Markets: Fixed Income
On Friday, global markets had a dull trading session in holiday thinned trading conditions given the absence of US market participants, who observed Independence Day. The European data failed to provide much direction, as services PMI came out slightly better than expected, but the euro zone retail sales disappointed once again. There was also no follow-through action on the back of Thursday’s surprisingly weak US Payrolls report and most markets traded sideways. In the euro zone, German yields were mainly slightly higher following Thursday’s sharp decline, with 2-year yields up by 0.8 basis points, 5-year yields up by 1.5 basis points and 10- year yields up by 1.2 basis points. 30-year yields were down by 1.3 basis points.
Thin eco calendar puts focus on US supply
Today, the euro zone calendar is empty, but in the US, the non-manufacturing ISM is scheduled for release. The non-manufacturing ISM is expected to show the third consecutive improvement in June. The headline index is expected to increase from 44.0 to 46.0. We have no clear reasons to distance ourselves from this consensus estimate. Later this week, the calendar remains thin in the euro zone and in the US, the calendar heats up only on Friday with the trade balance (May) and Michigan consumer confidence (July). In May, the US trade balance is expected to show a minor widening in the trade deficit as imports are forecasted to come out flat, while exports might have contracted slightly. Michigan consumer confidence is expected to show a slight decline in July, the first in five months, as both ABC and conference board’s consumer sentiment deteriorated in June.
Given the thin data calendar this week, much attention will go out to supply, as the US plans four auctions for a total amount of $73B, for which it will have to raise $60B. Today, the Treasury will hold an $8B 10-year TIPS auction. In the euro zone, the Netherlands, Austria and Portugal will tap the market. The Netherlands plans to issue a new 5-year benchmark on Tuesday (€5B), while Austria will tap its 5- and 17- year bonds (€2.2B) and Portugal its 10-year benchmark (€1B). In the euro zone, the net cash flows will be positive, due to several German coupon payments and redemptions over the weekend.
On the ECB front, the MFI interest rate statistics indicated that banks have continued to pass through recent interest rate cuts in their lending rates to both households and non-financial corporations, although there were also some exceptions especially towards household loans (consumption and other purposes). The main concern however relates to the flow of bank loans to the real economy following the recent sharp slowing in lending growth, which even turned negative recently. This has raised concerns about a credit squeeze in the euro zone, which may force the ECB to bypass the banking sector and to broaden their private asset purchases beyond covered bonds. The purchases of covered bonds may start today. Besides the lending data, we also continue to keep a close eye on the amounts deposited at the ECB. These have surged again in the wake of the 12-month refinancing tender, which may indicate that banks are not in a position yet to step up lending. Last week’s annual report of the BIS indicated that governments should still do more to recapitalize the banking sector. As long as this has not happened, we might get into a Japanese style situation where zombie banks failed to support an economic recovery.
Regarding trading, following the three-month rally since the beginning of March and the recent correction, most markets are again at important crossroads. Last week’s surprisingly weak US Payrolls report has raised doubts about the economic recovery hopes and pushed yields, equities and commodity prices sharply lower again. In the euro zone, German 10-year yields have fallen again from 3.75% to 3.34%, which corresponds with the targets of the short-term double top formation with neckline at 3.55%, while in the Bund strong resistance is still seen at 121.55 (neckline major double top formation on the continuation charts). We suspect that a sustained break higher in the Bund above 121.55 will only happen, if at the same time equities and commodities would also break lower. Regarding equity markets, we keep a close eye on the 877 level in the S&P (4688 in the DAX) and concerning commodity markets, strong support is seen at 245 in the CRB-index. A sustained break higher above 121.55 would bring the historic lows in German 10-year yields at around 2.9/3% again in the picture. We however do not anticipate on such a move as long as this is not confirmed on the equity and commodity markets. In the US, we are not that far yet, strong support in US 10-year yields is still seen at 3.30%.
In the UK, the calendar looks very thin today, but will heat up in the course of the week with the industrial production data, trade balance and the Bank of England rate decision, where the QE policy is expected to be increased to £150B.
