Markets: Fixed Income
On Monday, global bonds gained more ground, as doubts about the strength of a potential economic recovery persisted despite a stronger than expected ISM non-manufacturing survey. As a result, equities and commodities remained under downward pressure and are now testing first important support levels. A sustained break would suggest that recent optimism about the economic outlook was overdone. Reduced risk appetite continued to support the government bond markets, which extended Thursday’s Payrolls’ gains.
In a daily perspective, there was a steepening of the US yield curve, as the longer end of the curve lagged the short end on supply concerns ahead of this week’s longer-term auctions. Yesterday, the 10-year TIPS auction attracted decent demand, as the bid/cover ratio came in at 2.51 compared to an average of 2.01, while the pricing was also in line with pre-auction talk. As such, 2- and 5-year yields were down by respectively 4 and 3.6 basis points, while 10- and 30-year yields were up by 0.8 and 3.7 basis points.
In the euro zone, there was a bull flattening of the German yield curve, as yields were down across the yield curve. 2-year yields were down by 2.6 basis points compared to 4.9 basis points in 30-year yields.
Amount deposited at the ECB surges to a record high
Today, the economic calendar remains thin as it only contains the German factory (May). In April, German factory orders came out flat after rising significantly in March. For May, the consensus is looking for a slight increase (0.5% M/M) and if confirmed, this will add to the expectations that the German manufacturing sector might have seen the worst of the downturn.
On the supply front, bond investors will continue to focus on the US Treasury auctions, as the financing of the gaping US budget deficit has become a major issue. Yesterday, the 10-year TIPS auction went well. Today, the Treasury will issue a new 3-year Note auction for an amount of $35B. Usually, short-term auctions pose less of a risk compared to longer-term auctions, where the growth and inflation outlook is much more uncertain. It’s therefore of the essence that governments set out a credible path to fiscal sustainability. Otherwise, a public finance crisis may still loom around the corner. In the euro zone, the Netherlands will issue a new 5- year benchmark 2.75% January 2015 for a minimal amount of €5B. This week, the net cash flows on the European bond market will be positive, due to several German coupon payments and redemptions over the weekend.
On the money market, the Euribor rate fixings continue to decline. Following the 12-month refinancing operation, the decline has again accelerated, as there is a lot of excess liquidity available in the money market. This should also help to support lending in the euro zone, but until now a lot of the additional liquidity pumped into the banking system has been deposited at the ECB. Yesterday, the amount deposited rose to an all-time high at €316B. Over the coming two days, the ECB will hold four refinancing operations for a maturity of one week and the maintenance period (today) as well as 3- and 6-months tomorrow. Last week, banks demanded already much less liquidity in the weekly tender and if this trend continues the amount of money deposited at the ECB should start to decline too. Although ECB president Trichet called the 12-month tender an enormous success, we are afraid that as long as banks are not recapitalized there remains a huge risk for a credit squeeze, which could thwart any potential economic recovery. Today, ECB’s Ordonez will speak in Madrid. Yesterday, ECB’s Nowotny indicated that the ECB will review its unconventional measures after the summer. Recent comments of ECB’s Weber and Gonzalez-Paramo have indicated that the ECB may have to bypass the banking sector, if it would come to the conclusion that the banking sector had become dysfunctional.
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 from 3.75% to 3.30%, which means that the targets of the short-term double top formation with neckline at 3.55% have been reached. Yesterday, the Bund also broke again above the neckline of a major double top formation on the continuation charts at 121.55, which further improves the technical outlook. We suspect that to make more headway, equities and commodities should also break lower. Yesterday, the CRB already fell again below 245 and in the equity markets we keep a close eye on the 875 zone in the S&P. A sustained break lower in the equity and commodity markets 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 industrial production data for the month May are scheduled for release. In April, UK industrial production showed the first increase in fourteen months and for May, another slight increase is expected (0.2% M/M).
On the supply front, the DMO will issue a new 10-year benchmark 3.75% September 2019 for an amount of €4B. Last week, the 30-year Gilt didn’t go well.
