account that the sales are heavily influenced by the forced sale of foreclosed houses. Therefore this series has behaved much better than other housing data throughout the housing crisis. On Wednesday, New Home Sales are scheduled for release. In February, new home sales are expected to show their seventh consecutive decline after falling sharply (-10.2% M/M) in January. We don’t exclude an upward surprise in this week’s housing data, but builder’s confidence remains close to the lows and also inventories are still very high. After last week’s New York en Philadelphia Fed, this week we will receive the Richmond Fed survey. Last week’s business confidence data were mixed with the NY Fed headline index deteriorating, while the Philly Fed painted a less negative picture, but the details remained very weak. The Richmond Fed is forecasted to come out broadly unchanged and we have no reasons to distance ourselves from this forecast. On Friday, Michigan consumer confidence is forecasted to confirm the first outcome at 56.6 and on Wednesday, the durables are expected to show their fifth straight monthly decline. Durables are forecasted to have dropped by 2.2% M/M in February after falling by 4.5% M/M in January. Part of the decline is expected to come from weaker civilian aircraft orders. On Thursday, the final figure of fourth quarter GDP is forecasted to show a downward revision from 6.2% Q/Q to 6.6% Q/Q, but this piece of news is in the mean time outdated.
The Treasury will issue this week a package of $98B in 2-, 5- and 7-year Notes. The auctions take place on Tuesday, Wednesday and Thursday and settle on Tuesday 31 March. As only one 2-year Note matures ($18B), the operation will raise another hefty $80B in fresh cash. The size of the 2-year Note auction has been kept unchanged at a record $40 B, but the amounts of the 5- and 7-year Note auctions have been upped by $2B to respectively $34B and $24B. The last two 2-year Note auctions went reasonable well with aggressive bidding and good participation of the buyside. The 5-year Note auction is often sloppily bid, but not last month, while the 7- year Note will only be auctioned for the second time since its reintroduction. The first 7-year Note auction went well, but this is not necessarily a good pointer for this month’s auction. It remains to be seen whether there is already an investor constituency for this maturity. The Fed’s decision to purchase up to $300B Treasury papers mostly in the 2- to-10-year maturity bucket is of course a support for the auctions, even if the $300B is not so huge when compared to the issuance of $98B this week. So, the auctions are another test for investors’ appetite in Treasury papers.
We count the appearance of at least nine Fed governors (of which 8 regional Fed presidents) throughout the week. These are interesting as it will be the first speeches since the surprise FOMC/FED decision last Wednesday to aggressively expand its balance sheet. So, the governors will come out to explain these decisions to the markets and the public. Fed chairman Bernanke testifies tomorrow on the AIG case before a House Committee. We won’t dig into all these speeches beforehand, but signal that Boston Fed president Rosengren testifies today on Funding Credit for Small and Mid-size businesses in Massachusetts. On Friday, St-Louis Fed Bullard was the first to kick off the Fed speakers’ parade. He said there was a genuine risk of deflation and monetary policy was focussed on preventing this from taking root.
Treasury Secretary Geithner will unveil its long awaited plan at 12h45 GMT to facilitate the purchase of toxic assets on the banks’ balance sheets. In an interview Geithner yesterday already spoke about his plan to the press. It envisions the creation of a series of public-private investments to soak up $500 to $1000B in troubled loans and securities. To encourage investors to buy these assets, the US government will offer lucrative subsidies (including cheap finance in exchange for collateral) and shoulder much of the risk (non recourse loans). Taxpayers will share in the eventual gains if the investments prove ultimately profitable. The new rules on executive pay that are applicable on firms receiving government money won’t be applicable for these operations. According to the press (NYT), the plan takes a three-pronged approach. Firstly, the FDIC will set up special purpose investment partnerships and lend about 85% of the money needed to buy up troubled assets. Secondly, the Treasury will match the private money that each of the firms puts up on a dollar-fordollar basis with government money. Thirdly, the Treasury plans to expand landing through the TALF. As private investors will bid in auctions against each other for the assets, the government hopes to buy them at a deep discount. The plan looks still very complicated and some crucial details are still missing (what interest will be charged). If the price is very low, the question remains whether banks will agree to sell the assets and when the price is “too high”, the private investors may be unwilling to participate. This problem prevented the TARP in its original concept to work. So, big uncertainties remain, but at least in Asia, equity markets are happy with the plan and book gains of about 3%.
