Markets: Fixed Income
On Friday, global bonds traded mixed, as US Treasuries reacted positively to the US Payrolls report, while European bonds, which had lagged the sell-off in US Treasuries over the past two weeks, fell still lower. The US Payrolls report came out close to expectations, as markets had already been anticipating a stronger report in the wake of the better ADP employment report and confidence surveys. As such, the release of the Payrolls report sparked a wave of short-covering in the US Treasury market and to a lesser extent also on the European bond market. US equity markets however extended their rally higher, as financials responded positively to the outcome of the stress tests in the US financial sector.
In a daily perspective, US yields fell off the recent highs on the back of the US Payrolls report. Hence, 30-year yields, which had been testing the November highs at 4.35% earlier on the day, declined by 3.7 basis points to close at 4.25%. 10-year yields fell by 5.4 basis points, while 2- and 5-year yields fell by respectively 1.6 and 3.4 basis points. In the euro zone, the picture was completely different, as the rise of longer-term German yields drove the German yield curve still steeper. 2- year German yields fell by 6.6 basis points, while 10- and 30-year yields rose again by more than 6 basis points. Both 10- and 30-year yields thereby broke above the January highs and are now at their highest level since November last year. As a result, the spread between 2- and 10-year German yields rose to new highs above 200 basis points. The other European bond markets still outperformed the German bond market, as the improvement in risk appetite drives the intra-EMU sovereign spreads ever lower.
Bund testing key support levels
Today, the calendar is thin as it only contains the French and Italian industrial production figures (March). Both French and Italian industrial production are forecasted to have declined further in March. For Italy, the consensus is looking for a drop by 2.0% M/M in March, while French industrial production is expected to have dropped by 0.5% M/M. We believe the risks might be on the upside of expectations after the better than expected German industrial production data last Friday. Later this week, euro zone industrial production is forecasted to show the seventh monthly consecutive drop. On Friday, the euro zone calendar heats up with the first quarter GDP figures and the final figure of April CPI inflation. Euro zone first quarter GDP is expected to show an even sharper contraction than in the final quarter of 2008. The headline figure is forecasted to come out at -2.1% Q/Q, from -1.6% Q/Q. The final figure of April CPI is expected to confirm the first estimate of 0.6% Y/Y. Core CPI, excluding food and energy, is forecasted to show a slight uptick (1.6% Y/Y from 1.5% Y/Y). In the coming months however, CPI headline inflation is expected to decline further and to become temporarily negative.
In the US, the calendar is empty today, but later this week, the April retail sales, CPI inflation data and first confidence indicators for the month of May are on the agenda. Last month retail sales surprised on the downside of expectation (-1.2% M/M) which might have been due to the timing of Easter. For April, the consensus is looking for only a marginal decline, but the risks might be on upside of expectations, due to the timing of Easter. This month, it will be interesting to see whether both consumers’ and producers’ sentiment will be able to extend its recent rebound from record low levels. CPI inflation is forecasted to have fallen further below zero in April (-0.6% Y/Y from - 0.4% Y/Y).
On the supply front, issuance activity will be moderate this week, as only the Netherlands, Portugal and Italy will tap the market and there are no auctions scheduled in the US. Last week, most auctions went smooth, except for the US 30- year Bond auction on Thursday where bidding has been rather sloppy. Despite the moderate issuance activity this week, the net cash flow will be highly negative, as no redemptions or coupon payments are scheduled. Given the upward pressure on longer-term yields, attention will mainly go out to the longer-term auctions from Portugal and Italy, which respectively plan to tap the 14- and 30-year sector. Today, Italy will detail the amounts it plans to sell.
Regarding trading, the longer end of the German bond market underperformed the US Treasury market on Friday, as the Bund had been lagging the break lower in the US T-Note and long bond future. As such, the Bund is currently testing key support at 120.37 and a sustained break lower would deteriorate both the short- and the longer-term technical pictures. In yields, German 10- and 30-year yields are currently above the January highs. The positive reaction of the US Treasury market on the US Payrolls report may however indicate that the sell-off on the bond markets has gone far enough for now, unless equities would extend their recent rally higher and break above the January highs at 943 for the S&P500. Recent trading action has nevertheless signalled that the balance of risks for longer-term yields has shifted from the downside to the upside. Therefore, we now prefer a sell-onupticks instead of a buy-on-dips approach at the longer end of the curve, but would wait on a correction higher before installing such short positions.
In the UK, the calendar is empty today.
