Markets: Fixed Income
On Monday, markets were in a correction mood following the impressive rally higher seen in the equity and commodity markets over the past few weeks. The decline in risk appetite helped government bonds to recoup some of last week’s substantial losses. As such, government bonds rebounded off the recent lows, while the S&P500 and the CRB commodity index failed to break above the January highs. There were however some upbeat comments from ECB president Trichet and Fed president Bernanke, but awful industrial production figures from France and Italy reminded investors of the depth of the recession.
In the US, the rebound in US Treasuries got additional support from the Fed purchases, as the Fed bought $3.51B of Treasury issues maturing between 15/08/2026 and 15/02/2039, while there is no supply scheduled for this week. This led to a substantial decline in yields, with 2- and 30-year yields falling around 8 basis points and 5- and 10-year yields even more than 10 basis points.
In the euro zone, there was some correction on the recent sharp steepening of the German yield curve, as the 2-year sector underperformed the rest of the yield curve. Hence, 2-year yields bucked the downtrend and rose by 3.3 basis points, while 5-year yields fell by 2.6 basis points and 10- and 30-year yields by respectively 5.9 and 5 basis points. The decline in risk appetite was also reflected in the intra-EMU sovereign spreads, which widened slightly.
German 10-year yields fall again below 3.40%
Today, the calendar remains thin as it only contains the French business confidence survey from the Bank of France (April) and the US trade balance (March). In France, business confidence is forecasted to have improved from 73 to 75 in April, but the data are rather outdated after the PMI’s. In the US, the trade balance is expected to show a widening deficit in March (-$29.0B to -$26.0B). Exports are forecasted to be down due to a significant decline in capital goods, while imports came out somewhat higher due to a rise in petroleum products.
On the supply front, the Netherlands will tap its 3-year benchmark for an amount between €2.5-3.5B. The auction will raise all new cash, as there are no redemptions or coupon payments scheduled. Nevertheless, we don’t expect any problems to get the bond sold, as short-term auctions have been well bid recently. Yesterday, Italy detailed the amount it plans to issue on Thursday. Italy plans to sell between €2.5-3.5B of its 4-year BTP, 0.75-1.5B of its 6-year BTP and 1.5-2.5B of its 30- year BTP. Especially, demand for the 30-year BTP will be closely monitored, given the recent underperformance of the long end of the curve.
Regarding monetary policy, ECB’s Draghi, Tumpel-Gugerell and Weber are scheduled to speak today. Yesterday, ECB president Trichet sounded cautiously optimistic after chairing the bimonthly BIS meeting of central bankers in Basel, Switzerland. ‘As far as growth is concerned, we’re around the inflection point in the cycle’. ‘There is a general sentiment, as regards a number of risk premia, a number of features such as spreads’ that ‘we came back to the pre-Lehman situation’, he said. Trichet warned however that central bankers and policy markers should carefully consider how to withdraw from special stimulus measures launched during the financial crisis. ‘An exit strategy, or the path to a sustainable mode, is absolutely of the essence. It’s an essential part of confidence today and has been a feature of this meeting’ he added. Recently, increasing concerns about the longer-term impact/ unwinding of the unconventional measures have been seen as one of the key drivers behind the upward pressure in longer-term yields, for example in the US where the Fed has started to purchase Treasuries, but could not prevent longerterm yields from breaking above key resistance levels. In the euro zone, the ECB still focuses on improving the lending conditions via the banking channel, although it also announced to start buying covered bonds from June onwards. The ECB’s focus on the banking channel was supported by the latest MFI interest rate statistics report for the month of March, which once again showed a substantial decline in interest rates charged to households as well as non-financial corporations. The fall in interest rates indicates that the monetary transmission mechanism is still working in the euro zone, which is very important, as 70% of the financing of the economy goes through commercial banks.
Regarding trading, government bonds benefited from profit-taking seen in equity and commodity markets. The rebound put a bullish engulfing pattern on the screens both in the Bund as well as in the US T-Note future, which is a technical trend reversal signal that strengthens our view that the sell-off on the bond markets has gone far enough. As such, German 10-year yields couldn’t confirm Friday’s break above the 3.40% level, which keeps the sideways range between 2.90%/3% and 3.40% intact. Whether this will remain the case will largely depend on the equity markets, as a break higher in the S&P500 above the January highs at 943 is likely to coincide with a break higher in German 10-year yields. Last week’s trading action has nevertheless signalled that the balance of risks for longer-term yields has shifted from the downside to the upside. Hence, we now prefer a sell-on-upticks instead of a buy-on-dips approach at the longer end of the curve, even while new longs can be considered from a speculative point of view.
In the UK, Gilts outperformed the German bond market, except for the 30-year segment. Gilts couldn’t however really benefit from a strong reverse-auction, as investors may have been cautious ahead of today’s longer-term auction.
This morning, the BRC retail sales monitor and the RICS house price index surprised on the upside. Later on today, we still get the March trade balance and industrial production data. In March, the UK trade deficit is forecasted to have declined from £3248 to £3000, while industrial production is expected to show the thirteenth consecutive monthly contraction. On a monthly basis, industrial production is forecasted to have dropped by 0.9% M/M, driven by a 0.8% M/M decline in manufacturing.
On the supply front, the UK will tap a long-term conventional Gilt 4.75% December 2030 for an amount of £2.25B. At its last auction in November last year, the bid/cover was a low 1.37, while the tail was also large at 1.8 basis points.
