Markets: Fixed Income
On Monday, the unwinding of recent steepeners continued in the wake of Friday’s better than expected US Payrolls report. The report has increased market fears that the Fed could start raising interest rates earlier than previously expected and caused a sharp rise in short-term yields. Following Friday’s increase with 30 basis points, US 2-year yields rose another 10 basis points yesterday to stand at its highest level since November last year. The eco calendar was however uneventful and equity markets traded lower for most of the session. A late rally on the US equity markets however left equities almost unchanged for the day and pushed US longerterm yields somewhat higher too ahead of this week’s auctions.
In a daily perspective, both the US and German yield flattened quite sharply. Compared to the rise in US 2-year yields by 10.6 basis points, 5- and 10-year yields rose by respectively 9 and 4.6 basis points, while 30-year yields even fell 1.9 basis points. In the euro zone, German 2-year yields were higher too and thereby confirmed Friday’s break higher above the 1.6% level. 10- and 30-year yields however fell by respectively 4.6 and 7.7 basis points. As a result, 10-year yields failed to break above the 3.70% level, neckline major double top, in a sustained manner. The spread between German and Irish 10-year yields widened slightly after S&P lowered the credit rating of Ireland from AA+ to AA and kept the negative outlook intact. The downgrade had little to no impact on other intra-EMU sovereign spreads.
ECB’s Stark warns against any further fiscal stimulus
Today, the calendar remains thin, both in the euro zone and in the US. In the euro zone, only the German industrial production data (April) are scheduled for release and in the US, the calendar contains the April wholesale inventories.
In March, German industrial production came out flat after six consecutive declines. This was an encouraging sign and is expected to be confirmed by the April figures. The consensus is looking for a rise of 0.3% M/M and we have no reasons to distance ourselves from this outcome. In April, US wholesale inventories are forecasted to show the eighth consecutive drop indicating that producers continue to reduce their stock levels. But the data are rather outdated and usually no market mover.
On the supply front, the Netherlands and Austria will tap the market. The Netherlands will sell between €2-3B of its 10-year benchmark, while Austria plans to sell €0.935B of its 6- and €1.1B of its 10-year benchmark. Yesterday, Slovakia sold €0.209B of its two-year zero coupon, but the most important news was the second downgrading of Ireland this year by S&P from AA+ to AA. The rating outlook remained negative. S&P pointed to the higher costs to support the banking system to explain the downgrading. The 10-year yield spread between Germany and Ireland widened 3 basis points to 202.8 basis points.
On the ECB front, the Finnish council member Liikanen will speak at the Bank of Finland’s quarterly press briefing. Yesterday evening, ECB’s Stark sounded somewhat more optimistic on the economic outlook, as he said that the euro zone ‘economy is no longer in free fall, we are seeing signs of stabilisation. Indicators of consumer confidence and business sentiment have continued to improve somewhat. We are also seeing some encouraging signs of normalisation in financial markets’. At the same time, Stark highlighted the importance of credible exit strategies for both fiscal and monetary policy in order to achieve a sustainable economic recovery. Regarding fiscal policy, Stark warned that ‘any further fiscal stimulus is likely to be counterproductive’, as higher deficits may put upward pressure on interest rates, while fears about a higher tax burden may induce consumers to save rather than spend any additional income. As such, Stark urged governments to lay out clear exit strategies via a full compliance with the Stability and Growth Pact. Regarding monetary policy, Stark indicated that the ECB will take appropriate action to ensure that the extraordinary measures can be quickly unwound and the liquidity provided absorbed. ‘This includes, for instance, unwinding the increase in the average maturity of our refinancing operations’.
Regarding trading, the focus on the exit strategies both in the euro zone and the US, where Fed’s Lockhart on Friday said that the Fed needs to be ‘anticipatory’ and not wait too long to tighten monetary policy, indicates short-term yields cannot be expected to remain at current historical low levels forever. This has already resulted in an unwinding of the recent steepening of the yield curve via a rise in short-term yields. The talk about exit strategies should also help to cap the recent rise in financial market’s inflation expectations, which in turn should temper the recent rise in longer-term yields. Yesterday, German 10-year yields failed to confirm Friday’s break above the 3.70% level, the neckline of a major double top formation, as 10-year yields fell by 4.6 basis points. Hence, despite the better than expected US Payrolls report, both equities and longer-term yields have failed to break higher in a sustainable manner. This may suggest that much of the good eco news has been discounted for now. In a short-term perspective, this may incite many investors to take profit on recent steepeners.
In the UK, Gilts outperformed the German bond market following a low offer/cover ratio, which indicates that there was not that much interest to sell Gilts to the Bank of England.
Overnight, the BRC retail sales monitor and RICS house price balance confirmed recent signs of improvement. The RICS house price index rose to its highest level since November 2007, while the underlying trend in retail sales is also improving, despite the decline in May.
