Markets: Fixed Income
On Wednesday, government bonds sold off, as the rebound on the equity markets accelerated after strong earnings from Intel and encouraging eco data out of the US, where the NY Empire State Manufacturing Survey and industrial output beated expectations. The European and US inflation data played no major role in trading. In a daily perspective, the European and US equity markets gained around 3%, with the S&P500 now coming close to the year highs at around the 950 level. Commodities tracked the general improvement in market sentiment, as the CRB index gained 3.5 points. The Minutes of the latest Fed meeting reflected the more positive mood on the economy, but had little visible impact on trading. The FOMC agreed that ‘the economic contraction was slowing’ and predicted that GDP would drop by between 1.5- 1% this year, more optimistic than their last forecast in April of a 2-1.3% contraction. For next year, they raised growth forecasts to between 2.1% and 3.3%, from a 2-3 per cent range. They also increased projections for inflation, but expect it to remain below 2% through this year and the next. Regarding the QE program, the Minutes stated that although an expansion of such purchases might provide additional support, the effects of further asset purchases, especially purchases of Treasury securities, on the economy and on inflation expectations were uncertain.
The improvement in risk appetite hit the government bond markets. In the US, the bear steepening of the yield curve continued with 2-year yields up by 7.3 basis points and 10-year yields by 13.4 basis points. In the euro zone, German yields moved higher too, but the increase was again more limited, as 2-year yields rose by 3.7 basis points and 10-year yields by 6.3 basis points. The other European government bond markets even still outperformed, as the intra-EMU sovereign spreads narrowed quite sharply on the improved economic outlook, which lured investors to higher yielding assets.
Longer-term outlook yields still upwardly oriented?
Today, the euro zone calendar contains only second-tier data. In the US, the weekly claims, Philly Fed and NAHB housing market index are scheduled for release. In the week ended July 11, initial claims are forecasted to have dropped by 12 000 to a total number of 550 000 after falling significantly in the previous week. We believe the risks might be on the downside of expectations as the massive auto shutdowns that have already occurred will limit the extent of the July shutdowns. Continuing claims, which are reported with an extra week lag, are expected to drop from 6 883 000 to 6 850 000. The Philly Fed is forecasted to show a marginal worsening (-5.0 from -2.2) in July after the impressive rebound in June. The positive surprise in the NY Empire State Manufacturing Survey however suggests that the risk is on the upside. The NAHB housing market index is expected to rise marginally (16 from 15) in July.
Today, the ECB governing council will also hold its monthly non-monetary policy meeting. Usually, no statement is published afterwards, so one shouldn’t expect any impact. Yesterday, the ECB released the euro area securities issues statistics for the Month of May. These indicated that the annual growth rate of outstanding debt securities issued by non-financial corporations was 9.9% in May, the same as in April. This however falls apart into a sharp decline in short-term debt issuance by 21.3% Y/Y and a sharp increase in longer-term fixed rate debt issuance by 21.9% Y/Y. The sharp decline in short-term issuance suggests that the recent negative growth rates in short-term bank lending to non-financial corporations may be mainly driven by demand factors instead of credit supply factors. The decline in demand may partly reflect the lower need for working capital due to the sharp economic downturn. With regard to longer-term financing needs, demand will also have fallen due to the scaling back of investment plans, but the strong growth in debt issuance nevertheless suggests that tight credit supply may play a bigger role. As such, there is still a lot uncertainty on whether there is a euro zone credit crunch or not.
On the supply front, France will tap three short-term BTANs as well as three inflationlinked OATs, while Spain will tap a 15-year Obligaciones. Demand should be wellsupported thanks to the large redemptions and coupon payments this week.
Today, the earnings season will continue with Nokia, JPMorganChase, IBM, Novartis and Google reporting Q2 earnings. Until now, most companies have reported better than expected earnings, which resulted in a sharp rebound on the equity markets. Consequently, the S&P moved from the bottom of its tight sideways range at the 875 zone towards the top of the range at the 950 zone. A sustained break on either side may to a large extent decide what action policymakers will take next. In the US, there is currently some discussion going on whether a second stimulus package is needed, while in the euro zone the ECB is under pressure to start purchasing corporate bonds in addition to their covered bond purchases.
Regarding trading, as long as no sustained break has happened on the equity markets, we stick to our view of more range trading on the bond markets. There is still a lot of uncertainty on the economic outlook, which suggests that trading can remain quite volatile over the next weeks. Nevertheless, over the past days, the downtrend in yields has halted again and yields have corrected upwards. This correction occurred at interesting technical support levels both in the US and in Germany, which does suggest that the longer-term outlook for yields is still upwardly oriented. In the US, 10-year yields rebounded off the neckline of a major longer-term multiple top formation at 3.30%, while in Germany, 10-year yields rebounded off the neckline of a multiple bottom formation at 3.25%. For now, we do expect more range-trading between 3.30% and 4% in the US and 3.25% and 3.75% in Germany.
In the UK, the calendar is empty today.
