Markets: Fixed Income
On Tuesday, global bonds recouped early losses and gained further ground, as US equities fell sharply ahead of the start of the second quarter earnings sea-son which will begin this evening with Alcoa. The S&P closed almost 2% lower at 881 and is now close to the first important support zone at 875. Commodities also ex-tended their recent downward correction following Monday’s break lower in the CRB-index, as the unexpected strong increase in the German factory orders couldn’t re-move investors’ doubts about the strength of the economic recovery.
In a daily perspective, there was a flattening of the US yield curve, as the short end of the curve underperformed after the 3-year Note auction showed a quite sloppy bidding, but decent demand. As a result, 2-year yields moved 2.4 basis points higher, while 5-, 10- and 30-year yields declined by respectively 3.4, 5.2 and 4.9 basis points. In the euro zone, German bonds traded lower for most of the day, but rebounded af-ter the official closing of the cash markets. As such, the rises in yields will be re-versed in the opening this morning.
Equities in the drivers’ seat at start of earnings season
Today, the eco calendar remains rather uneventful as it only contains the German industrial production data (May) and final figure of euro zone first quarter GDP growth. In May, German industrial production is forecasted to have risen by 0.5% M/M after falling by 1.9% M/M in April. We have no clear reasons to distance our-selves from the consensus. The final figure of euro zone first quarter GDP growth is expected to confirm the previous estimate of -2.5% Q/Q and no big changes are expected in the breakdown.
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. Today, the Treasury will hold a 10-year Note auction for an amount of $19B. Longer-term auctions require close monitoring, as investors have been more wary to invest in longer-term bonds given the current very uncertain growth, inflation and pub-lic finances outlook. Yesterday, the sloppy bidding in the 3-year Note auction led to an underperformance of the short end of the curve in the US. In the euro zone, Por-tugal will tap its 10-year benchmark for an amount of €1B. Yesterday, Italy sold €5.5B of its new 15-year BTP, while the Netherlands issued a new 5-year benchmark for an amount of €6.204B and Austria sold €2.2B of its 5- and 15-year benchmark. The Flemish Community sold €0.75B of a new 3.5 year bond and €1.25B of its 7-year bond. These were priced at respectively 40 and 70 basis points above asset swap.
On the money market, the ECB will hold a 3- and 6-month refinancing operation at a fixed rate of 1% today. Yesterday, the amount allotted in the weekly tender sta-bilized slightly above €100B, while the amount allotted over the maintenance period fell to €38B compared to €56B one month ago. The amount deposited at the ECB deposit facility declined for the first time since the 12-month refinancing operation of two weeks ago. Via its unconventional refinancing operations the ECB governing council wants to strengthen the liquidity position of the banks and ease the financing conditions in the euro zone economy. As such, the ECB has succeeded in bring-ing down money market rates, but concerns about a ‘credit squeeze’ remain given the recent sharp slowing in lending and the huge amounts deposited at the ECB. Although the slowing in lending may be partly due to weaker demand, it also suggests that supply constraints are restraining a normal functioning of the economy, which may only be removed when banks are recapitalized. Today, ECB’s executive board member Gonzalez-Paramo and the governor of the Bank of Spain Ordonez will speak in a discussion on ‘Recovery or revolution. Reviewing paradigms’. Yesterday, ECB’s Ordonez sounded pleased with the impact of the cov-ered bond purchasing program, which he called ‘a great success’. He also still ex-pects an economic recovery at the beginning of 2010, although he admitted that un-certainty remains very high, as the improvement in the qualitative indicators (expecta-tions, confidence) has not yet translated in the quantitative indicators.
Regarding trading, following the three-month rally since the beginning of March and the recent correction, most markets are again at important cross-roads. Last week’s surprisingly weak US Payrolls report has raised doubts about the economic recovery and has pushed yields, equities and commodity prices sharply lower. 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. This week, 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 confirmed its break 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 eq-uity and commodity markets. In the US, supply concerns may hamper the decline in yields.
Also in the UK, the calendar contains only second-tier data.
On the supply front, the DMO will tap its inflation-linked Gilt 1.25% 2027 for an amount of £1B, while the Bank of England will hold a £3B reverse auction.
