Markets: Fixed Income
On Wednesday, global bonds traded mainly lower on supply concerns and hopes that the worst of the economic crisis has passed. Rather weak 5-year bond auctions in Germany and the US and a failed 40-year Gilt auction in the UK brought supply concerns again to the forefront of investors’ minds. At the same time, the US eco data (durable orders/new home sales) again surprised on the upside, while the German IFO, although falling to a new record low, contained a glimmer of hope as the expectations component rose for the third consecutive month.
In the euro zone, German bonds closed the session little changed, although the very long end of the curve underperformed. Hence, 30-year yields were up 4 basis points compared to 0.9 basis points in 2-year yields and 1.2 basis points in 5-year yields, while 10-year yields even declined slightly by 0.3 basis points. Regarding the intra-EMU sovereign spreads, the narrowing continued reflecting the general improvement in risk appetite. The highest spreads narrowed the most with Ireland (-13), Greece (-11) and Italy (-6) outperforming.
In the US, yields were up across the curve in the wake of the 5-year Note auction and despite the first Fed Treasury purchases for an amount of $7.5B. Yields were up between 4.6 basis points in 2-year yields and 10.3 basis points in 30-year yields.
US Treasuries decline for fifth consecutive day
Today, the eco calendar isn’t very eventful and contains the final figure of fourth quarter GDP and the weekly jobless claims. Last month, Q4 GDP was sharply downwardly revised from -3.8% Q/Q to -6.2% Q/Q due to downward revisions to several components. The final figure is expected to show another downward revision to - 6.6% Q/Q. Last week, initial claims came out slightly lower than expected at 646 000. For the week ending March 21, the consensus is looking for a broadly unchanged figure (650 000). Continuing claims, which are reported with a one-week lag, are forecasted to come out marginally higher (5 473 000 from 5 475 000). We have no reasons to distance ourselves from these expectations.
Fed speakers on duty might be a more important feature in today’s trading and include Dallas Fed Fisher, Atlanta Fed Lockhart, Minneapolis Stern and Richmond Fed Lacker. Treasury Secretary Geithner testifies to the House Financial Panel on regulation. According to news reports, Geithner would focus on a stricter regulation of hedge funds. It is a preparation on the G-20 meeting that takes place on April 2. We suspect Geithner will receive questions on AIG and on its private/public Investment Program. Last, but not least, the Treasury will hold a $24B 7-year Note auction.
The Fed purchased a sizeable $7.5B of outstanding Treasury issues maturing between 02/29/16 and 02/15/19. The operation generated a 2.9 offer/cover. The Treasury tapped 13 different issues with the 02/16 (the active 7-year Note), 08/16 and 05/17 by far the largest ones for a combined amount of about $4.8B. The active 7- year, the most important for the mortgage market was well tapped, probably no coincident and targeted because of its impact on the pricing in the mortgage market. This might be a tactic that will be used in other sectors too. The Fed will probably also take into account the pricing. Seven issues in the sector weren’t tapped. The amount of $7.5B is big and probably won’t be so high in the next auctions. If it would, the purchase of $300B over the next 6 months would be exhausted after about 15 weeks.
The $34B 5-year Note auction (coupon of 1.75%) couldn’t replicate the success of the 2-year Note auction that took place on Tuesday. Indeed the auction stopped at 1.849%, well above the 1.802% bid in the WI trading. The bid/cover of 2.02 fell slightly short of the 2.12, but as the size has been upped sharply in recent months, that wasn’t a bad result. Indirect bidding accounted for 30% of the takedown which is quite healthy, given the average of 14.4% since the Treasury switched to monthly, end-of-month 5-year Note auctions in February 2006. The dealer bid was a record. Concluding, the 5-year Note auction attracted quite good demand, but the bidding was distinctively sloppy. Today, the monthly funding operation of $98B will conclude by the conduct of a $24B 7-year Note auction. The auction will raise all new cash at settlement on March 31 since no 7-year Notes mature. It is only the second 7-year Note auction since April 1993 when the Treasury stopped issuing the sector. The first auction in February didn’t go particularly well. Indeed, the auction stopped at 2.748%, well above the 2.732% bid in the WI trading at the time of the stop. The bid/cover amounted to 2.11 while the indirect bidders took down 38.7% of the auction. As it was the first 7-year Note auction since April 1993, there is little relevant history available to compare the results of today’s auction with. The large purchase of the Fed in the active 7-year yesterday during yesterday’s buy-back operation is a positive though, as investors might see additional possibilities to gain.
Regarding trading, the correction in Treasuries continued for a fifth day and reached now important support (June Note future). The gradual and slow erosion during most of the session was exacerbated after the 5-year Note auction turned out to be sloppily bid. Treasuries abruptly shifted down, testing the important 122-28+ (June Note future) that held though and led to a small rebound. The 7 and 30-year sectors underperformed; the former ahead of today’s 7-year Note auction, the latter probably because of its outperformance in Tuesday’s session. Both the 5- and 10-year yield moved above resistances at 1.75% and 2.75%, technically negative signals. Looking to the drivers of the price action, surprisingly better eco data, now New Home sales and durable orders, slowly make investors think that the economy might be in a less bad shape than expected until recently. Equities traded volatile yesterday, but ended positive via a late session rebound, which in the light of recent performance isn’t bad at all.
