Markets: Fixed Income
On Wednesday, most markets failed to choose clear direction following a mixed bag of US eco data. US headline inflation showed a larger than expected decline in March and fell into negative territory for the first time since 1955, but core inflation held up better than expected. The NY Empire State Manufacturing Survey pointed to a significant improvement in business sentiment, but the sharp fall in March industrial production highlighted the still very weak conditions. The Beige Book confirmed this picture, as it indicated that the US economy is still contracting but at a slightly slower pace.
Also corporate earnings couldn’t convince, as markets reacted disappointed on the Q1 earnings of UBS, while pessimistic comments of Intel and Wall Mart added to the economic uncertainty. European equities closed the session mixed, but in the US, a late rally pushed the S&P 500 1% higher.
Government bonds benefited from some technical buying following the recent improvement in the technical picture and uncertainty about the economic outlook. In the US, the belly of the curve outperformed with 5- and 10-year yields down by 1.6 and 2 basis points compared to a slight rise by 0.8 basis points in the 2- and 30-year sector.
In the euro zone, German yields fell more substantially partly due to the overnight gains in the US Treasury market. The belly of the curve outperformed too with 5- and 10-year yields down by respectively 7.9 and 5.7 basis points and 2- and 30-year yields down by respectively 3.7 and 2.1 basis points. The intra-EMU sovereign spreads were little changed.
ECB’s Weber remains sceptical about asset purchases
The euro zone data calendar heats up today with the final figure of March euro zone CPI and the February industrial production data. According to the flash estimate, euro zone CPI halved in March (0.6% Y/Y from 1.2% Y/Y) and the final figure is expected to confirm this outcome. More attention might go to the core CPI figure, which is expected to drop from 1.7% Y/Y to 1.4% Y/Y. In January, euro zone industrial production showed a record drop (-3.5% M/M), driven by an awful German industrial production figure (-6.1% M/M). For February, a more modest decline is forecasted (- 2.5% M/M), as also German (and French) industrial production showed a softer decline.
In the US, the calendar is again well-filled with the housing starts and permits (March), the Philly Fed (April) and weekly claims. In February, housing data surprised on the upside of expectations and spurred talk that the worst in the US housing market might be behind us. Therefore, it is important to keep an eye on the March housing data to see whether this better performance can be sustained. The Philadelphia Fed is expected to show a marginal uptick (-32 from -35); while initial claims are forecasted to have stayed broadly unchanged in the week ended April 11.
On the supply front, Spain and France will tap the market today. Especially the Spanish auctions will be closely monitored, as Spain will tap the long end of the curve with a 10- and 15-year bond auction for an amount of €3.5-4.5B. France on the other hand, will tap three short-term BTANs and three inflation-linked OATs for an amount of respectively €6.5-8B and €1-1.5B. Yesterday, Germany sold €5.967B of its 2-year Schatz. The bid/cover was rather low, but this was mainly due to the lower amount retained by the Bundesbank compared to previous auctions and shouldn’t therefore be seen as a sign of weakness, as also the tail was small.
On the ECB front, ECB’s Liikanen will speak at a seminar on strategic intelligence. Yesterday, ECB’s Weber suggested the ECB will continue to focus its nonconventional measures on the banking system given its dominant role in the financing of the euro zone economy. Therefore, he again pointed into the direction of an extension of the maturity of the ECB’s refinancing operations. The purchasing of private debt securities in the secondary market should stand lower in the priority list, according to Weber. He also disputed that the monetary transmission mechanism isn’t working, as according to a study of the Bundesbank from October last year to February 75-80% of the rate cuts have been passed on in the bank lending rates to corporates, which is in line with previous cycles. Regarding the interest rate outlook, Weber said that the deposit rate has reached its bottom and repeated that according to him 1% is the bottom for the repo rate. Otherwise he added, the interbank market could come to a halt, while zero policy interest rates could also hamper the functioning of money market funds as well as the commercial paper market and make it more difficult for insurers to fulfil their obligations. Weber also indicated that the package of measures to be unveiled in May should be valid at least through 2009. This means that the ECB is determined to keep rates at very low levels for a prolonged period of time, which should also keep longer-term yields at low levels.
Regarding trading, German bonds moved substantially higher yesterday and the Bund is now again above the neckline of the double top formation at 122.53. The very short term technical picture even became slightly bullish as the Bund closed above the neckline of a short-term double bottom formation at 122.69. Also in the US, the technical picture of the T-Note has improved earlier this week and is again more neutral oriented. The recent developments suggest that the Bund isn’t ready for a test of the contract low at 120.37, but also the upside looks fairly limited, unless equity sentiment would deteriorate again. As such, we now have a more neutral view on the longer end, but are still looking for a downward correction before installing new long positions. At the shorter end of the curve, we still have more positive view for the 2- and 5-year sector, as the ECB is likely to indicate that rates will remain at very low levels for a prolonged period of time.
In the UK, Gilts sharply underperformed the German bond market on the back of the Bank of England’s repurchase auction for an amount of £3.48B, which showed again a rather high offer/cover ratio of 2.29. Yesterday, the Bank of England purchased also £8.71M of corporate bonds, which is again very low and highlights the difficulties the Bank of England is facing in the corporate bond market. The Bank announced that, from now on, it will hold only three instead of four corporate bond reverse auctions a week.
On the supply front, the DMO plans to sell £4B of its 5-year Gilt 2.25% 2014. Over the previous weeks, demand for longer-term conventional Gilt auctions has been disappointing raising some doubts about the success of the Bank of England’s quantitative easing policy. Inflation-linked Gilts in contrast have seen strong demand and this was also the case in yesterday’s inflation-linked auction.
