Markets: Fixed Income
On Thursday, the sell-off on the longer end of the US Treasury market continued and spilled over towards the European and UK bond markets, despite aggressive easing action from the ECB and the Bank of England. As expected, the ECB cut the main policy rate by 25 basis points to 1% and extended the maximum maturity of the refinancing operations from 6 to 12 months. However, the announcement to start buying covered bonds for an amount of about €60B and allow the EIB access to ECB refinancing indicates that the ECB is prepared to take whatever action is needed to support the euro zone economy. Earlier in the day, the Bank of England had already taken the markets by surprise by increasing its asset purchase facility by £50B to £125B. The move of the Bank of England could however only temporarily support the Gilt market. Profit-taking on the US equity markets was of no help too, as the sell-off in US Treasuries accelerated following a disappointing US 30-year Bond auction.
This resulted in a sharp bear steepening of the US and European yield curves. In the US, 2-year yields rose by 3.2 basis points, while 10- and 30-year yields rose by respectively 17.8 and 21.1 basis points. In the euro zone, German 2-year yields rose by 4.2 basis points, although Trichet kept the door open for more interest rate cuts, when he explicitly said that the governing council hadn’t decided that 1% would be the lowest level. The fact that rates are currently ‘appropriate’ however suggests that no rate cut should be expected at the next meeting. At the longer end of the curve, German 10- and 30-year yields rose by respectively 14.1 and 15 basis points. As a result, German 10-year yields are close to the upside of its longer-term sideways range between 2.9/3% and 3.4%, while 30-year yields are closing in to the January highs at 4.20%. The intra-EMU sovereign spreads continued to narrow sharply on the back of the general improvement in risk appetite.
German yields test key resistance levels
Today, the calendar contains the German industrial production figures (March), but all eyes will be on the US payrolls report (April). After the better than expected ADP employment report on Wednesday, markets will have raised their expectations for a better payrolls report. Therefore, the current Bloomberg consensus of 600 000 can be considered as outdated. We believe that a Payrolls report of below 500 000 will be needed to surprise the market in a positive way, while a report of above 550 000 will be considered as disappointing. As we have our doubts on the significant improvement in the ADP report, which may be partially due to the distortions in the seasonally adjustment of the claims, we see risks for a disappointing Payrolls report. Besides the headline number, we also keep a close eye on the temporary help agencies, as signs of improvement in the labour market might appear first in this index. German industrial production is forecasted to drop by 1.3% M/M in March.
At the same time, markets will still digest yesterday’s ECB rate decision and unconventional measures. The step from the ECB towards quantitative easing or call it credit easing with the purchase of covered bonds opens the door for more asset purchases if needed. Combined with the possibility that the policy rate may still fall further, this should limit the upside in both short-term and longer-term yields. From a technical point of view, German 5-, 10- and 30-year yields are now close to very important resistance levels at respectively, 2.60%, 3.40% and 4.20%. A sustained break above would dismiss our call for range trading. This is however not our main scenario, even though the break higher in longer-term US yields has indicated that the balance of risks for longer-term yields has shifted from the downside to the upside. Therefore, we now prefer a sell-on-upticks instead of a buy-ondips approach. Besides the German bond market, we are also close to similar important resistance levels in equity and commodity markets, with the S&P 500 and CRB index close to the January highs at respectively 943 and 245. These strong resistance levels may incite first some profit-taking following the recent impressive rally higher and provide some support for bonds too. In case of a break higher on the equity and commodity markets, this would be a clear warning signal to the bond markets that the sell off is not over yet and would warrant a stop loss on existing long positions.
In the UK, Gilts outperformed the German bond market yesterday on the back of the surprise increase in the Bank of England’s asset purchase facility. UK yields were nevertheless still higher on the day and stand currently above the levels when the Bank first announced its purchase facility.
