Markets: Fixed Income
On Thursday, global bonds continued to perform well, although equity and commodity markets rebounded slightly following Wednesday’s sharp sell-off. This reflects the more cautious underlying sentiment from investors in response to Wednesday’s disappointing US retail sales. Yesterday, US initial claims came out higher than expected, but had no large impact on trading, while in the euro zone the Spanish Q1 GDP data showed a sharp, but as expected, contraction of 1.8% Q/Q. The comments of several ECB governing council members indicated that the recent decision on buying covered bonds had failed to put them all on the same line.
In the US, there was a bull flattening of the yield curve, as 2-year yields fell by 2.4 basis points, while 10- and 30-year yields fell by respectively 3.1 and 5.1 basis points. Despite the recent decline, both 10- and 30-year yields are still above the recent highs seen at respectively 3.05% and 3.85%. The Fed yesterday purchased $2.975B of outstanding Treasuries maturing between 15/5/2010 and 28/2/2011.
In the euro zone, the German yield curve flattened too, as 2-, 5- and 10-year yields fell by respectively 2.3, 3.4 and 3.8 basis points. The 30-year sector underperformed, as 30-year yields fell by only 1.6 basis points. As a result, 10-year yields are again below the key 3.4% level, while 30-year yields are still testing the year highs at 4.18%. The more cautious mood from investors was also visible in the intra-EMU sovereign spreads, which widened again.
Bund extends rebound
Both in the euro zone and in the US, the calendar is well-filled today. In the euro zone, first quarter GDP and April CPI data are scheduled for release. The first estimate of euro zone CPI showed an unchanged reading in April. The final figure is expected to confirm the first outcome 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, CPI inflation is expected to decline further and to become temporarily negative. Euro zone first quarter GDP is forecasted to show an even sharper contraction than in the final quarter of 2008. The advance figure is expected to come out at -2.0% Q/Q from -1.6% Q/Q. We believe the risks might be on the downside of expectations following this morning’s awful German GDP data (-3.8% Q/Q) with business investment, inventories and net exports proving a serious drag on growth. Nevertheless, market impact might be limited as the market is already anticipating on an awful figure.
In the US, the calendar contains the April CPI data, the NY Empire State Manufacturing Survey (May), Michigan consumer confidence (May) and April industrial production. On a monthly basis, CPI inflation is expected to come out flat in April, while the yearly figure is forecasted to have fallen further below zero (-0.6% Y/Y from -0.4% Y/Y). The risks might be somewhat on the upside of expectations due to Easter. In April, US industrial production is forecasted to show the sixth consecutive contraction, but the pace of contraction is expected to have slowed in April (-0.6% M/M from -1.5% M/M). This month, both consumers’ and producers’ sentiment is forecasted to have improved further. In May, the consensus is looking for an improvement in the NY Fed from -14.65 to -12 and Michigan consumer confidence is forecasted to rise from 65.1 to 67.0.
On the supply front, there are no auctions scheduled for today. Yesterday, both Italy and Slovakia tapped the market. Italy sold just over €7B of three different BTPs including a 30-year bond. The auctions went reasonably taking into account the large amount on offer. Slovakia on the other hand sold €2B of a new 6-year bond via syndication at a spread of 170 basis points over mid-swap. The successful issuance comes barely one month after the failure to sell bonds with a maturity of 17 years. The auctions couldn’t however prevent the intra-EMU sovereign spreads from widening sharply yesterday. The 30-year yield spread between Germany and Italy for example widened 7 basis points yesterday to 118 basis points compared to a recent low of 92 basis points only a week ago.
On the ECB front, yesterday’s comments highlighted the divergent opinions within the governing council with regard to the quantitative easing policy as well as the rate outlook. On the one end of the spectrum, ECB’s Weber, Stark and Gonzalez-Paramo stressed there is no need to broaden the asset purchases and called interest rates ‘appropriate’, but on other end of the spectrum other members like Slovakia’s Sramko and Slovenia’s Kranjec indicated that the ECB is likely discuss other options on non-standard measures and suggested there had been no decision on a rate floor. Although the divergent comments may hurt confidence in the ECB and the economic policy response from the euro zone, it may be a supportive factor for European government bonds, as it keeps the possibility open that the ECB may buy government bonds and risks to prolong the recession in the euro zone.
Regarding trading, investors’ sentiment with regard to government bonds has improved over the course of the week, as the rally on the equity market halted and some eco data (US retail sales) surprised on the downside. As such, German 10-year yields failed to break above the year highs at 3.4% in a sustainable manner. Hence, the sideways range between 2.9/3% and 3.4% is still intact. A fall below 3.28% (previous reaction high) would suggest that the recent upward pressure in yields is abating. As such, new long positions may still be considered.
In the UK, the calendar is empty today.
