Markets: Fixed Income
On Tuesday, government bonds showed good resilience in the face of better than expected US housing data and consumer confidence and gained even further ground after the US 2-year Note auction attracted strong demand and oil prices dropped lower. As such, government bonds once again ignored the gains on the equity markets, which continued their rally higher too. The reappointment of Bernanke at the helm of the Fed may also have supported the bond markets.
In a daily perspective, US yields declined by 0.8 basis points at the 2-year segment and by 4.1 basis points in the 10-year segment. As such, the recent flattening of the US yield curve continued, as search for yield drives longer-term yields lower. In the euro zone, German yields declined too. 2-year yields fell by 2.5 basis points compared to a decline by 3.6 basis points in the 10-year segment. The intra-EMU sovereign spreads stabilized or narrowed slightly.
German bonds still close to key technical levels
Today, the calendar contains the German IFO indicator (August), the US durable orders (July) and new home sales (July). The German IFO business climate indicator is forecasted to extend its rebound in August. The consensus is looking for an increase from 87.3 to 89.0 with improvements in both the current assessment and expectations sub-indices. After the better than expected PMI’s, ZEW and yesterday’s Belgian business confidence, the risks are on the upside of expectations. In June, the US durables dropped more than expected due to a sharp decline in nondefense aircraft orders. For July however, an increase by 3.0% M/M is expected. A positive surprise due to increases in orders for commercial aircraft and motor vehicles is not excluded. New home sales are forecasted to show the fourth consecutive increase in July. An increase by 1.6% M/M to 390 000 is expected and if confirmed, this will add to the hopes that the housing market has hit the bottom.
On the supply front, the US Treasury will hold a $39B 5-year Note auction. The issue will raise all new cash. Yesterday, the 2-year Note auction showed strong nondealer demand, but the bidding was quite sloppy. Nevertheless, the bond market rallied higher afterwards.
This evening, Atlanta Fed president Lockhart, a voting member, will also speak on the US economy. Recent comments from central bankers at Jackson Hole have indicated that both the Fed and the ECB intend to maintain their current very accommodative stance for the foreseeable future. Yesterday, ECB executive board member Gonzalez-Paramo confirmed this cautious approach, as he said that the situation of the European economy is still ‘uncertain’ and added that interest rates are at an ‘appropriate’ level. These comments suggest that no big change should be expected at next week’s ECB meeting, despite the recent better than expected eco data.
Regarding trading, over the past month, government bond markets have remained quite well supported despite the general improvement in the economic outlook. Indeed, despite the rally on the equity, commodity and credit markets, yields are still well below the year highs set at the beginning of June. The improvement in risk appetite has nevertheless led to a significant tightening in the credit spreads, which has even pushed several EMU countries’ yields to new cycle lows. Last Friday’s technical break higher on the equity markets suggests that risk appetite is still improving and that the tightening in spreads is not over yet. At the same time, central bankers at the annual Jackson Hole symposium repeated they don’t plan to withdraw monetary stimulus yet, which should keep yields rather low. Yesterday’s reappointment of Bernanke should be reassuring in this context. This week’s trading action indeed confirmed that the upside pressure on yields is currently quite limited, as yields continue to ignore the rally on the equity markets and even fall lower once the rally shows signs of fatigue. From a technical point of view, US 10-year yields failed to retest the 4% level in August and fell below their uptrend line recently (see graph above). Next important support is seen at around 3.25%, which is the neckline of a potential double top formation. In Germany, similar support is seen at around 3.25%. A break below would bring the cycle lows again in the picture (see graph below).
In the UK, the calendar is empty today. Yesterday evening, BoE’s Bean called the initial responses to the QE ‘moderately encouraging’, but added that ‘it is very early to draw conclusions on the efficacy of these measures, as the transmission lags through to nominal spending are likely to be quite long’. He also indicated that ‘policymakers are considering the benefits of developing additional macroprudential instruments which can be used to respond to rapid credit growth and rising asset prices’. According to Bean, ‘these new instruments should directly target the incentives to extend excessive credit’ by e.g. setting higher capital requirements or higher margin requirements for transactions with institutions outside the banking sector that were beyond the oversight of regulators.
