Markets: Fixed Income
On Monday, government bonds were under severe pressure, as equities recouped part of last week’s steep losses and rallied sharply higher. The S&P500 closed more than 3% higher, even though no major eco data were on the calendar. This may indicate that underlying sentiment remains positive and suggests that another test of the January highs at 943 may be in the making. Commodities benefited too from the increase in risk appetite, as the CRB index reversed Friday’s losses to remain close to the January highs. Government bonds were also weighed down by massive corporate issuance both in the US and the euro zone and ongoing government bond supply.
In a daily perspective, there was a huge bear steepening of the US yield curve with 2-year yields up 5.6 basis points, while 5, 10 and 30-year yields rose by around 10 basis points. Hence, the Fed purchase of $3.180B Treasuries maturing between 15/8/2019 and 15/2/2026 failed to prevent the sharp increase in longer-term yields. Interestingly, the increase in longer-term yields was completely due to an increase in the break even inflation rates, which rose to their highest level since September last year, at 1.6% for the 10-year break even inflation rate.
In the euro zone, the major part of the sell-off in the bond markets happened after the official closing and is as such not yet reflected in the cash market. Bond yields are however expected to open sharply higher this morning.
German 10-year yields again testing the upside
Today, the calendar contains the German ZEW index (May) and the US housing starts and permits (April). Last month, the German ZEW index jumped back into positive territory, for the first time since July 2007. The current situation however deteriorated further in April. In May, the German ZEW index is expected to continue its upward trend (20 from 13). In February, both housing starts and permits showed some improvement, but it appeared only short-lived in March. For April, the consensus is looking for a slight rise in both housing starts (520 000 from 510 000) and permits (530 000 from 516 000). We have no clear view to distance ourselves from the consensus.
On the supply front, Ireland will tap the market today, as it plans to sell €0.75- 1B of its 5- and 10-year benchmark. Yesterday, Belgium sold €2.46B of three different bonds in the 5-, 6- and 10-year maturity sector. The success of the Belgian auction indicates that demand for non-German debt is strong, as the increase in risk appetite has resulted in a hunt for spreads. This is also reflected in the huge success of the corporate bond market. According to the ECB euro area securities issues statistics for March, the annual growth rate of outstanding debt securities issued by nonfinancial corporations has increased from 7.9% in February to 8.9% in March. The increase is completely due to long-term debt issuance, which rose by 17.5% Y/Y in March. The success of the corporate bond issuance has also resulted in a huge spread narrowing and may have also contributed to the increase in longer-term government bond yields, as investors switched from longer-term government bonds to longer-term corporate bonds.
On the ECB front, ECB’s Kranjec and Tumpel-Gugerell are scheduled to speak. Last week, Kranjec suggested that the ECB may spend more than the €60B it announced at the latest ECB policy meeting. His comments contrasted with other governing council members, like Weber, who insisted that 60B is the maximum. The divergent comments from the ECB may be a positive for the European bond market, as it may keep hopes alive that the ECB in the end may also decide to buy government bonds.
Regarding trading, yesterday’s trading action indicates that the underlying sentiment is still quite upbeat, as equities and commodities reversed part of last week’s losses and remain close to key resistance levels at 943 in the S&P500. A sustained break higher could also have major implications for the European bond market, where German 10-year yields are again testing the upside of its sideways trading range at 3.40%. Therefore, a sustained break higher in the equity markets is likely to go hand in hand with a break higher in longer-term yields. In the US, 10- and 30-year yields are still above the necklines of their multiple bottom formation at respectively 3.05% and 3.85%. As such, yesterday’s trading action puts our sideways trading range between 2.90/3% and 3.4% in German 10-year yields under severe strain, but we don’t front-run on a break higher.
In the UK, the calendar contains the CPI data. In April, CPI inflation is expected to remain below the 2% target in the UK. The consensus is looking for a decline from 2.9% Y/Y to 2.4% Y/Y and also core CPI, excluding food and energy, is forecasted to come out slightly lower (1.6% Y/Y from 1.7% Y/Y).
