Markets: Fixed Income
On Tuesday, global bonds rebounded, as the sell-off at the short end of the curve in the wake of the US Payrolls report looked overdone. Weak eco data from Germany and a very strong 3-year Note auction supported the rebound. The long end however lagged ahead of this evening’s US 10-year Note auction and Thursday’s 30-year Bond auction. Equity markets continued to struggle to extend their recent rally higher above the year highs, despite the news that 10 leading US banks are preparing to repay $68B in TARP funds. In the euro zone, the problems at Arcandor, the large German retailer, who filed for insolvency, got quite some attention.
In the US, 2-year yields fell by 9.6 basis points after rising more almost 50 basis points since the release of the US Payrolls report. The sharp rise in short-term yields looked more like a forced unwinding of curve steepeners than a bet that the Fed was about to tighten and therefore some correction was likely. At the longer end of the curve, the decline in yields was much more limited yesterday. US 10-year yields fell by 1.8 basis points ahead of this evening’s auction, while 30-year yields moved even 3.8 basis points higher.
In the euro zone, the flattening of the curve was less outspoken, as German 2-year yields declined by 5.7 basis points and 10 and 30-year yields by respectively 4 and 3.3 basis points. The intra-EMU sovereign spreads traded mixed with Italy, Ireland, Portugal and Austria underperforming their European peers.
Fed speakers and Beige Book closely watched today
Today, the calendar contains the French and Italian industrial production figures (April) and the US trade balance (April). In France, industrial production is forecasted to show its eighth straight contraction in April. But the pace of contraction might have slowed somewhat as the consensus is looking for a decline by 0.2% M/M (from -1.4% M/M). In Italy, markets are looking for the first increase in industrial production in a year. After the weaker than expected German industrial production data yesterday, the risks might be somewhat on the downside of expectations. The US trade deficit is expected to widen again (-$29B from -$27.6B) in April with both imports and exports rising. This increase in imports is forecasted to be partially related to the rise in the price of imported oil.
On the supply front, Germany will tap its 5-year Bobl for an amount of €6B, as well as issue a new 10-year inflation-linked Bundei for an amount of €3B. Demand should be solid given the redemption of a German Schatz this week and the increased appetite for linkers. On the European bond market, Portugal also plans to sell €1B of its 10-year benchmark. Yesterday, the spread between Austrian and German 10-year yields widened after the auction, as the bid/cover ratio was lower than at previous auctions, especially for the 10-year maturity. Ahead of today’s auction, Portuguese bonds also underperformed slightly. In the US, the Treasury will hold a 10-year Note auction for an amount of $19B. Yesterday, the 3-year Note went very well, which shouldn’t have been a major surprise following the sharp spike higher in short-term yields after the Payrolls report.
There are also several central bankers from the ECB and the Fed scheduled to speak today. Especially the Fed speeches and the Fed’s beige book may need to be closely monitored given the recent speculation that the Fed may start raising interest rates from their historic lows by the end of the year.
Regarding trading, the recent focus on the exit strategies both in the euro zone and the US has indicated that interest rates cannot be expected to remain at current historical low levels forever. The talk about normalizing fiscal and monetary policy should help to cap the recent rise in financial market’s inflation expectations, which in turn should also temper the rise in longer-term yields. In Germany, 10-year yields failed to confirm Friday’s break above the 3.70% level, the neckline of a major double top formation, as yields fell on the first two days of the week. 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.
Also in the UK, the calendar contains the April trade balance and industrial production data. In April, the UK trade deficit is forecasted to have contracted further (from - £2 537 to -£2 400). Industrial production has now declined for thirteen straight months in the UK, but recently the pace of contraction slowed somewhat. For April, markets are looking for a decline by 0.1% M/M.
