Markets: Fixed Income
On Monday, government bonds lost further ground on supply concerns ahead of this week’s massive issuance in the US. The US Treasury will auction a record $115B of securities this week and also in the euro zone supply picks up again to €16.75B, after a near drought last week. As such, government bonds were under downward pressure, although the rally on the equity market showed some signs of fatigue. The underlying positive sentiment was nevertheless supported by the larger than expected rebound in German consumer confidence and the strong rise in the US new home sales. The slowing in euro zone M3 money supply and credit growth had little immediate impact.
In a daily perspective, the US yield curve steepened, as 2-year yields rose by 4.1 basis points and 10-year yields by 6.1 basis points. The 20-year TIPS auction was rather well received yesterday, but most attention will go out to the 2-, 5- and 7- year Note auctions over the coming days. In the euro zone, there was a bear flattening of the German yield curve, as 2-year yields rose by 4 basis points compared to 0.9 basis points for 10-year yields. The intra-EMU sovereign spreads narrowed again in the wake of a strong Belgian auction and on the back of the improvement in risk appetite.
Intra-EMU sovereign spreads continue to narrow
Today, the euro zone data calendar is empty, but in the US, the S&P Case Shiller house prices (May), Conference Board’s consumer confidence (July) and the Richmond Fed are scheduled for release.
Last month conference board’s consumer confidence showed a decline after rebounding significantly at the start of the year. The headline index dropped from 54.8 to 49.3 and another, marginal, decline is expected for this month (49.0) after the deterioration in the Michigan consumer confidence. The Richmond Fed however is forecasted to extend its upward trend in July. The headline index is expected to have risen from 6 to 8 and we have no reasons to distance ourselves from the consensus. Recently, the decline in Case Shiller house prices moderated somewhat. For May, a further slowing in the pace of decline is forecasted from -18.12% Y/Y to -17.90% Y/Y. This would add to recent signs of stabilization in the US housing market after the housing starts, building permits, existing home sales and new home sales all surprised on the upside. This would be an important first step towards a sustainable economic recovery in the US.
This evening, San Francisco Fed president Yellen will speak on the US economy, while the US Treasury will issue a new 2-year Note for an amount of $42B, which will raise approximately $22B in new cash. Short-term auctions should go rather well, as Bernanke last week signalled that the Fed, despite recent ‘signs of stabilization’, intends to maintain a ‘highly accommodative’ monetary policy for ‘an extended period’. In the euro zone, the Netherlands plans to tap three off the runs for an amount between zero and €2B. Yesterday, the Belgian auctions attracted strong demand, as the improvement in risk appetite drives investors to higher yielding non-German debt. As a result, the intra-EMU sovereign spreads continued to narrow. Yesterday evening, Latvia also reached a preliminary agreement with the IMF on a policy package that can lead to the completion of the first review under the country’s Stand-By Arrangement. The completion of the review may lead to the disbursement of about €195M from the lender. The EU yesterday already released €1.2B to Latvia. The agreement may further increase risk appetite and lead to a further narrowing of the spreads.
Regarding trading, recent losses on the bond markets remained rather limited compared to the gains on the equity markets. Indeed, longer-term yields both in the US and in Germany are still some way off the recent highs at respectively 4% and 3.75%, while most equity indices have broken above this year highs. This suggests that Bernanke and other policymakers have managed to keep inflation expectations in check, despite recent signs of economic improvement. This week’s digestion of the supply will be a good test for investors’ appetite for government bonds now that risk appetite is rising. A break below 115-25+, neckline previous double bottom, in the US T-Note future would bring the highs at around 4% again in the picture, in which case the pressure on the upside in German yields would rise too.
In the UK, the CBI distributive trades report (July) is scheduled for release. In June, the sales index stayed unchanged at -17 and for this month a slight deterioration is expected.
