Markets: Fixed Income
On Friday, government bonds traded again lower, as the rebound in the housing starts and building permits added to the underlying sentiment that the US recession is nearing its end. The earnings from Citigroup, Bank of America and General Electric were not bad, but failed to inspire the equity markets. As a result, the S&P500 didn’t break above the year highs. Commodities however continued their rebound, as the CRB tested again the 245 mark. This morning, press reports about an agreement between CIT and its bondholders on a refinancing deal put government bonds further under pressure.
In a daily perspective, the yield curve steepened both in the US and in Germany. In the US, 2-year yields were up less than 1 basis point, while 10-year yields moved 7.4 basis points higher. In the euro zone, German 2-year yields increased by 3.3 basis points compared to a rise of 6.4 basis points in 10-year yields. The positive sentiment was also reflected in a further narrowing of the intra-EMU sovereign spreads.
Equity markets remain in the drivers’ seat
Today, the calendar is thin with only the US leading indicators (June) scheduled for release. The consensus is looking for the third consecutive increase, but the pace of increase might have slowed somewhat. The market impact might be limited as a most of the sub-indices are already known. Later on this week in the US, the focus will be on the bi-annual testimony of Fed president Bernanke before Congress on Tuesday and Wednesday, as the data calendar remains unattractive during the remainder of the week with only the existing home sales and weekly claims worth mentioning. US existing home sales are forecasted to show the third consecutive improvement in June. The consensus is looking for an increase by 0.6% M/M after rising by 2.4% M/M in May. Initial claims, for the week ended July 18, are forecasted to increase again after falling significantly in the previous two weeks due to seasonal adjustment factors. Regarding the testimony, we expect Bernanke to welcome the recent signs of improvement in the economy, but to signal at the same time that it is too early to tighten monetary policy. Recently, most policymakers have adopted a wait-and-see stance, as the economy appeared to be stabilizing. Hints that the Fed may not increase their Treasury purchases anymore may however hurt the Treasury market.
In the euro zone, the industrial new orders (May), German IFO (July) and PMI’s (July) are on this week’s agenda. In May, industrial new orders are expected to show the first increase in ten months. The consensus is looking for a rise by 1.9% M/M, but we believe that the risks might be on the downside of expectations after the disappointing industrial production data. On Friday, both the PMI’s and German IFO indicator are scheduled for release. In July, the euro zone manufacturing PMI is expected to show the fifth consecutive increase. The consensus is looking for an improvement from 42.6 to 43.5, but the risks might be on the downside of expectations after the unexpected drop in the German ZEW. Services PMI is expected to improve somewhat in July after the marginal deterioration in June. The IFO indicator will probably receive less attention than is normally the case as it will be published at the same moment as the PMI’s. The German IFO is forecasted to extend its upward trend in July.
On the supply front, the number of auctions will slow substantially due to the summer recess. This week, only Ireland is planning to tap two bonds for a total amount of €0.75-1.5B, while in the US the Treasury will detail the amounts of next week’s auctions. Next week, the US Treasury plans to auction a 20-year TIPS and a 2-, 5- and 7-year Note.
Regarding trading, last week’s first positive earnings from the banking sector and Intel as well as strong growth figures out of China have increased investors’ optimism that the global economic recession may be nearing its end. This pushed the equity markets again towards the year highs and helped commodities rebounding. A sustained break above the 950 zone in the S&P500 would be a very bullish technical signal, as it would implicate that the bear market is over. This would also ease the need for a second stimulus plan in the US and lower the pressure on the ECB to start purchasing corporate bonds in addition to their covered bond purchases. In response, government bond yields corrected upwards last week and the rebound from technical important support levels (at 3.30 in US 10-year yields and 3.25% in German 10-year yields) suggests that in a longer-term perspective yields are still upwardly oriented. A break higher in the equity markets would bring the recent highs at respectively 4% in the US and 3.75% in Germany again in the picture.
In the UK, the calendar contains the M4 money supply data. In June, money supply is expected to have softened further (14.6% Y/Y from 16.6% Y/Y). The numbers are however distorted by the impact from money holdings of institutions that intermediate between banks. Therefore, the MPC focuses on M4 growth excluding the deposits of these intermediaries. Then, the bulk of the increase had been concentrated in nonbank financial corporations’ money balances, which might be related to the asset purchase facility.
Later this week, the calendar remains attractive in the UK with the retail sales and second quarter GDP figures. In June, the official retail sales are forecasted to have risen again after showing an unexpected decline in May. Second quarter GDP is expected to have contracted by 0.3% Q/Q, a significantly softer contraction than in the first quarter. Regarding monetary policy, the Minutes of the July meeting may shed some further light on the rationale behind the surprising decision of the MPC to leave the amount of the asset purchases unchanged. Recent comments of the BoE’s chief economist Bean suggested that one shouldn’t draw too many conclusions out of this decision, which might suggest that the MPC may still decide to increase their programme in August.
