Markets: Fixed Income
On Tuesday, global bonds failed to gain much ground on the back of the losses in the equity and commodity markets, as supply concerns came again to forefront.
Ahead of the start of the US earnings season yesterday evening, investors continued to take profit on the recent rally in the equity and commodity markets and sent the S&P500 more than 2% lower. Just like on Monday, global bonds couldn’t really benefit from the increased risk aversion. Bonds moved slightly higher during the European session, but the rally soon ran out of steam once US traders joined, even though US equities lost further ground. There were no market-moving data on the calendar and also the 10-year TIPS auction failed to move the market.
In a daily perspective, there was a slight bull steepening of both the US and German yield curve. In the US, 2- and 5-year yields were down by respectively 3.2 and 3.7 basis points compared to 2.6 basis points in 10-year yields and 1 basis point in 30-year yields. In the euro zone, German 2-year yields declined by 4.7 basis points following some dovish comments of ECB’s Provopoulos who suggested that the repo rate may fall below 1%. His comments were however denied later on in a statement of the central bank of Greece. 5-year yields fell also by 2.4 basis points, while 10-year yields were unchanged and 30-year yields even up by 1.8 basis points. Outside Germany, yields rose slightly more as the intra-EMU spreads widened around 3 basis points on the deterioration in global market sentiment. There was also limited reaction on the new budget plans in Ireland.
Short end of the European yield curve outperforms
The calendar remains thin today as it only contains some second-tier data with the German factory orders (February). From September last year, German factory orders have showed sharp declines each month. For February, a more modest drop is expected (-2.1% M/M) as car orders rose recently due to the introduction of the scrap bonus. Nevertheless, a sixth consecutive monthly decline is forecasted.
On the supply front, Portugal will tap the market today. The tap of the 3-year OT 5% June 2012 for an amount of €0.75B shouldn’t pose too many problems, given its short-term maturity and the rather small size. Yesterday, Austria sold €0.88B in 10- year bonds and 0.55B in 30-year bonds. Although the bid/cover was slightly lower compared to the previous auction of the respective bonds, there was no underperformance of Austrian bonds in the wake of the auction. Overall, the recent narrowing of the intra-EMU sovereign spreads halted yesterday in line with the deterioration in sentiment on the equity markets.
Ireland yesterday unveiled its emergency budget plans to restore order to public finances. Within the budget the creation of a ‘bad bank‘ got much attention, as Ireland will be the first euro zone country to take such dramatic action. Under the plans, Ireland will set up a national management agency that will take over an estimated €80-90B of bad loans in return for government bonds. The PM acknowledged that the move ‘will result in a very significant increase in gross national debt’, but said that the cost of servicing the debt would be met ‘as far as possible from income accruing from the assets of the new agency’.
On the ECB front, ECB’s executive board member Stark yesterday criticized the G20 decision to create $250B in special drawing rights as potentially inflationary. ‘That is pure money creation, that is helicopter money for the globe’, he was quoted as saying in the German Handelsblatt. His comments highlight the concerns within the ECB’s governing council with regard to the longer-term impact of quantitative easing and do suggest that the ECB will continue to follow a more cautious approach compared to the Federal Reserve and the Bank of England when they announce new non-standard measures at their next meeting in May. As such, the ECB may limit its non-standard action to an extension of the maturity of its refinancing operations and/or the purchasing of short-term commercial paper. Yesterday, the Greek governor Provopoulos sounded more dovish than some of his colleagues when he suggested the ECB could reduce the repo rate to below 1%. The central bank of Greece however issued a statement afterwards in which it said that his comments were inaccurate reported. This supports our view that the 1% level may prove the bottom of the cycle. Regarding non-standard measures, Provopoulos indicated that the ECB should focus its efforts on commercial banks given their dominant role in the financing of the euro zone economy. He however did not want to exclude the purchasing of corporate debt.
On the money market, the ECB will hold a special long-term refinancing operation for a maturity of 6 months. Since the ECB has begun to provide unlimited liquidity at a fixed rate against a broader range of collateral, the tensions in the money market have decreased significantly. This is reflected in the substantial decline in the liquidity spread, which has brought down the Euribor rates towards the official policy rate. The provision of unlimited liquidity has also led to a fall in the eonia rate to below the policy rate closer to the deposit rate, as there is now more liquidity in circulation than needed (which is also some form of quantitative easing). However, since the peak in January at €857B, we have seen the amount of liquidity injected via the refinancing operations declining to €662B. This may indicate that banks have improved their liquidity management or that they, in a context of deleveraging, are not willing to lend more.
Regarding trading, German bonds failed to gain much ground on the turnaround in sentiment in the equity markets, even though the short end outperformed. The outperformance of the short end may still continue, as we were surprised by the extent of the losses on the back of the ECB rate decision last Thursday and see no reason why short-term yields should move higher in a context where the ECB is discussing more non-standard easing. At the longer end of the curve, we remain more careful, as the short-term technical picture is still bearish following the break below the neckline of a short-term double top at 122.54. The Bund should recoup this level to improve the short-term technical outlook. A sustained fall below the 122.11 level on the other hand would raise the odds for a test of the contract low at 120.37, which would also correspond with the targets of the double top formation. Therefore, these levels look ideal to install new long positions.
In the US, the short-term technical picture of the T-Note future is also bearish following the fall below the neckline of a double top formation at 122-24. Here, much attention will go out to the Minutes of the latest Fed meeting and the upcoming supply with today a 3-year Note auction. Supply concerns have flared up again, especially at the longer end of the curve, following the disappointing auctions in the UK (see below) and this morning in Japan. Japanese 5-year yields rose to their highest level since December last year, on the back of the auction results which showed a sloppy bidding (large tail).
In the UK, Gilts again underperformed the German bond market following another disappointing Gilt auction. Indeed, following the disappointing 30- and 40- year Gilt auctions, this time the 10-year Gilt auction was quite poorly received with a long tail of 3.3 basis points compared to 1.8 basis points at the previous auction.
Today, the DMO will tap a longer-term inflation-linked Gilt 1.25% 2032 for an amount of €1.1B. Over the past weeks, inflation-linked Gilts have been well received by investors, as the quantitative easing policy of the Bank of England has raised longerterm inflationary concerns. Yesterday, the Bank of England purchased £43.17M of corporate bonds and will offer to buy again 146M today.
