Markets: Fixed Income
On Tuesday, government bonds moved higher on the back of the weaker than expected US retail sales and profit-taking seen in the US equity markets. Following the recent rally of more than 25%, the S&P 500 is now approaching first important resistance at around the previous highs at 877. This high-profile resistance incited investors to take some chips off the table, despite optimistic comments of US president Obama and Fed president Bernanke on the economic outlook. Obama indicated that the government plans were ‘starting to generate signs of economic progress, while Bernanke has seen ‘tentative signs that the sharp decline in economic activity may be slowing’. Bernanke added that ‘a levelling out of economic activity is the first step toward recovery’.
Sentiment on the US Treasury market was supported by the ongoing purchases of the Fed, which yesterday bought $7.3B of the outstanding issues maturing between 30/9/2013 and 15/02/2016. Hence, for the second day in a row, US yields declined quite substantially. 2-year yields were down by 2.4 basis points, 5- year yields by 8.3 basis points and 10- and 30-year yields respectively 7.4 and 5.6 basis points.
In the euro zone, the belly of the curve outperformed, as 5- and 10-year German yields fell by more than 5 basis points compared to 1.5 basis points in the 2- and 30- year segment. Hence, the short end underperformed despite some dovish comments of ECB’s Orphanides and Constancio (see below for more details) ahead of today’s German Schatz auction. The intra-EMU sovereign spreads traded stable to slightly higher.
Bund moves again higher in the range
Today, the euro zone data calendar remains thin, but in the US, the calendar is wellfilled with March CPI and industrial production data, the NY Empire State Manufacturing Survey (April) and NAHB housing market index (April). On a monthly basis, consumer prices are expected to have risen by 0.1% M/M in March, while the year-onyear figure is forecasted to fall into negative territory. Nevertheless, the risks might be on the downside of expectations after the unexpected decline in PPI, yesterday. Industrial production is forecasted to show its largest annual drop since June 1946, when it fell by 16.0% Y/Y. Especially the manufacturing sector is expected to remain weak as the index of average hours worked in manufacturing declined by 2.1% M/M In March. Last month, the New York empire state manufacturing index plunged to a new cyclical low (-38.23) and is expected to remain close to this level in April (-35). NAHB housing market index is forecasted to rise to 10 after stabilizing (at 9) in the previous two months.
On the supply front, Germany will tap its 2-year Schatz 1.25% March 2011 for an amount of €7B. Demand should be well supported by the favourable cash flows due to the redemption of a German Bobl on Friday for an amount of €18B. Yesterday, the Netherlands sold €2.025B of its 10-year benchmark. Although the amount was at the lower end of the pre-announced range, the auction appeared to be a success, as the spread over Germany remained stable in the aftermath of the auction. Yesterday, Austrian bonds underperformed their peers following some comments of Paul Krugman who said that Austria and Ireland may join Iceland in being close to default. The 10-year yield spread over Germany widened by 3 basis points. This morning, the head of central bank of Austria Nowotny however tried to ease concerns, as he stated in an e-mail that ‘the creditworthiness of the state of Austria and of the Austrian banking sector is beyond any doubt’. If sentiment on the equity markets deteriorates again following the recent impressive rally, increasing risk aversion may push the spreads again higher.
On the ECB front, the influential governor of the German Bundesbank, Weber, will speak today on ‘Ways out of the crisis’. Markets will again be looking for hints with regard to the unconventional measures the ECB may announce at their next policy meeting at the beginning of May. Yesterday, Orphanides, the head of the central bank of Cyprus, didn’t want to rule anything out, but said that ‘in the current context, I could see extending maturities to up to 12 months as a natural extension of the framework we already have in place’. With regard to the purchasing of assets he indicated that such purchases may still have their merits in an economy predominantly financed via the banking sector like the euro zone, as the financing conditions not only depend on the bank lending rates, but also on other rates in the commercial paper or corporate bond market. Both Orphanides and the governor of the Portuguese central bank, Constancio, sounded also very downbeat on the economic outlook. Orphanides pointed to a further downward revision of the ECB staff projections, while Constancio called the recession in Europe ‘as more accentuated than in the US’ and called on policymakers to undertake more action to support the economy. They however diverged slightly on the inflation outlook, as Orphanides said that the risk of deflation has increased somewhat and that weakness in world demand is likely to exert downward pressure on inflation, not only for this year, but also for next year and maybe beyond that. Constancio on the other hand said that ‘the risks of deflation’ don’t seem sustainable.
On the money market, the ECB will hold a 3-month longer-term refinancing operation at a fixed rate of 1.25%. Yesterday, the weekly refinancing operation saw strong demand, as the amount allotted and the number of banks participating rose to the highest level since January. This may indicate the banks are still very dependent on the ECB for their liquidity management and may signal some adverse effects from the almost zero interest rate policy.
Regarding trading, German bonds had a constructive session yesterday and the Bund is currently trying to move again above the neckline of the double top formation at 122.53. A sustained break above would improve the technical picture. In the US, the T-Note future yesterday already confirmed the break above a similar neckline at 122-24. Weaker than expected eco data, but also a change in sentiment on the US equity markets, now that the S&P 500 is coming close to important resistance at 877, contributed to the gains on the bond markets. From a very short-term perspective, the Bund may even come under the positive influence of a short-term double bottom formation with the neckline at 122.69 and the first target at 123.62. The recent developments suggest that the Bund isn’t ready for a test of the contract low at 120.37. At the shorter end of the curve, the Schatz underperformed slightly ahead of today’s auction. This should however pose no major problems given the supportive cash flows. As such, we remain positive on the short end of the curve.
In the UK, Gilts outperformed the German bond market, although the repurchase auction from the Bank of England showed again a high offer/cover ratio of 3.14. This indicates that investors were offering 3 times as much Gilts than the Bank of England was willing to purchase.
