Markets: Fixed Income
On Monday, investors started the week on a cautious note, as rising risk aversion drove equities and commodities sharply lower and government bonds higher. In Asia, equity markets still eke out some decent gains, but sentiment soured during the European and US session, even though the German IFO indicator came out better than expected. The downward revision of the World Bank’s global growth forecasts from 1.7% to 2.9% raised concerns about the economic outlook and incited investors to book more profits on the three-month rally higher. The increase in risk aversion offset concerns about the upcoming supply both in the euro zone as well as in the US and government bonds ended the day with good gains.
In a daily perspective, the belly of the curve benefited the most, as US 5- and 10- year yields declined by around 10 basis points compared to 7.3 basis points and 6.6 basis points in respectively 2- and 30-year yields. In the euro zone, there was a bull flattening of the German yield curve, as 2-year yields fell by 0.8 basis points and 5- and 10-year yields fell by respectively 3.2 and 5.2 basis points. 30-year yields declined 4.4 basis points. The increase in risk aversion was also reflected in the widening of the intra-EMU sovereign spreads.
Bonds gain, as risk aversion offset supply fears
Today, the calendar heats up with the euro zone flash PMI’s (June), the Richmond Fed (June) and US existing home sales (May). In June, both euro zone services and manufacturing PMI are forecasted to extend their rebound. For the manufacturing sector, the consensus is looking for an increase from 40.7 to 42.1, while services PMI is expected to rise from 44.8 to 45.6. The risks might be on the upside of expectations after the better than expected ZEW and IFO indicators. In the US, the Richmond Fed is expected to improve somewhat further (to 5 from 4) after jumping into positive territory in May. We have no clear view on the risks as the earlier released regional business confidence indicators painted a mixed picture. US existing home sales are expected to show the second consecutive increase in May. An increase by 3.0% M/M is expected (after 2.9% M/M in April). The risks might be somewhat on the upside of expectations as pending home sales rose by 6.7% M/M in April. Today, the OECD will also announce its new economic outlook and following yesterday’s downward revision by the World Bank markets will closely monitor the new economic forecasts.
On the ECB front, ECB’s Nowotny yesterday warned against a premature relaxation of support programs both with regard to monetary policy and regarding fiscal policy. Instead, he favours a steady hand policy and doesn’t expect monetary policy rates to change this year. Regarding the purchases of covered bonds, he indicated that the purchases will be done mainly by the national central banks with a small quota for the ECB. The buying process should be done within one year and the duration of the bonds will be up to a maximum of five years. He also didn’t see a strong rationale behind the recent sharp rise in oil prices. Nowotny’s comments on fiscal policy are a bit at odds with ECB president Trichet, who urged governments to start reducing budget deficits as soon as next year. Both Nowotny and Trichet do however agree that current monetary policy is appropriate. As such, no changes should be expected at the next policy meeting in July. The outlook that ECB policy rates won’t fall any further this year should also support demand at the 3- month and 1-year longer-term refinancing operations. These are expected to attract record-breaking demand, as banks will have the opportunity to fund themselves for an unlimited amount at the very favourable rate of 1%. This may result in a liquidity boost of several hundred billion euros and bring money market rates still somewhat lower.
On the supply front, the Netherlands will tap three different off-the-run bonds with a 2-, 3- and 9-year maturity for an amount between €0-2B, while in the US, the Treasury will hold a $40B 2-year Note auction. Today, the Belgian new 3-year benchmark is likely to be priced at asset swap -6 basis points, at the low end of the range between -3 to -6. The total order book tops €6B. Ireland, which plans to sell a new 10- year benchmark via syndication, has refined its price guidance to 215 basis points over mid-swaps (from 215-225), as the order book was close to €7B. And France plans to raise €4B of its new 30-year benchmark at 2 basis points over the 2038 OAT.
Regarding trading, yesterday’s trading session indicated that investors want more hard evidence of an economic recovery. Indeed, the third consecutive rise in the German IFO wasn’t enough to prevent investors from booking more profit on the equity and commodity markets. Therefore, we look out for today’s US existing home sales, which may signal whether a turnaround in the key US housing market is finally coming closer. From a technical point of view, the short-term technical picture of the Bund and the T-Note future improved following respectively the break above the neckline of a double bottom formation at 119.31 and the reversal of a previous breakdown at 115-06+. A break above the downtrend channel in the Bund at 120.41 and above the neckline of a short-term double bottom formation at 115-25 would further improve the technical outlook.
In the UK, the eco calendar is empty, but on the supply front, the DMO will tap a longer-term Gilt 4% 2022 for an amount of £4B. This morning, BoE’s Dale will speak too.
