Markets: Fixed Income
On Friday, government bonds reversed early weakness and closed again higher, once the rally on the US equity markets halted. As such, the better than expected eco data once again failed to push yields higher. Indeed, despite a stronger than expected improvement in the EU Commission’s economic sentiment indicator and an upward revision of the UK Q2 GDP data and US Michigan consumer confidence, yields both in the US and in the euro zone remain close to the recent lows.
In a daily perspective, US yields fell by around 2 basis points, while in the euro zone, German yields were slightly higher. The latter was however mainly due to the early close of the cash markets, as bonds rallied higher after the closing. The intra- EMU sovereign spreads widened slightly ahead of the supply, which will heat up again now that the summer period is over.
Bund opens above key resistance zone on equity weakness
Today, the calendar contains the first estimate of euro zone CPI (August) and Chicago PMI (August). Euro zone CPI inflation is expected to stay in negative territory in August, for the third consecutive month. The consensus is looking for an outcome of -0.3% Y/Y, but the risks might be on the upside of expectations after the higher than expected inflation figures in Germany, Spain and Belgium. In the US, the Chicago PMI is expected to have risen from 43.4 to 47.2 in August. We have no reason to distance ourselves from the consensus, as the NY Empire State Manufacturing survey and the Philadelphia Fed survey showed both a strong improvement.
Later this week, the US calendar remains attractive with the manufacturing and nonmanufacturing ISM, car sales and the payrolls report. In August, the manufacturing ISM is forecasted to jump back above 50, for the first time since January 2008. An improvement from 48.9 to 50.1 is forecasted. The non-manufacturing ISM, which has lagged the rebound in the manufacturing ISM, is expected to have risen from 46.4 to 48.0 in August. Last month, the US payrolls report surprised on the upside of expectations showing a decline in employment by 247 000, while a drop by 325 000 was expected. For this month another slight improvement is expected to - 225 000, which would be in line with the gradual decline in the claims. In the euro zone, the unemployment rate is forecasted to have risen from 9.4% to 9.5% in July. Also in July, euro zone retail sales are forecasted to show the first increase in three months. The consensus is looking for an increase by 0.1% M/M, but the German retail sales, released tomorrow, might give us a first indication.
Despite the recent improvement of the economic outlook, we do expect the ECB governing council to maintain their ultra-accommodative monetary policy stance for the foreseeable future. As such, no change in interest rates or nonstandard monetary policy should be expected at this Thursday’s ECB policy meeting. Therefore, the economic recovery looks still too fragile, while the inflation outlook is not expected to threaten price stability. This is likely to be reflected in the new ECB staff projections for growth and inflation, which will show inflation to remain clearly below 2%, despite an upward revision of the growth outlook. Such a continuation of their ultra-accommodative policy stance will put the ECB in line with the other major central banks, which have recently also decided to maintain (Fed) or even to extend (Bank of England) their policy accommodation. A preview of this week’s ECB policy meeting will be published in the course of the week.
On the supply front, there are no auctions scheduled in the US this week, but on Thursday the Treasury will detail the amounts of next week’s 3-, 10- and 30-year auctions. In the euro zone, Austria, France and Spain will tap the market. In the absence of redemption payments, the net cash flows will be highly negative. On Friday, the Italian auctions were well digested in the market, although the Italian bond market underperformed slightly.
Regarding trading. Over the past month, government bond markets have continued to perform strongly despite the general improvement in the economic outlook. Indeed, despite the rally on the equity, commodity and credit markets, yields are still well below this year highs set at the beginning of June. The improvement in risk appetite has also led to a significant tightening in the credit spreads, which has even pushed several EMU countries’ yields to new cycle lows. It appears that the outlook for central bank policy rates to remain low for extended period of time has set a new liquidity driven rally on all asset markets into motion, which does also support the government bond markets. Last week’s trading indeed confirmed that the upside pressure on yields is currently quite limited, as yields continued to ignore the better than expected eco data. From a technical point of view, US 10-year yields failed to retest the 4% level in August and even fell below their uptrend line. First important support is seen at around 3.25%, which is the neckline of a potential double top formation (see graph above). In Germany, similar support is seen at around 3.25/20%, which is currently under test. A sustained break below would bring the cycle lows again in the picture. In the Bund, these levels correspond with 122.50/85. This morning’s dismal performance of the Asian equity markets and China in particular has resulted in a sharp higher opening of the Bund above these levels.
In the UK, the calendar is empty today.
