Markets: Fixed Income
On Friday, global bonds fell sharply lower, as investors continued to reposition on a global economic recovery. Equities ended the week higher with many stock markets recording a sixth consecutive weekly rise. It was the belly of the yield curve that was hit the hardest both in the US and in Germany.
In a daily perspective, US yields were up by 6.5 basis points in the 2-year sector and by 8.4 basis points in the 30-year sector. The 5- and 10-year sector underperformed with yields rising by respectively 12.3 and 11.5 basis points. Hence, US 30- year yields closed at their second highest level since November last year.
In the euro zone, German yields were also significantly higher with 5-year yields up by 11.2 basis points compared to 9.8 basis points in 2-year yields and 9.5 basis points in 10-year yields. The 30-year sector outperformed with a rise of 4.7 basis points. The German government bond market underperformed their peers, as the intra-EMU sovereign spreads continued to narrow, except for Ireland which saw its AAA rating placed on review for a possible downgrade by Moody’s. The move didn’t however come as a surprise following the downgrades by S&P and Fitch earlier this year.
Bund testing the recent lows
Today, the euro zone calendar is empty, but later this week; we will receive the April business confidence indicators. Tomorrow, the German ZEW index is expected to jump back into positive territory for the first time since July 2007. Economic sentiment is expected to have improved from -3.5 to 2.0, according to the current consensus. If confirmed, we shouldn’t become too enthusiastic, as the ZEW index has lost much of its correlation with the other confidence indicators. Therefore, we will look for confirmation in the real business confidence indicators. On Wednesday, manufacturing PMI is forecasted to show its second consecutive improvement. The consensus is looking for an outcome of 34.7 (from 33.9). On Friday, the German IFO indicator is scheduled for release.
In the US, the calendar contains the March leading indicators. Although interesting, the indicator is rather outdated and shouldn’t contain much new information. Later this week, a number of housing data are scheduled for release. After the improvement in housing market conditions in February, it will be interesting to see whether this progress can be sustained or whether it was just a one-time correction. On Friday, the durables are expected to fall back after the rebound in March.
On the supply front, it will be a very quiet week, as only Ireland will tap the European bond market and in the US, there is only a 5-year TIPS auction scheduled. Last week, the intra-EMU sovereign spreads continued to narrow especially at the shorterterm maturities, as they benefited from the overall improvement in risk appetite and the decent auctions from the Netherlands, Germany, France and Spain. For the second week in a row, the net cash flow will also be positive with large redemptions from Greece (9.29B) and Austria (5.55B). This could result in an outperformance of both countries, as these funds are likely to be reinvested in Greek and Austrian bonds.
On the ECB front, we look out for the comments following the ECB nonmonetary policy meeting on Thursday. At this meeting, the ECB governing council is likely to search for a consensus on the non-standard measures they will announce at the policy meeting in May. Until now, most governors have backed the idea of a lengthening of the maturity of the refinancing operations up to one year, but on the purchasing of private debt securities is still much uncertainty. Last week, the influential governor of the German Bundesbank, Weber, said that those market interventions should continue to be less important compared to the measures taken to increase bank lending. The purchasing of government bonds looks no option. At the May meeting, another rate cut of 25 basis points looks a done deal, but whether 1% will be the bottom is still open for debate. Nevertheless, a lengthening of the refinancing operations to one year will likely be seen as a signal from the ECB that rates will remain low for a prolonged period of time, which is also likely to have a downward impact on somewhat longer-term yields. But whether this will be sufficient to keep also the very long end (10- to 30-year yields) at very low levels remains to be seen. Therefore, we continue to prefer a steepening of the European yield curve.
Over the weekend, ECB’s executive council member Bini Smaghi downplayed the deflation fears and suggested that 1% could indeed be the bottom for the repo rate. Bini Smaghi said that it’s important to be able to hold the key rate at a ‘certain level’ without boosting liquidity and inflation expectations too much and added that ‘we are very close to this level’. He also warned against loosening monetary policy too much because of ‘exaggerated deflation fears’.
Regarding trading, German and US government bonds fell sharply lower on Friday, with the Bund testing the recent reaction lows in the 121.61 area. A sustained break below would again raise the odds for a re-test of the contract low and target of the double top formation (neckline 122.53) at around 120.37. Such a downward correction should be seen as an opportunity to install new long positions. At the shorter end of the curve, we hold on to our more positive view given the outlook for further monetary easing in the euro zone. Besides the eco data this week, a lot of attention will continue to go out to the US and European equity markets, which are currently testing important resistance at the February highs. In the S&P 500 this level comes in at 877. Today, Bank of America and Texas Instruments will publish their Q1 results.
In the UK, Gilts still underperformed the German bond market in spite of the asset purchase programme by the Bank of England. This week a lot of attention will be focused on the new budget, which will be presented on Wednesday. The budget may highlight again the rapid deterioration in public finances and the difficult choices the UK government is currently facing.
Overnight, there was again some positive news out of the UK housing market with the Rightmove house price index showing a third consecutive monthly rise.
