Markets: Fixed Income
On Wednesday, the much smaller fall in the ADP employment figures and optimism on this evening’s outcome of the US financial stress tests buoyed recent positive sentiment on the global financial markets. While the stress tests will indicate that some banks will need more capital, investors reacted relieved on indications that the gap would be manageable without more government intervention. As a result, financial stocks soared yesterday pushing the US equity indices again higher. The rally on the equity markets was once more confirmed in the commodity markets, where the CRB index gained more than 5 points. During the morning session, the better than expected services PMI in the euro zone and the UK had also contributed to the positive sentiment.
The improvement in risk appetite continued to weigh on the government bond markets, as investors switch government bonds for more risky assets. The losses on the bond markets remained however quite limited, especially in the US, where the 10- year Note auction attracted strong demand by investors. In a daily perspective, US yields were unchanged to slightly higher. The 3-year sector however underperformed heavily with a rise of 4.3 basis points following the purchase of $6.948B of the 3-year Note by the Fed. The offer/cover ratio was very high at 5.47, as $37.983B offers were submitted. The 30-year sector also underperformed ahead of today’s auction. In the euro zone, the German yield curve steepened ahead of today’s ECB meeting. The improvement in risk appetite was also reflected in a further narrowing of the intra- EMU sovereign spreads.
ECB to decide on ‘non-standard’ measures
Today, all eyes are focused on the monthly policy meetings of the ECB and the Bank of England, as the eco calendar is rather thin and only contains the German factory orders (March) and US weekly claims. German factory orders are forecasted to have dropped by 1.0% M/M in March, the seventh consecutive monthly decline. Nevertheless, the pace of decline may have softened in March after the recent improvements in German business confidence indicators. In the week ended May 2, initial claims are projected to stay broadly unchanged from the previous week at 635 000 (from 631 000). Continuing claims, on the contrary, are forecasted to extend their upward trend to 6 350 000 (from 6 271 000). In the coming weeks, initial claims might climb somewhat higher due to GM and Chrysler plant shutdowns.
Especially, the ECB’s press conference will attract a lot of attention today, as the ECB has announced a decision on additional unconventional measures for this meeting. The rate decision itself shouldn’t be a surprise, as the ECB has well signalled another 25 basis point cut in the main policy rate to 1%, while the deposit rate will be left unchanged at 0.25% in order to prevent disruptions in the money market. The question however remains whether the 1% level will be the bottom of the cycle and what for unconventional measures the ECB may decide on. Based on recent comments from the ECB’s executive board, the unconventional measures 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. As such, the ECB is likely to refrain from following 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 debt securities in order to ease financing conditions. If the ECB were to decide to purchase assets, commercial paper is the most likely option, as the short-term nature of these securities would limit the credit risk the ECB is taking on board even in case of less high graded companies and would make it easier for the ECB to unwind the policy compared to longer-term bonds. This would indeed happen automatically once they come on maturity.
On the supply front, France and Spain are planning to tap the market in the euro zone, while the US Treasury will conclude its refinancing operations with a 30-year Bond auction for an amount of €14B. Spain will tap the shorter end of the curve (3- and 5-year) for an amount of €3.5-4.5B, while France will tap four longerterm OATs between 2017 and 2038 for a total amount of €6.5-8B. The auctions will all raise new cash, as there are no redemptions or coupon payments scheduled this week. Yesterday, both the German Bobl as well as the US 10-year Note auction were well received.
Regarding trading, the German yield curve steepened sharply yesterday, as 2-year yields fell by 3.4 basis points compared to a rise of respectively 2.9 and 4.2 basis points in 10- and 30-year yields. This underlines the increasing upward pressure on longer-term yields which has been highlighted by the break higher in US 10- and 30- year yields last week. Whether a lengthening of the ECB refinancing operations combined with a commitment to keep rates low for a given period of time will be sufficient to keep longer-term yields at very low levels in the euro zone remains to be seen. In both Canada and in Sweden, longer-term yields have continued to trend upwards afterwards in line with the rising trend on the global bond markets. As such, if the recent break higher in longer-term US yields, equities and commodities is confirmed following today’s ECB meeting and bank stress tests as well as tomorrow’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 remain intact, 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 outperformed the German bond market on the back of strong demand for the 10-Gilt auction. The bid/cover in the auction was 2.5 compared to 1.82 in the previous auction, while the tail of 0.2 basis points was also very small.
Today, the Bank of England is expected to leave rates unchanged at their monthly policy meeting. But also here the focus will be on the unconventional measures the Bank of England has taken and more specifically whether the Bank will maintain its target of £75B of asset purchases.
