Markets: Fixed Income
On Thursday, global bonds recouped early losses and eked out moderate gains, as supply concerns eased following a successful inflation-linked Gilt auction in the UK and a strong 7-year Note auction in the US. Technical factors have played a role too, as both the US and German bond markets had come close to important support levels. Hence, the ongoing improvement in risk appetite in global markets failed to cause more downward correction on the government bond markets. The eco data were however quite weak with continuing claims hitting a new record high, UK retail sales plunging and credit growth slowing sharply in the euro zone.
In the US, yields declined across the curve around 5-9 basis points ahead of today’s second round of Fed purchases of Treasury securities. In the euro zone, the German yield curve flattened following the recent steepening, as 2-year yields rose 0.7 basis points compared to a decline of 1.7 and 3.9 basis points in 10- and 30-year yields. Overall, the intra-EMU sovereign spreads narrowed further on the back of the improvement in risk appetite.
US Treasury multi-day correction is over
Today, the calendar contains the February personal income and spending data and final figure of Michigan consumer confidence (March). In January, personal spending showed its first increase (0.6% M/M) after six straight declines. For February, the consensus is looking for another slight increase (0.2% M/M). If confirmed, this paints a more positive picture for first quarter consumer spending after the sharp plunge in consumer spending in the last quarter of 2008. Personal income, on the contrary, is expected to decline somewhat (-0.1% M/M) after rising by 0.4% M/M in January. The PCE deflator is expected to show a slight rise (0.8% Y/Y from 0.7% Y/Y). The first estimate of Michigan consumer confidence showed a marginal improvement 56.6 (from 56.3) in consumer sentiment, while a slight deterioration was forecasted. The final figure is forecasted to show a slight upward revision to 56.8. There are no Fed appearances of which we are aware.
The Fed will conduct its second round of purchases of Treasury securities. This time it will target the 03/11 to 04/12 maturity sector. Settlement takes place on Monday. The Fed purchased a solid $7.5B of securities on Wednesday. Given its $300B program is expected to take 6 months, if the Fed again buys more than $7B it would indicate the Fed wants to frontload its program. We will also be curious whether the Fed will again buy substantial in the active issue, now the 3-year (03/12), as it did with the 7-year in the previous operation.
Treasury Secretary Geithner spoke about his reform program for the financial sector. It contains four chapters, notably systemic risk, consumer & investor protection, regulatory structure and international coordination. The first chapter was explained in more detail. It is based on six elements. Firstly, there will be the establishment of a single entity with responsibility for systemic stability. Systemically important firms will get special attention and will be identified by their size leverage and interdependence with the broader financial system, regardless whether it is a bank, insurance company, hedge fund or other. Secondly, the government will require institutions to have more capital and will introduce countercyclical elements in the system. Thirdly, all hedge, private equity, and other investment funds above a specific threshold should register with the SEC. Fourthly, there will be a comprehensive oversight and disclosure for derivatives markets that will be complemented by central clearinghouses. Fifthly, the SEC will develop new requirements and guidelines for money market funds to make the industry "less susceptible to runs". Sixthly, Geithner proposes the creation of a resolution mechanism for failing nonbank financial firms that should resemble the current FDIC rules for failing banks. Geithner stressed that he was looking for a comprehensive reform, not a cosmetic one. Of course, the proposals will need to be specified and put into law by Congress. It will of course also be on the table of the G-20 when it meets next week.
The $24B 7-year Note auction (coupon 2.375%) went well, even if it was dealer dominated. Dealers upped their bid to $48.8B from $35B in the previous auction for a bid share of 80.8% of total bid. The Dealer takedown amounted to 64.3%, up from 57.6% in the previous and first 7-year Note auction. Direct bid rose to $2.1B (from $1.1B) and was quite aggressive, as it showed a 85.12% hit ratio. The Indirect bid eased however to $9.4B from $10.1B in February and wasn’t aggressive too, at least compared to the dealers’ and direct bid, leading to an Indirect takedown of 28% well below last month’s 38.7%. The auction stopped at 2.384%, slightly below the 2.388% in the WI trading at the moment of the stop and the bid/cover of 2.52 compares to February’s 2.1. Concluding, the auction went successful with strong demand and aggressive bidding. The upped interest of the dealer and Direct bid might be due to the Fed’s purchase program that offers opportunities to eke out some profits.
