Markets: Fixed Income
On Wednesday, global bonds rebounded strongly on the correction on the eq-uity markets and a strong German 30-year and UK 10-year auction. The positive auction results suggest that following the recent rise, longer-term yields are again at attractive levels for bond investors. The eco data were mixed with the euro zone and UK services PMI coming out slightly above consensus. In the UK, the services PMI even rose again above the 50 level for the first time in a year, but in the US, the im-provement in the non-manufacturing ISM was slightly disappointing. Moreover the ADP employment report pointed to another awful Payrolls report to be published on Friday. There were also rising concerns about the developments in emerging markets following a failed Treasury bill auction in Latvia, as fears about a devaluation of the lat mounted.
In a daily perspective, US yields declined between 3.5 and 8 basis points with the belly of the curve outperforming. In the euro zone, there was a sharp correction on the recent bear steepening of the German yield curve, as 10- and 30-year yields fell by respectively 8.6 and 14.2 basis points compared to respectively 1.5 and 6.8 basis points in 2- and 5-year yields. The intra-EMU sovereign spreads widened on in-creased risk aversion.
ECB and BoE to leave monetary policy unchanged
Today, all eyes will be focused on the ECB and Bank of England monetary pol-icy meeting. With regard to the interest rate decision, both central banks are widely expected to keep rates unchanged at respectively 1% and 0.5%. Neither any addi-tional unconventional measures are expected to be announced, as the ECB has out-lined its credit easing plan at their previous meeting and the Bank of England has in-creased their asset purchase program by £50B to £125B at their latest meeting. The ECB is nevertheless expected to detail its covered bond plan, which will amount to around €60B, while the new ECB staff projections for growth and inflation for 2010 will shed a light on the longer-term economic outlook. The details of the covered bond plan may indicate how the ECB plans to divide the purchases over the different euro zone member states, which may prove a yardstick for potential future purchases of other assets. It will also be interesting to see whether the ECB is becoming increasingly concerned about the rapid fall of the dollar, as a surge higher in the euro on a trade weighted basis may lead to an unintended tightening of monetary conditions in the euro zone at a time the economy is still very fragile. As such, any comments from Mr. Trichet on the strength of the euro could also be sig-nificant from a monetary policy point of view, as a further strengthening of the euro may force the ECB to become more aggressive in their monetary policy.
The economic calendar is thin today, as it only contains the euro zone retail sales and US weekly claims. In March, euro zone retail sales showed the sixth consecu-tive monthly decline, while a slight increase was expected. For April, the consensus is looking for an increase by 0.2% M/M, which might be (partially) Easter related. In the week ended May 30, US initial claims are forecasted to stabilize around the 620 000 level. Continuing claims, on the contrary, are expected to extend their upward trend (6 855 000 from 6 788 000).
On the supply front, France and Spain will tap the market today and in the US the Treasury will detail the amounts of next week’s 3-, 10- and 30-year bond auctions. This week’s auctions from the UK and Germany have gone pretty well, which indicates that the recent sharp rise in longer-term yields has improved inves-tors’ interest for longer-term bonds. This should also be reflected in today’s 5-year Spanish bond auction and the French OAT auctions. At the same time, concerns about the economic situation in Central and Eastern Europe may mount again following yesterday’s failed Latvian Treasury Bill auction and rising specula-tion on a devaluation of the lat. This may also be reflected in a widening of the intra-EMU sovereign spreads, which have been narrowing sharply since the beginning of the year.
Regarding trading, yesterday’s correction on the equity and bond markets may sug-gest that the economic recovery trade has gone far enough and that equity markets and longer-term yields aren’t ready for a sustained break higher. Indeed, both the eq-uity markets and German 10-year yields were at crucial levels, which in case of a break higher would have suggested that the era of low longer-term yields is over and that we were heading for a V-shaped recovery. As long as we are below, we hold on to our long bond positions, but keep tight stop loss protection in case we would still break above the year highs in the equity markets and above the 3.68% level in Ger-man 10-year yields (below 118.48 in the Bund).
In the UK, the Halifax house price index is scheduled for release, but most attention will of course go out to the Bank of England policy meeting.