Regarding trading, yields fell sharply last week after the FOMC announced a big expansion of its balance sheet. Before the FOMC meeting and on Thursday and Friday, Treasuries declined. However, especially the losses on Thursday/Friday were mildly and even healthy given the outsized gains on Wednesday evening. The technical pictures of the Treasuries improved with the exception of the 30-year one that remained unchanged. The very long end was disappointed that the bulk of Fed purchases of Treasuries would happen in the 2-to-10-year maturity buckets. Other credit markets profited too and corporate supply was again hefty. Looking to this week’s Treasury trading, two potential obstacles are the new supply and the Geithner plan. If the Geithner plan would be favourably received and trigger a return of risk appetite and thus an equity rally, Treasuries might have a difficult time, even if recently Treasuries and equities not always moved in lockstep. Also overnight, the decline in Treasuries, albeit in very thin trading, is very modest given the gains in equities. Supply is the other hurdle. Against these negatives, the Fed’s plan to purchase Treasuries remains of course a positive, while the technicals are also positive. For the June Note future a drop below 122-28+ would deteriorate the picture, while resistance stands at 126-04. Despite Wednesday’s big rally, we aren’t overly bullish on Treasuries. We would play the range short term, buying around 122-28+ and selling around 126-04/24 (last week high/contract high). In a longer term perspective, the aggressive Fed policy clearly includes key risks for Treasury investors. Therefore unloading some of the long positions around contract highs should be considered.
ECB unlikely to buy government bonds anytime soon
Today, the calendar is thin as it only contains the euro zone trade balance (January). Last month, the trade balance showed an unexpected narrowing in the trade deficit. The deficit shrank from 4.0B to 0.3B as both imports and exports declined. For January, the consensus expects the deficit to widen to 1.9B. As traditional for periods of recession, both imports and exports are forecasted to have dropped in the first month of 2009. Tomorrow, the calendar heats up with March PMI figures. Last month, manufacturing PMI dropped to a new cyclical low (33.5) and the consensus expects an unchanged reading for March. Indeed, we might see some stabilization at these very low levels, but we have no clear view on the risks surrounding consensus. Also services PMI dropped to a new cyclical low last month, with all sub-indices showing a further deterioration. For March, the consensus is looking for a stable outcome in the services sector too. One day later, we will receive the German IFO indicator which is also expected to stay broadly unchanged. On Thursday, the M3 money supply and credit growth data are scheduled for release. In January money supply growth slowed significantly (5.9% Y/Y from 7.5% Y/Y) and a further slowing is expected for February. More attention will however go to the lending data.
On the ECB front, ECB president Trichet and German central bank governor Weber both suggested that the ECB isn’t likely to follow other central banks in announcing large-scale asset purchases. Instead, the ECB still prefers to work through the bank channel and appears to be discussing a further lengthening of its liquidity- providing operations. Since October last year, the ECB is offering unlimited amounts at fixed interest rates for up to six months. A lengthening of their refinancing operations could ‘lift market confidence, as well as lower longer-term rates’, Weber said on Friday. Trichet defended the ECB’s preference to work via the bank channel by stressing that in the euro zone most private-sector funding comes from banks, while in the US the securities market is much more important. Another option the ECB could take would be a further widening of the collateral accepted in the refinancing operations. Aside, Weber also indicated that the ECB still had ‘room for manoeuvre’ thereby suggesting that the ECB could cut rates again at the April meeting. Trichet also repeated that the ECB could cut rates below the current record low of 1.5%, but said that rates close to zero have ‘drawbacks’ and are not ‘appropriate’ in Europe. Trichet also defended the European governments against the US calls for more fiscal stimulus saying that Europe doesn’t need to boost spending more to combat the global financial crisis.
On Friday, the intra-EMU spreads continued to narrow, although several officials denied there was a rescue plan between the euro zone governments and the ECB to help member states that would face severe financing problems. The narrowing of the spreads since mid March mainly reflects the general improvement in risk appetite also visible in other markets like the equity markets and does support our view that most of the widening was due to risk aversion and only to a minor extent to a heightened default risk.
Regarding trading, the eco calendar looks rather uneventful today. The toxic assets plan of Finance Minister Geithner (see US part for more details) will attract most attention. In Asia, equity markets started the week on a strong footing, despite the losses on Wall Street on Friday. If this is good indication for today’s trading, European bonds may struggle to make further headway. Also from a technical point of view, strong resistance is very close now in the Bund at around 124.70 (previous reaction high) and at 125.63 (contract high). These levels look still too tough to break above, the more as the ECB is unlikely to buy government bonds anytime soon. Therefore, we stick to our buy on dips approach and look to take (at least partial) profit on existing longs in case of a test of the highs. The euro of course remains a wildcard, as further strong gains of the single currency to above 1.40 against the dollar would put additional downward pressure on European yields and threaten our strategy.
