Markets: Fixed Income
On Friday, government bonds remained rather well supported, despite stronger than expected eco data and a late rally on the US equity markets. Indeed, although the euro zone PMI surveys and the German IFO indicator both beat expectations and indicated that business sentiment has improved further, the losses on the bond markets remained very limited. Bonds even rebounded off the lows on the back of the very weak UK Q2 GDP growth data. Profit-taking on the equity markets following the recent sharp rally higher offered some additional support to the bond markets during the afternoon. After the European closing, US equities rebounded, but the rebound failed to drag bonds lower.
In a daily perspective, US yields were little changed, as 2-year yields fell by 1.7 basis points, while 10-year yields rose by 0.3 basis points. In the euro zone, the stronger than expected improvement in the business sentiment surveys led to an underperformance of the short end of the curve. 2- and 5-year yields rose by 2.7 and 3.3 basis points, while 10-year yields rose by 1.9 basis points and 30-year yields declined by 0.1 basis points. Non-German European bond markets outperformed, as the improvement in risk appetite contributed to a narrowing of the intra- EMU sovereign spreads.
Rising equity markets weigh on bonds
This week, the eco calendar looks interesting both in the euro zone and in the US. In the euro zone, today’s M3 money supply and credit growth data as well as Wednesday’s ECB Bank lending survey and Friday’s ECB MFI interest rate statistics should provide more insight into the euro zone financing conditions. Over the past months, the sharp slowing in lending growth to households and non-financial corporations has raised talk about a ‘credit crunch’ in the euro zone, which may hamper a sustained economic recovery. This week, we will also get the first inflation data for the month of July and the June unemployment rate. Although euro zone headline inflation is expected to fall further into negative territory, this shouldn’t have much market impact as long as longer-term inflation expectations remain anchored around the 2% level. The unemployment rate is expected to continue its sharp rise to 9.7%, which may hamper consumer spending and raise protectionist pressures. In the US, today’s new home sales and Tuesday’s Case-Shiller house price index for the month of May will be closely watched for confirmation on the recent signs of a turnaround in the US housing market, as this is still considered as a first key step towards a sustained economic recovery in the US. Later on this week, we also look out for the Conference Board consumer confidence survey on Tuesday, the durable orders report on Wednesday, the weekly claims on Thursday and last but not least the first estimate of Q2 GDP growth. Quarterly growth is expected to come out at - 1.5% in Q2 compared to a negative reading of -5.5% in Q1.
Besides the eco data, the centre of the earnings season will shift from the US towards Europe. As such, it will be interesting to see whether European companies will be even confident about the economic outlook compared to their US peers. Since the beginning of the US earnings season, the equity markets have rebounded sharply and managed to break above key technical resistance levels to new highs for the year. If confirmed this week, this would signal that the outlook for the global economy is improving more rapidly than previously thought and raise speculation about the timing of an exit strategy, although Mr Bernanke last week stated that monetary policy will remain accommodative for an extended period. Wednesday’s publication of the Beige Book may provide further insight in how the Fed sees the economy evolving. In the euro zone, there are no ECB speeches or events scheduled.
On the supply front, bond investors will focus on the record supply in the US, where the Treasury will hold four auctions for a record amount of $115B. Today, the Treasury will raise $6B new cash in a 20-year TIPS auction, which will be followed by a 2-, 5- and 7-Note auctions over the coming days. In the euro zone, Belgium will tap three OLO’s today for a total amount of €1.7-2.3B. Later on this week, the Netherlands and Italy also plan to tap the market. It will be interesting to monitor the appetite for government bonds now that global market sentiment has improved and equities have been performing very well. The positive net cash flow should ensure decent demand.
Regarding trading, last week’s losses on the bond markets remained rather limited compared to the gains and the break higher on the equity markets. This suggests that bond investors are still quite confident that inflation won’t pose a major problem and that growth will remain slow, despite recent signs of improvement. We nevertheless hold on to our sell-on-upticks approach, although the recent highs at around 4% in US 10-year yields and 3.75% in German 10-year yields will remain difficult to break above.
In the UK, the Hometrack house price survey showed prices stabilizing in July on a monthly basis. Compared to a year ago, there is still a decline of 7.7%. According to Hometrack, ‘the housing market remains in a fragile state’. ‘A sustainable and broad based recovery needs to be founded on both an improving economic outlook and availability of mortgage finance’.
