Markets: Fixed Income
On Tuesday, global bonds extended their recent gains on month-end and quarter- end buying. Indeed, bonds remained well supported despite the rebound on the equity and commodity markets. The eco data were very weak with euro zone headline inflation falling to a record low and German unemployment rising more than expected. In the US, the decline in house prices continued to accelerate, while the Chicago PMI fell to a new cycle low and consumer confidence could barely rebound following the plunge in the previous month.
On daily basis, yields fell by 4.7 to 6.9 basis points in the US compared to 2.8 to 3.2 basis points in the euro zone. Despite the positive sentiment on the equity and commodity markets, the intra-EMU spreads widened slightly with Irish bonds underperforming. The spread between Irish and German 10-year yields widened by 9 basis points following Monday’s evening’s downgrade of Ireland from AAA to AA+ by S&P.
Bund nearing first important resistance levels
Both in the euro zone and in the US the calendar contains unemployment and business confidence data.
In the US, the ADP employment report is forecasted to show a decline in employment by 663 000 in March. Especially the development in continuing claims raises fears that another awful labour market report is in the offing and also the initial claims remained at record high levels in March. We have no clear reasons to distance ourselves from the consensus as all available evidence points to another very weak labour market report. In the euro zone, the unemployment rate is expected to have risen to 8.3% (from 8.2%) in February, but the risks might be on the upside of expectations. The ISM manufacturing index is expected to show its third consecutive improvement in March. The headline index is forecasted to rise from 35.8 to 36.0. We have a neutral view on the outcome, as the regional surveys showed a mixed picture. In the euro zone, the final figure of manufacturing PMI is expected to confirm the first outcome of 34.0, which was slightly higher than in February.
Yesterday, the OECD urged the ECB to follow the example of the Bank of England and the Federal Reserve to start a more aggressive quantitative easing policy. In its quarterly forecasts the OECD stated that ‘the growing disinflationary pressures anticipated during the next two years’ implied that the “remaining scope for cutting policy rates should be used quickly and quantitative easing policies implemented’. The statements highlight the immense pressure on the ECB ahead of Thursday’s policy meeting to take more unconventional measures. Recent comments of ECB governing council members have indicated that a further lengthening of the refinancing operations beyond the current maturity of six months is likely, but on Friday ECB vice president Papademos suggested that the ECB could also purchase private debt securities in the secondary market. Although a short-term commercial paper facility is an option, we think the ECB will first want to see more evidence of a credit squeeze before embarking on such a policy. For a complete preview on the upcoming ECB meeting, we refer to our ECB flash on our website.
On the supply front, Greece sold €7B of its 5-year benchmark 5.5% August 2014 at an asset swap spread of 225 basis points compared to 260 basis points at the issuance. Nevertheless, intra-EMU sovereign spreads widened again with the Irish spread up 9 basis points. The Austrian spread widened again three basis points, as Hungary saw its rating downgraded for the second time in as many days. Following the downgrade by S&P to BBB-, Moody’s lowered the rating from A3 to Baa1 and kept its negative outlook intact. Over the past months, Austrian bonds have proved quite sensitive to the developments in Central and Eastern Europe due to the huge exposure of its banking sector to the region.
Ahead of Thursday’s ECB meeting, the debate on the potential unconventional measures the governing council may take will continue to support the German bond market. Yesterday, German bonds had again a very strong session, as the bond market ignored the rebound on the equity markets and extended their recent gains. The Bund is now coming close to important resistance levels at 124.71 (previous reaction highs), at 125.63 (contract high) and at 126.53 (contract high on the continuation charts), where we would still favour at least partial profit-taking on existing long positions. Although we have a bullish view on the German bond market, we prefer a buy-on-dips approach, as the highs have been tested several times over the past months and have proved too tough to break above for now. In a short-term perspective, a break above the 124.71 would improve the technical picture, as it would paint a double bottom on the charts. Also in the US Treasury market, there is still some room on the upside available, as the first important resistance level in the TNote future is only seen at around 126-04.
In the UK, manufacturing PMI is expected to show a slight increase from 34.7 to 35.0, but the risks remain on the downside. Yesterday, the Bank of England bought £68.6M of corporate bonds and announced its plans to buy a maximum of 136M today.
On the supply front, the DMO will tap its 6-year Gilt 4.75% September 2015 for an amount of £3.5B. Following last week’s failed 40-year Gilt auction, the auctions will be closely monitored to see whether the investors’ are still willing to buy UK Gilts at these very low yield levels.