Regarding trading today, the eco data should be on the backburner with equities, technicals and maybe Fed officials of a greater influence. While equity price action was rather encouraging, we think that the up-leg that started on March 6 might show signs of exhaustion and should be followed by a pause/correction. This could give Treasuries some respite and a rebound. The 7-year Note auction is of course still a hurdle, but market may also be relieved that the financing operation is off the table once the results of the 7-year Note has been published. So, in the shorter term, we stick to our buy-on-dips strategy and have reached levels where such a strategy may be implemented. The general MT outlook for Treasuries is bullish (technicals), but there are risks longer term preventing us to become wildly enthusiast for Treasuries at current levels (see higher). Therefore, we play the range short term, buying around 122-28+ (June Note future) and selling around 126-04/24 (last week high/contract high).
Failed 40-year Gilt auction puts supply concerns again on the forefront
Today, the eco calendar contains the euro zone M3 money supply and credit growth data (February) and the French consumer confidence indicator (March). In January, M3 money supply growth and bank lending slowed sharply. For February, a further slowing from 5.9% to 5.5% Y/Y is expected and also lending to households and companies are forecasted to have declined further. French consumer confidence is forecasted to come out marginally lower (-44 from -43).
On the supply front, Germany yesterday sold only €5.713B of its new 5-year Bobl 2.25% April 2014, as the Bundesbank retained €1.287B for its own market operations. The amount retained as well as the bid/cover ratio of 1.3 was in line with the inaugural auctions of the previous two 5-year benchmarks, but nevertheless indicates that demand for German bond auctions remains rather weak. Yesterday, the German Finance Agency also revised its issuance plans for the rest of the year. The Agency announced that the supplementary budget and the Investment and Redemption Fund will increase the borrowing requirements by €23B in the second half of 2009. The major part of the increase will be done in Bubills (15B), while the Schatz will be increased by 5B and the 30-year Bund by 3B. By doing the most in short-term Treasury discount papers, Germany wants to keep the impact of the additional supply on German yields very limited. On the European bond market, Slovenia yesterday issued also a new 5-year benchmark 4.375% April 2014 for an amount of €1.5B. The issue was priced at a spread of 160 basis points above mid-swap and 205.9 basis points above Germany. Overall, intra-EMU spreads continued to narrow benefiting from the improvement in risk appetite. The Irish spread over German 10-year yields for instance fell sharply for the second day in a row on the back of Tuesday’s successful auction. Since the peak at 283 basis points last week, the spread has now declined by almost 50 basis points to 234 basis points. Based on the plunge in the CDS of Ireland, a further narrowing can still be expected.
Yesterday, the Dutch government announced a new stimulus plan for an amount of €6B to be spent over the next two years. This will lead to a further deterioration of the Dutch public finances. Last week, the government already increased the budget deficit forecast for next year from 5.2% to 5.4% of GDP, the double of what the EU Commission forecasted only back in January. It will be interesting to see whether this will also have an impact on the spreads. Yesterday, the spread over Germany still narrowed, but the CDS on the Netherlands spiked 9 points higher from 83 to 92.5. Today, Wellink, the governor of the Dutch central bank, will present its annual report.
Regarding trading, German bonds traded volatile yesterday, but closed the session almost unchanged. This morning however bonds open again lower, as global market sentiment remains positive and supply concerns have again moved to the forefront due to yesterday’s disappointing UK auction and rather weak auctions in Germany and the US. This will mainly weigh on the longer end of the curve, where the Bund is moving closer to the first important support levels at around 122.11 (last week lows). A break lower would raise the odds for a test of the contract lows at 120.37 where we would install new long positions. Ahead of next week’s ECB meeting, we nevertheless expect the downward correction to shift into a lower gear, as the ECB is likely to cut interest rates again by 50 basis points and to announce an extension of its refinancing operations beyond the current maximum maturity of six months, which would also have a downward impact on longer-term interest rates. Therefore, from a speculative point of view, new longs can already be considered at around 122.11.
In the UK, Gilts had a rollercoaster ride yesterday, as they fell sharply on the back of the failed 40-year Gilt auction, but recouped the losses afterwards and rallied even sharply on the back of the Bank of England’s reverse-auction results (see graph).
Today, the calendar contains the February retail sales. In the previous months, UK retail sales constantly surprised on the upside of expectations and some even questioned the reliability of the series. Nevertheless, the consensus is looking for a decline by 0.4% M/M in February as weather conditions were awful with extensive snow at the start of the month and also the reversal of discounting might play.
On the supply front, the DMO will tap its inflation-linked Gilt 1.875% Nov 2022 for an amount of €1.1B. Yesterday, the UK failed to sell £1.75B of a 40-year conventional Gilt, as investors bid for only 1.63B. The failed auction comes on the back of a very difficult 5-year Gilt auction last week. Increasingly weak demand for Gilt auctions may reflect concerns about the state of the UK’s public finances, but also inflation concerns due to the BoE’s quantitative easing policy. The latter should be of no concern with the inflation-linked Gilts. Therefore, demand is likely to be better supported, although the Bank of England doesn’t buy linkers in its asset purchase facility.
Yesterday, the Bank of England bought £85.5M of corporate bonds and will hold another tender today for a maximum of 128M. The Bank also bought 3.5B Gilts, with a cover ratio of 1.4.
