Markets: Fixed Income
On Friday, government bonds recouped Thursday’s losses, as risk aversion reemerged at the beginning of the US earnings season and a weaker than expected US Michigan consumer confidence survey. Better than expected French and Italian industrial production data in the euro zone weighed only temporary on the bond markets, the more as equities fell again later in the session. Bonds were further underpinned by news reports that CIT group may not get FDIC-backed paper issuing ability, which may lead to a default and cause problems for many small and medium sized US companies. There may also have been some relief following the strong US Treasury auctions earlier in the week.
In a daily perspective, the yield curve flattened, as US 2-year yields fell by 2.5 basis points compared to 10.1 basis points in 10-year yields. In the euro zone, German yields declined by 3 to 4 basis points across the curve. The intra-EMU sovereign spreads were stable on Friday amid a lack of supply.
Bond yields testing important support levels
Today, the calendar remains thin both in the euro zone and in the US. Later this week the calendar heats up with the US retail sales, euro zone and US industrial production data, CPI and the first confidence indicators for this month.
Tomorrow, US retail sales are forecasted to show the second consecutive increase in June. On a monthly basis, retail sales are expected to have risen by 0.4% M/M after rising by 0.5% M/M in the previous month. Part of the increase might be related to the surge in oil prices. Also in June, US industrial production is expected to show the eighth consecutive drop. The main source of weakness is expected to come from the manufacturing sector. In the euro zone however, the consensus is looking for the first increase in industrial production in nine months. In May, euro zone industrial production is expected to have risen by 1.5% M/M; the risks might be on the upside of expectations after the better than expected national IP data. US consumer price inflation is forecasted to fall deeper into negative territory in June. On a yearly basis, CPI is forecasted to drop from –1.3% Y/Y to –1.5% Y/Y. The monthly data are expected show an increase by 0.6% M/M due to gains in food and energy. In the euro zone, the final figure of June CPI is expected to confirm the first estimate of –0.1% Y/Y. In July, the regional US business confidence indicators are forecasted to stabilize, while the German ZEW indicator is expected to extend its upward trend.
On the ECB front, ECB president Trichet will speak today at the IFO seminar on ‘enhanced credit support: key ECB policy actions for the euro area economy’. Recently, concerns have risen that the ECB actions might not be sufficient to prevent a
credit crunch in the euro zone. However, for the time being the ECB is in a wait-andsee mode awaiting the impact of the rate cuts and their unconventional measures before embarking on new measures. Nevertheless, if there would be more evidence of a credit crunch, it cannot be excluded that the ECB will have to start buying commercial paper and government bonds. Last week, German Finance Minister Steinbrueck issued some calls in this direction. In the short-term, we keep a close eye on the deposit facility to see whether the liquidity pumped into the banking sector flows towards the real economy. Over the weekend, the ECB announced that it has bought 23 million euros of covered bonds last week.
On the supply front, there are no auctions scheduled in the US this week, which should be supportive for the Treasury market. In the euro zone, supply should also be no major issue, despite the planned auctions from Italy, France and Spain, as the net cash flow will be highly positive due to redemptions from France, Austria, the Netherlands and Portugal.
Regarding trading, following the three-month rally since the beginning of March and the recent correction, most markets are again at important crossroads. Rising doubts about the economic recovery 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 on the bond markets, equities and commodities should break lower. Last 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. This morning’s weak performance on the Asian equity markets suggests that the pressure remains on the downside, as investors are nervously awaiting the US earnings season. Concerns about CIT group as well as California contribute to the safe haven flows.
In the UK, Gilts rebounded after Thursday’s sell-off due to the unexpected decision not to expand its QE policy.
Today, there are no UK data scheduled for release, but the Bank of England will conduct its APF purchases of Gilts maturing between March 2020 and December 2030 for an amount of £2.25B.