Regarding trading, the technicals and a strong 7-year Note auction helped Treasuries yesterday higher for the first time in six sessions. The market tested the downside and key support (122-28+ for the June Note future) ahead of the US session, but the inability to sustain gave way to some bottom fishing. Later on, a rally developed helped by a strong 7-year Note auction and relief that the monthly funding operation was off the table. Equities that were stronger too didn’t play a major role. For today, the eco calendar is not really important and events are missing too. The Fed second round of purchasing Treasury securities at the shorter end of the curve will attract attention, but it isn’t yet clear in which way it exactly might drive the market, except ofcourse for its underlying general positive impact. There may be some support for longer-dated Treasuries from the end-of-month extension motive, but we haven’t the precise information about the lengthening of duration of the relevant index. Equities did better than we expected yesterday, but nevertheless the rally should be nearly in for some at least pause following one of the best monthly results in decades. While the tight correlation between equities and Treasuries has loosened recently, correcting equities would be a positive. Overall, Treasuries still seem to be in mostly sideways trading. Following the most recent downward correction, there should a tendency for Treasuries to move higher in the range.
So, in the shorter term, we stick to our buy-on-dips strategy with the ideal entry levels (122-28+ June Note future) reached in yesterday’s session. 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. 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).
Papademos suggests ECB may buy corporate bonds
Today, the calendar contains the January industrial new orders and German CPI inflation data (March). Industrial new orders are forecasted to show their sixth consecutive monthly decline in January. After falling by a steep 5.2% M/M in December, the consensus is looking for a decline by 5.6% M/M in January. But the data are rather outdated and therefore, no market reaction is expected. Last month, euro zone inflation rose by 0.4% M/M, which might have been due to the unwinding of strong discounting in January. In Germany, inflation is forecasted to have risen by 0.1% M/M (EU harmonised) in March, after increasing by 0.7% M/M in February. On a yearly basis however, CPI inflation is forecasted fall below, 1% (0.7% Y/Y). Yesterday, the inflation data of North Rhine-Westfalen however showed a larger decline from 0.9% to 0.3% Y/Y, which puts the risks on the downside for the overall figure too.
On the supply front, Italy will sell €1B of its 2.35% September 2019 and 0.5B of its 2.1% September 2017. Yesterday’s successful inflation-linked Gilt auction in the UK indicates that demand for linkers is quite strong at the moment, as concerns are rising that the policy measures against deflation may lead to an inflation spike further out. The intra-EMU sovereign spreads continued to narrow, with Irish 10-year yield spread over Germany plunging another 10 basis points despite awful Q4 GDP figures, which showed the economy contracting an incredible 7.1% Q/Q. Overnight, Spanish PM Zapatero suggested that Spain could step up its fiscal stimulus plans because its government debt was still only 38-39% of GDP, much less than euro zone average of 68%. According to the EU Commission forecasts the debt-to- GDP ratio is however already expected to rise sharply to 53% over the next two years, as the budget deficit may mount to 7% of GDP this year. Although his new plans may lead to a further deterioration of the public finances, the impact on the Spanish spread may remain limited and will mainly depend on the overall market sentiment on risk appetite. Yesterday, the Dutch spread narrowed further despite their new stimulus plan for an amount of €6B.
On the ECB front, ECB vice-president Papademos again indicated that the ECB could take more unconventional measures to support the credit markets and reduce the cost of funding. He thereby pointed to an extension of the maturity of the refinancing operations, in line with recent comments from other ECB governing council members. Although Papademos also mentioned the possibility of purchasing private debt securities in the secondary market, he stressed that in the euro zone the banking system has a more dominant role in the financing of the private sector than the capital market. As such, we expect the ECB to focus first on a restoring of the monetary transmission mechanism before purchasing corporate bonds. A decision on the potential lengthening of the refinancing operations can already be expected at next week’s monetary policy meeting, when the ECB is widely expected to cut rates by 50 basis points to 1%.
Regarding trading, German bonds rebounded yesterday on technical buying and an easing in supply concerns following a successful inflation-linked Gilt auction. Hence, although market sentiment remained quite positive, the downward correction halted and the Bund even rebounded before a real test of last week’s lows at 122.11 occurred. Ahead of next week’s ECB meeting, where the ECB will not only cut interest rates, but is also likely to announce an extension of its refinancing operations we expect sentiment on the German bond market to improve again, as such an extension would also have a downward impact on longer-term interest rates. We however continue to play the recent range in the Bund between 122.11 and 125.30/63, as the highs may remain too tough to break above.
In the UK, Gilts continued to trade volatile following the failed 40-year Gilt auction on Wednesday and amid the reverse-auctions from the Bank of England. Yesterday, Gilts underperformed the German bond market despite the much weaker than expected retail sales and a successful inflation-linked Gilt auction.
Today, the calendar is thin as it only contains the final figure of fourth quarter GDP. The final figure is forecasted to show an unchanged reading of -1.5% Q/Q and no major adjustments in the sub-indices are expected. There are also two speeches from the Bank of England. Chief economist Dale will speak on the UK economic outlook at a conference in London, where also David Miles will speak. Miles will replace Blanchflower from the June meeting onwards and will speak on fiscal policy and other risks facing the economy. Deputy Governor Tucker responsible for financial stability will participate in a panel discussing the international responses to the causes of the global banking crisis.
