Markets: Fixed Income
On Wednesday, global bonds sold off on supply concerns after a Russian central banker suggested Russia could switch some of its reserves from US Treasuries to IMF bonds and a disappointing 10-year Note auction.
Global bonds started the day already lower on the back of strong gains in Asian and European equity markets and weren’t able to recoup the losses despite a weaker than expected opening on Wall Street. Rising Treasury yields once again weighed on the performance of the US equity markets, which was all the more clear when US 10- year yields hit the 4% level in the aftermath of the disappointing 10-year Note auction. This pushed equities towards the lows of the day and equities could only rebound when Treasuries reversed some of their losses on the back of the Beige Book. The Beige Book painted a weak economic picture, as ‘reports from the twelve Federal Reserve District Banks indicate that economic conditions remained weak or deteriorated further during the period from mid-April through May’. This suggests that recent market speculation on an early Fed tightening has been overdone and resulted in a re-steepening of US yield curve yesterday.
In a daily perspective, US yields were up between 4.9 basis points in 2-year yields and 11 basis points in 30-year yields ahead of today’s 30-year Bond auction. The rise in yields occurred despite the Fed purchasing $3.5B of Treasuries maturing between 15/08/2019-15/02/2026.
In the euro zone, German yields were higher too. German 2-year yields rose by 2.5 basis points compared to 6.7 basis points in 30-year yields. The German and Portuguese auctions had little impact on trading. Overall, the intra-EMU sovereign spreads were slightly tighter.
US retail sales may be decisive for near term outlook
Today, the US calendar heats up with the retail sales (May), weekly claims and business inventories (April). In the euro zone, the eco calendar is empty today.
In April, US retail sales showed an unexpected decline, but for May an improvement is forecasted. The consensus is looking for an increase by 0.5% M/M partially due a price driven increase in gasoline station sales and a rebound in motor vehicle sales. Another disappointing figure could raise questions about the sustainability of the current recovery. In the week ended June 6, initial claims are forecasted to extend their recent stabilization (615 000 from 621 000), while continuing claims (for the week ended May 30) are expected to have risen from 6 735 000 to 6 780 000. US business inventories are forecasted to show the eighth consecutive decline (-1.0% M/M) in April.
On the supply front, Italy will issue a new 5-year benchmark and tap two BTPs in the 12- and 14-year maturity segment, while the US will hold a 30-year Bond auction. Yesterday’s weak bidding in the 10-year Note auction indicates that investors are only prepared to invest in longer-term Treasuries at higher yield levels.
On the central bankers’ front, the ECB will publish its monthly bulletin, while Fed’s Lockhart will speak on the US economic outlook. Last week, Lockhart caused a sharp spike higher in short-term yields, as he was quoted as saying after the payrolls that ‘he could envision the Fed eventually raising US benchmark interest rates while continuing to run an expansionary monetary policy’. Yesterday evening, the Beige Book however indicated that ‘although several Fed Districts have seen expectations improving, they do not see a substantial increase in economic activity through the end of the year’. This may indicate recent market speculation on a Fed tightening is still premature. Regarding the ECB, the ECB’s MFI interest rate statistics showed yesterday that the interest rates charged to both household and non-financial corporations continued their substantial downtrend. This confirms the ECB governing council’s view that the pass-through mechanism from policy rates to the real economy has continued to function in recent months, which should refrain them from taking more unconventional measures. On the contrary ECB’s Weber yesterday once again warned that the ECB should be prepared to raise rates as a precaution, even when it isn’t initially required with respect to medium-term price developments.
Regarding trading, today’s US retail sales report may be key for the near term outlook for bonds and equities. Much of the recent improvement in market sentiment is based on the turn of the inventory cycle, but as long as consumer demand remains weak this positive influence may dwindle again and put the economic recovery at risk. Last month, the retail sales disappointed and caused a temporary correction on the US equity markets, which also supported the bond markets. Another disappointing figure may have a longer-lasting impact, while a positive figure may force a break higher in the equity markets and result in another sell-off on the bond markets. Another item to watch today is of course the 30-year Bond auction following yesterday’s disappointing 10-yeaer Note auction. Although this may push longer-term yields still somewhat higher ahead of the auction, there is some risk for relief afterwards as this is the last auction for now. The next auction, a 2-year Note auction is only scheduled for 23 June. In the US, the 4% level may also proof to be such a high-profile level, which may be difficult to break above. In the euro zone, German 10-year yields are still testing the 3.70% level, neckline double top formation. A sustained break higher would bring the targets of the double bottom with neckline at 3.40% in the picture at around the 4% level.
In the UK, the eco calendar is empty today, although the DMO will tap an inflationlinked 0.75% 2047 for an amount of £0.725B.
