Markets: Fixed Income
On Tuesday, global bonds traded sideways to slightly higher, as the eco data couldn’t convince investors that a real economic recovery was nearby. US Treasuries got some additional support from a very strong 2-year Note auction.
In the euro zone, the composite PMI fell short of expectations due to an unexpected decline in the services PMI, while the manufacturing PMI extended its recent improvement but remained well below the 50 level. In the US, the Richmond Fed rose slightly, but the smaller than expected rise in the existing home sales indicated that it is still too soon to expect a turnaround in the housing market, which is seen key to a sustainable economic recovery. As a result, investors maintained their cautious mood and equities couldn’t rebound following Monday’s sharp sell-off. This offered some support to the government bond markets and helped them to recoup their early losses. Very strong demand and aggressive bidding at the US 2-year Note auction added to the positive sentiment and may indicate investors are looking for a soft statement from the Fed this evening. The smooth 2-year Note auction also eased supply concerns about the upcoming 5- (today) and 7-year Note auctions (tomorrow).
In a daily perspective, yields declined across the curve in the US, with 2-year yields down by 3.3 basis points, 5-year yields 2.7 basis points, 10-year yields 6 basis points and 30-year yields 8.1 basis points. In the euro zone, German yields were slightly higher, but this was mainly due to early closing of the cash market. Non-German European bond markets performed even worse, as the intra-EMU sovereign spreads are again widening, especially for longer-term maturities, after Ireland had to pay a huge premium to sell its new 10-year benchmark.
ECB 1-year refinancing operation in the focus
Today, the euro zone calendar is empty, but in the US, the durable good orders (May) and new home sales (May) are scheduled for release. After the broad based (1.9% M/M) increase in April, durable goods orders are expected to drop again in May. The consensus is looking for a decline by 0.9% M/M partially due to a decline in orders for motor vehicles. We have no clear reasons to distance ourselves from this estimate. New home sales are forecasted to have risen by 2.3% M/M in May, the third increase in four months, albeit from historical very low levels.
But most attention will be focused on the FOMC meeting, where we expect no dramatic changes to the statement. As such, we expect the Fed to reaffirm that the federal funds rate will remain at exceptionally low levels for an extended period of time and leave the amounts for asset purchases unchanged. Since the start of its Treasury purchases in March, the Fed has bought around $177B of the preannounced amount of $300B. This means that the Fed still has some time before it has to decide to increase or halt its Treasury purchases. Nevertheless, given the recent increase in longer-term yields, the Fed may put some more stress to its exit strategy once the economy recovers. The bleak picture painted in the Beige Book has however indicated that it’s still way too early for a withdrawal of monetary policy stimulus.
In the euro zone, ECB’s Bini Smaghi will speak again. Yesterday, Bini Smaghi stressed the importance of keeping global imbalances in check to prevent future economic crises and highlighted the prominent role of the IMF to achieve this. He therefore pointed to a strong and effective surveillance in crisis prevention and responsible lending and warned that these objectives should not be put at risk due to short-term needs during this crisis.
On the money market, the ECB will hold its first 1-year refinancing operation, besides a three-month operation. Both will be executed under full allotment and at an interest rate level of 1%. Yesterday, demand at the weekly refinancing operation dwindled, as many banks are expected to switch to the 1-year maturity. This may result in a liquidity boost of several hundred billions euros and may bring money market rates still somewhat lower.
On the supply front, Italy will tap its 10-year inflation-linked BTP (€1.5B), while the US Treasury will hold a 5-year Note auction ($37B). Yesterday, Belgium sold €5B of its new 2-year benchmark, while Ireland and France sold each €6B of its new 10-year and 30-year benchmark. The 2-year Note auction in the US went very well, but this isn’t a guarantee for today’s auction.
Regarding trading, government bonds have rebounded quite strongly over the past two weeks, as investors turned more cautious about the economic recovery and want too see more hard evidence of improving economic conditions. The more cautious mood was also reflected on the equity markets, as most European and US indices failed to break above the year highs in a sustainable manner and turned south again. From a technical point of view, the Bund is currently under the positive influence of a double bottom formation with the neckline at 119.31, while in the US, the T-Note future has reversed a previous break down. A break above the downtrend channel in the Bund at 120.36 and above the neckline of a short-term double bottom formation at 115-25 would further improve the technical outlook.
In the UK, the calendar contains the CBI distributive trades report (June). In May, sales fell back after a sharp rebound in April (17 from 3). For June another slight deterioration is expected.
Today, the MPC will testify on the inflation report. It will be interesting to see whether they hint at any need for an increase in the amount for asset purchases. Yesterday, MPC member Dale sounded positive about the impact of the QE policy on the real economy.
