Markets: Fixed Income
On Monday, global bonds plunged, as stronger than expected eco data raised investors’ optimism that the worst of the global recession is over. Indeed, the further improvement in the manufacturing business confidence surveys in the euro zone, the UK and the US as well as the better than expected US personal income and spending data overshadowed the widely expected Chapter 11 filing of GM. In response, equities and commodities moved higher and broke above key resistance levels. Both the S&P and the CRB commodity index set new highs for the year. The S&P however failed to close above the year highs at 943.85. On the government bond markets, yields rose very sharply, especially at the longer end of the curve, but remained mostly below the highs set last week. Nevertheless, in contrast to the end of last week, the rise in government bond yields couldn’t prevent equities from moving higher.
In a daily perspective, US 5, 10- and 30-year yields surged around 20 basis points higher compared to only 3.2 basis points in 2-year yields. Also in the euro zone, there was a bear steepening of the German yield curve, as 2-year German yields increased by 2.1 basis points, while 5, 10- and 30-year yields rose by respectively 6.2, 8 and 10.7 basis points. The increasingly positive economic outlook resulted in a narrowing of the intra-EMU sovereign spreads. Hence, overall European government bonds outperformed US Treasuries, which was also helped by the strength of the euro and the weakness of the dollar.
Bund remains close to key longer-term support
Today, the calendar contains the euro zone unemployment rate (April) and the US pending home sales (April). In April, the euro zone unemployment rate is forecasted to have risen from 8.9% to 9.1%, the highest level since March 2005. In the US, pending home sales are forecasted to show the third consecutive increase in April. The consensus is looking for an increase by 0.3% M/M after rising by 3.2% M/M in March. Later this week, all eyes will be on the US labour market with the Payrolls report on Friday and the rate decisions in the euro zone and UK. Last month, the Payrolls report showed some easing in the number of job losses. Employment dropped by 539 000, compared to 699 000 in March. For May, the consensus is looking for a decline in employment by 530 000. Based on the development in initial claims, we have no reason to distance ourselves from the consensus, but the ADP report tomorrow might give us a better indication.
On the supply front, Germany will tap its 30-year Bund today for an amount of €4B. The auction result will give an indication on the demand for longer-term bonds. Later on this week, France and Spain will tap the European bond market too. The net cash flow will be highly negative this week, as there are no redemptions scheduled. In the US, no auctions will take place this week. On Thursday, the Treasury will nevertheless announce the amounts for next week’s 3-, 10- and 30-year auctions.
On the ECB front, we are currently in the ‘purdah period’, which means that the governing council members should refrain from commenting on the monetary policy outlook. Following last month’s rate cut to 1%, no rate change is expected at this meeting, as Trichet called current rates ‘appropriate’. Markets will however look out for the details of the covered bonds program and the new ECB staff forecasts for growth and inflation.
Regarding trading, the sell-off on the government bond market continued yesterday, despite some tentative signs last week that the sell-off was abating. Positive eco data raised investors’ confidence that the worst of the global recession is over and pushed equities, commodities and government bond yields sharply higher, especially at the longer end of the curve. A sustained break higher in the S&P above the year highs at 943 and above the 3.68% level in German 10-year yields would signal that the sell-off isn’t over. In the Bund, the corresponding level is seen at 118.48, the neckline of a major double bottom on the continuation charts. We don’t front-run on such a break and keep existing long positions intact. Tight stop-loss protection is however warranted in case we would break below 118.48. Last week’s positive correlation between equities and bonds indicated 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. 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 become an increasingly important issue for the euro zone economy and put the ECB under pressure to become more aggressive too. This should also be supportive factor for the European bond market
In the UK, the calendar contains the April lending data. The number of mortgage approvals will be watched closely, as this has been a good leading indicator for the UK housing market.
