Markets: Fixed Income
On Wednesday, government bonds enjoyed a very strong session, as investors turned ever more risk averse ahead of the US earnings season. A very strong US 10-year Note auction contributed to the bullish sentiment on the bond markets and bonds closed at around the session highs, although US equities staged a late rebound. As a result, the S&P tested but didn’t break below the key support zone at around 875. On the commodity markets, the CRB index continued its sharp decline, which was set into motion after last week’s disappointing US Payrolls report. Also on the currency markets, the increase in risk aversion was reflected in the surge of the yen.
In a daily perspective, the US yield curve flattened significantly after the successful 10-year Note auction. Both demand and bidding were very aggressive and pushed 10-year yields sharply lower. US 10-year yields declined by 14.6 basis points compared to a decline by 5.6 basis points in 2-year yields. In the euro zone, German yields reversed Tuesday’s gains, but lagged the down-move in the US. Other European government bonds still underperformed, which was reflected in a widening of the intra-EMU sovereign spreads in line with the increase in risk aversion noted in other markets.
Bond markets keep close eye on equities
Today, the calendar contains US weekly claims and May wholesale inventories and in the euro zone we look out for the ECB monthly bulletin. This morning, the German trade surplus rose to €9.6B in May from €9.4B in April, as exports stabilized, while imports continued to fall. Although the trade balance points to some stabilization, it is too soon to speak about any recovery in world trade.
Last week, US initial claims came out close to expectations, falling by 16 000. For the week ended July 4, another slight decline is expected (to 605 000) and we have no reasons to distance ourselves from the consensus. Continuing claims, which are reported with a one-week lag, are forecasted to show a small increase (from 6 702 000 to 6 710 000) after falling more than expected in the previous week. Wholesale inventories are expected to show the ninth consecutive decline in May (by 1.0% M/M). In the US, there are several Fed members scheduled to speak, while the Treasury will hold its last auction of the week, as it plans to tap its 30-year Bond for an amount of $11B.
On the money market, the Euribor rate fixings continue to fall in the wake of the 12-month refinancing operation. Yesterday, the amounts allotted in the 3- and 6- month operations declined, as banks have fulfilled their liquidity needs in the 12- month tender. Following Tuesday’s fine tuning operation, the amount deposited at the ECB collapsed from €278B to €71B. The question however remains whether banks are able to help foster an economic recovery or whether first a further recapitalization of the banking sector is needed. Yesterday, ECB’s executive board member Bini Smaghi warned that ‘there is a risk of arriving at the appointed time with a banking system that is not able to support demand for financing’. He said there was still uncertainty on the impact of the recession on banks’ bad loans and the bank system was still unable to finance itself over the medium and long term. This represents a problem because without that financing the provision of loans to the real economy risks being blocked, worsening the crisis.
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 astonishingly weak US Payrolls report 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 3.25%, 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. In the US, 10-year yields have fallen from 4% to 3.30%, which is a first important support zone. We suspect that to make more headway, equities and commodities should also break lower. This week, the CRB broke already 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. At the same time, yesterday’s widening in the intra-EMU sovereign spreads indicates that such a move may also result in a renewed widening of the spreads. In a daily perspective, this morning’s more constructive sentiment in Asia following yesterday’s late rebound in Wall Street, may result in some downward correction on the bond markets today.
In the UK, the Bank of England will decide on monetary policy. Rates are expected to remain unchanged, but a further increase in the asset purchase facility to the maximum authorized amount of £150B looks likely. This would give the MPC the opportunity to continue with its asset purchases until the meeting in August, when the Inflation Report would provide them the opportunity to asses the impact of the purchases and to see whether a further increase may still be needed in which case the MPC would have to seek permission of the Chancellor.
Today, the data calendar contains the trade balance for the month of May. After widening slightly in April, the trade deficit is forecasted to contract in May as exports might have contracted less than imports.
