Markets: Fixed Income
On Thursday, government bonds corrected lower, as equity and commodity markets rebounded slightly following recent sharp losses. The unexpected decision of the Bank of England to leave both rates and its quantitative easing policy unchanged added to the correction in mood on the bond markets. There was also little relief in the US Treasury market after the last auction of the week had passed. The 30-year Bond auction saw again strong demand, but the bidding was less aggressive compared to the 10-year Note auction. Bonds temporarily spiked higher, but soon continued their downtrend.
In a daily perspective, US yields partly reversed Wednesday’s sharp decline, as 2- year yields rose by 1.6 basis points and 10-year yields by 9.5 basis points. In the euro zone, the German yield curve flattened slightly with 2-year yields up by 4.6 basis points and 10-year yields up by 2.2 basis points. The intra-EMU sovereign spreads stabilized yesterday following yesterday’s increase.
German Finance Minister warns again for a credit crunch
Today, the US calendar heats up with the trade balance (May) and first estimate of July Michigan consumer confidence. In the euro zone, the French and Italian industrial production figures are scheduled for release.
Both French and Italian industrial production are forecasted to have dropped in May. In France, industrial production is expected to show the ninth consecutive decline, but a slowing in the pace of contraction is anticipated. The consensus is looking for a decline by 0.2% M/M. Italian industrial production is forecasted to have dropped by a steeper 1.1% M/M in May, after surprising on the upside of expectations in the previous month. We believe an upward surprise is not excluded after the better than expected German figures. In the US, the trade deficit is forecasted to have widened marginally in May (from $29.2B to $30.0B) as imports are expected to come out flat, while exports might have contracted slightly. The first estimate of Michigan consumer confidence is expected to illustrate a slight decline in July, the first in five months, after both ABC and conference board’s consumer sentiment deteriorated in June.
Yesterday, German Finance Minister Steinbrueck repeated that ‘in certain cases the Bundesbank could purchase corporate bonds’, in a sign that concerns about a disruptive credit squeeze in Europe’s largest economy continue to mount. Earlier this week, Steinbrueck first suggested the idea that the central bank could do more itself to address a credit shortage, prompting Bundesbank president Weber to issue a statement saying he sees currently ‘no need’ to lend directly to companies.
‘Only if the banking system were dysfunctional would central banks have to think again about possible action, for example buying company bonds’. Overall, the comments of German Finance Minister Steinbrueck are very remarkable, as German officials have a tradition not to intervene in monetary policy issues and are considered as very conservative and focused on price stability. Therefore, these comments raise speculation that the situation in the German banking system must be very grave and should be tackled soon to prevent a credit crunch. The question however is whether such a move is possible ahead of the elections at the end of September. If not, this may cause much damage to the euro zone economy and delay a potential 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 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. Yesterday, yields corrected higher, and as such we suspect that to make more headway on the bond markets, 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.
In the UK, Gilts sold off yesterday after the Bank of England unexpectedly decided to leave the amount of their asset purchase programme unchanged at £125B, whereas an increase by £25B was expected. The statement stated that ‘the MPC expects that the programme will take another month to complete’ and that it ‘will review the scale at the August meeting, alongside its latest inflation projections’. The Minutes of the meeting should indicate whether the decision is due to profound concerns about the effectiveness of the programme or whether the decision will prove to be a temporary delay and that the MPC will raise the amount more substantially at the August meeting.
Today, annual producer price inflation is set to decline further in June. We keep a close eye on the core output inflation to see whether underlying inflationary pressures are abating.
