Markets: Fixed Income
On Thursday, government bonds surged, as equities and commodities were sold off in the wake of a much weaker than expected US Payrolls report and cautious comments from ECB president Trichet on the euro zone economic outlook. Earlier on the day, the 25 basis points rate cut of the Swedish Riksbank as well as the extension of its monetary operations to 12 months took mar-kets by surprise. Overall, yesterday’s data and central bankers’ action and com-ments suggests that recent talk about exit strategies was premature. Indeed, in the euro zone, Trichet repeated that the Governing Council has not decided that the refi rate has reached its lowest level, this in spite of the recent improvement in the survey data. In response, the short end outperformed the longer end of the curve. German 2- and 5-year yields fell by respectively 12.1 and 11.4 basis points compared to 10- and 30-year yields, which declined by respectively 8.6 and 6.4 basis points. In the US, the decline in yields was more limited due to rising supply concerns ahead of next week’s auctions, when the Treasury will hold a 10-year TIPS ($8B), 3-year Note ($35B), 10-year Note ($19B) and 30-year Note auction ($11B). Supply concerns mainly weighed at the longer end of the curve with 10- and 30-year yields down by respectively 4.2 and 1 basis point compared to a decline of respectively 5.7 and 8.7 basis points in 2- and 5-year yields. On the European bond market, the downgrading of Ireland by Moody’s by one notch from AAA to AA1 with outlook negative had little impact, as the move was largely expected following the ear-lier downgrades from S&P and Fitch.
Trichet urges banks to ‘live up to their responsibilities’
Today, US Markets are closed in observance of the Fourth of July on Saturday. In the euro zone, the calendar contains the May retail sales and final figure of June ser-vices PMI.
In April, euro zone retail sales showed the first increase in seven months partially boosted by the Easter holiday and sunny weather. For May, the consensus is looking for a slight decline (-0.1% M/M) as consumers might have scaled back spending ahead of the summer sales. In Germany however, retail sales showed an unexpected increase in May. Consumer spending data have become more important of late given the current debate on whether the improvement in the manufacturing surveys is mainly inventory driven or whether underlying demand is also improving following the abrupt standstill at the end of last year. The final figure of euro zone services PMI is forecasted to confirm the first estimate, which showed a slight decline. This was very disappointing, as the PMI is still way below the 50 level and calls for cautiousness on the economic recovery.
The very slow improvement in the business sentiment surveys may also ex-plain the more cautious tone at yesterday’s ECB’s press conference. There, ECB President Trichet called interest rates ‘appropriate’, but indicated that ‘economic activity over the remainder of this year is likely to remain weak, although it should de-cline less strongly than was the case in the first quarter of 2009’. He sounded more concerned about the ‘negative feedback loop between the real economy and the tur-moil in financial markets’, ‘further increases in oil and other commodity prices’ and the ‘increasingly unfavourable labour markets’. The ECB is however not planning any new monetary policy initiatives at the moment, but urged banks to live ‘up to their responsibilities’ to revive credit flows following their first 12-month refinancing operation last week, which he called an ‘enormous success’. At the time, the ECB injected a record amount of €442B into the money market, but saw much of the li-quidity flowing again to them in the days afterwards, as the use of the deposit facility surged by almost €250B. This increases concerns that banks are not in a position yet to step up lending. Therefore, Trichet urged banks to ‘take appropriate measures to further strengthen their capital bases and, where necessary, take full advantage of the government measures to support the financial sector, in particular as regards re-capitalisation’. Otherwise, we might get into a Japanese style situation where zombie banks failed to support an economic recovery.
Regarding trading, activity could be quite thin today, as US markets are closed. Yesterday the Bund surged on the back of the weak US Payrolls report and the cau-tious tone at the ECB press conference. Thereby, the Bund broke again above the neckline of a massive double top formation at 121.55. If confirmed over the coming days, this would improve the technical outlook.
In the UK, June services PMI is scheduled for release. In May, UK services PMI jumped above 50, indicating that activity is expanding. For June however, the con-sensus expects a slight decline (51.5 from 51.7) after six consecutive increases.
Yesterday, the long end of the Gilt market underperformed on the back of disappoint-ing 30-year Gilt auction.
