Markets: Fixed Income
On Thursday, the sell-off on the government bond markets showed some signs of easing, as US Treasuries rebounded slightly after the 7-year Note auction and ended the session higher for the first time this week. In the euro zone, government bonds were still mainly lower, as they had to catch up with the overnight losses in US Treasuries. Interestingly, US Treasuries and equities were again positively correlated, as equities reacted relieved that yields didn’t rise further and even fell back of their recent highs. The eco data didn’t play an important role in trading, as they were all close to consensus.
In a daily perspective, US 30-year yields reversed Wednesday’s gains and fell 14.5 basis points. As a result, there is a bearish engulfing trading pattern on the screens, which is a trend reversal signal. 10-year yields declined by 12.6 basis points, as investors took profit on the recent sharp steepening of the US yield curve with the 2/10 year yield spread setting record highs on Wednesday.
In the euro zone, German yields closed off the day highs. As such, German 10- year yields tested but failed to break above the key resistance level at 3.68%. A sustained break of this level would have suggested that the era of low long-term yields is over, but that is probably a bridge too far for now. Regarding the intra-EMU spreads, the spreads widened slightly, as the easy gains appear to be over.
Rally in German longer-term yields runs out of steam
Today, the calendar is again well-filled both in the euro zone and in the US. In the euro zone, the M3 data (April) and the May CPI estimate are on the agenda. In May, CPI inflation is expected to have dropped significantly. The consensus is looking for an outcome of 0.2% Y/Y (from 0.6% Y/Y). The risks are clearly on the downside after the national CPI data from Germany, Spain and Belgium and a negative outcome is not excluded. M3 money supply and credit growth data slowed again more than expected in March and also for April, another significant slowing is expected (4.5% M/M from 5.1% M/M). The credit growth data require close monitoring to see whether the ECB should step up their unconventional measures to prevent a disruptive credit crunch in the euro zone.
In the US, the preliminary figure of first quarter GDP, the Chicago PMI (May) and final figure of Michigan consumer confidence (May) are scheduled for release. According to the first estimate, US GDP contracted by 6.1% Q/Q (annualized) in the first quarter. But the preliminary estimate is forecasted to show a significant upward revision (to -5.5% Q/Q). Positive adjustments are forecasted to come from inventories, net exports and non-residential investments. Last month, the Chicago PMI showed a significant improvement (40.1 from 31.4) and for May, a more moderate increase is expected (to 42.0). We believe the risks are on the upside of expectations as most regional indicators came out better than expected. The final figure of Michigan consumer confidence is expected to show a marginal upward revision to 68.0 from 67.9.
On the supply front, there are no auctions scheduled today. Yesterday, Italy successfully sold €8.75B of government bonds, which was near the top end of the preannounced range. The 10-year yield spread nevertheless widened slightly ahead of the auction. This may indicate that the recent sharp narrowing of the spread has gone far enough for now. Unless equities would continue their rally higher, some stabilization can be expected.
On the ECB front, ECB’s Trichet is scheduled to speak on the role of central banks and the IMF in financial crises. Yesterday, ECB’s Weber strongly argued in favour a symmetric monetary policy to prevent future financial crises. Regarding the monetary transmission mechanism in the euro zone, Weber repeated that he sees no evidence that the interest pass-through is happening more hesitantly than in the period before the crisis. This is important given the focus of the ECB’s unconventional measures on the banking sector. This makes that the ECB is much more dependent on the lending behaviour from the banks for their policy compared to the Fed and the Bank of England who directly purchase assets on the financial markets.
Regarding trading, the sell-off on the government bond market showed some tentative signs of easing yesterday, as Treasuries rebounded after the 7-year Note auction. As a result, US 10- and 30-year yields fell off their recent highs and the 30-year yield even showed a potential trend reversal signal. This may indicate that the selloff on the bond markets has run its course for now. The positive correlation between equities and bonds over the past two days indeed indicates that US yields have arrived at levels where investors become worried about and this should cap the upside in yields. Indeed, any further rise in longer-term yields may push up mortgage rates and threaten any stabilisation in the key US housing market, which may have also detrimental effects on the bank’s balance sheets. Yesterday, the mortgage delinquencies in the US continued to rise sharply. The rise in US longer-term yields may therefore heighten the pressure on the Fed to augment their asset purchases at a time the dollar is already under severe pressure. A further rise of the euro on a trade weighted basis may therefore become an increasingly important issue for the euro zone economy and put the ECB under pressure to become more aggressive too. This should also support the European bond market from the current low levels and therefore we don’t expect German 10-year yields to break above the 3.68% in a sustainable manner. A break above this level would have deteriorated the longer-term technical picture for bonds and have signalled that the era of low longerterm yields is over. From a speculative point of view, new longs may be installed in the Bund at current levels with tight stop loss protection in case we would fall below 118.48.
In the UK, the rebound in consumer confidence halted in May according to the GfK consumer confidence index. This is however not the most important indicator and impact on trading may therefore remain rather limited.
