Markets: Fixed Income
On Tuesday, global bond markets traded broadly sideways, as equity and commodity markets digested the recent gains. Hence, optimistic comments from Fed’s Bernanke and a better than expected ISM non-manufacturing survey couldn’t really move the markets. Bernanke said the Fed continues ‘to expect economic activity to bottom out, then to turn up later this year,’ and ‘the housing market is beginning to stabilize and that the sharp inventory liquidation that has been in progress will slow over the next few quarters.’ US equity markets closed the session slightly lower, but nevertheless confirmed Monday’s break higher, improving the technical outlook for equities.
Yesterday, US Treasuries again underperformed the European bond market, despite a strong 3-year Note auction. As a result, US 30-year yields stand still above German 30-year yields following last week’s break higher above the 4% level. In a daily perspective, US yields rose by 2 basis points across the yield curve, while in the euro zone German yields fell between 2.6 and 4.2 basis points. Other European bond markets still performed better, as the intra-EMU spreads continued to narrow.
European bonds outperform US Treasuries
Today, the calendar contains the euro zone retail sales (March) and final figure of services PMI (April). In March, retail sales are forecasted to show the first monthly increase in ten months. The consensus is looking for a marginal increase by 0.1% M/M. The final figure of services PMI is expected to confirm the uptick seen in the first estimate, but the risks might be on the upside of expectations. In the US, the calendar contains the ADP employment report. In April, the ADP report is expected to show a job loss of 645 000, slightly less pessimistic than the March ADP report (-742 000). We don’t have a reason to distance ourselves from the consensus as we believe it might be too early to expect a significant improvement in labour market conditions. Also the development in initial and continuing claims points to another very weak labour market report.
On the supply front, Germany will tap its 5-year Bobl 2.25% April 2014 for an amount of €6B, while the US Treasury will hold a 10-year Note auction for an amount of $22B. Yesterday, both the Austrian and US 3-year Note auctions were well received.
With regard to tomorrow’s ECB policy meeting, we have issued a flash in which we outline our ECB strategy. Regarding the interest rate decision, no surprise should be expected, as several council members have pointed to another 25 basis points rate cut in the main policy rate to 1%, while the deposit rate is likely to be left unchanged. The question however remains whether the 1% level will be the bottom. At the same time, the ECB has also announced a decision on additional nonconventional measures. These will likely take the form of an extension of their refinancing operations towards the banking sector, combined with a commitment to keep policy rates at low levels for a prolonged period of time. Recent comments have shown reluctance to follow the quantitative easing policies of the Bank of England and the US Federal Reserve, which recently started to purchase government bonds as well as some private sector securities. In our flash, we summarize the choices the ECB governing council faces and what the implications for the European bond market may be.
Regarding trading, European bonds outperformed the US Treasury market yesterday. As such, the Bund is still within its recent tight sideways range between 123.47 and 121.61. A confirmation of the break higher in US 10- and 30-year yields may however also have implications for our strategy with regard to the European bond market, as US and European longer-term yields tend to move in tandem. The simultaneous break higher in longer-term US yields, equities and commodities (CRB) suggests that the current upward correction in yields, equities and commodities is more than just a bear market rally. Indeed, the improvement in the technical pictures suggests that the global economy is bottoming out, which fits well with the recent improvement seen in the leading confidence indicators. If this break higher in longer-term US yields, equities and commodities is confirmed following Thursday’s ECB meeting, the bank stress tests and Friday’s US Payrolls report, this would indicate that the risks for longer-term yields have shifted from the downside towards the upside. Although we expect the longer-term range in German 10-year yields between 2.90%/3% and 3.40% to hold, we would be more careful to go long bonds in the event of upward corrections in German 10-year yields towards 3.40%, and instead prefer short positions when yields approach the historic lows at around 3% in German 10-year yields.
In the UK, Gilts underperformed the German bond market yesterday, as Gilts had to catch up Monday’s losses on the European and US bond markets. Gilts however limited the underperformance, as they rallied higher on the back of a very low offer/cover ratio in the Bank of England’s Gilt purchasing operation.
Overnight, the UK data continued to surprise on the upside, as the consumer confidence indicator rebounded from 42 to 50. Later on today, the calendar still contains the services PMI. In April, services PMI is forecasted to show the fifth consecutive improvement. The headline index is expected to rise from 45.5 from 46.3, but the risks might be on the upside of expectations after the upward surprises in both manufacturing and construction PMI.
