Markets: Fixed Income
On Thursday, government bonds were moderately lower, as the correction on the equity market got no follow-through and equities stabilized. The short end of the curve however outperformed after several central bankers continued to talk soft despite the recent improvement in the economic data. Indeed, despite the upward revision of the ECB staff projections, the ECB clearly indicated that it’s too early to start withdrawing monetary policy accommodation and kept the liquidity spigots wide open by announcing that the interest rate of the next unlimited 12-month tender will be kept at 1%. The Swedish Riksbank yesterday also reaffirmed its plan to keep in-terest rates on hold for another year in spite of recent better eco data and in the US, Dallas Fed Fisher overnight indicated that the US economy will probably undergo a prolonged period of slow growth and uncomfortably high unemployment, which sug-gests that no tightening should be expected anytime soon. The continued soft tone from the central bankers helped to limit the impact of the slightly better than expected confidence surveys in the services sector in the euro zone, UK and the US. Longer-term government bonds nevertheless closed at the intra-day lows, as US equities staged a late rally.
In a daily perspective, there was a steepening of the yield curve both in the US as well as in Germany. In the US, 2-year yields rose by 1.6 basis points, while 10-year yields were up by 3.9 basis points. In the euro zone, German 2-year yields con-tinued their recent downtrend and set a new record closing low at 1.14% following the ECB’s one-year tender announcement. At the longer end of the curve, 10- and 30-year yields rose by respectively 1.1 and 3.3 basis points. The intra-EMU sover-eign spreads widened again despite the successful auctions from Spain and France.
Payrolls decisive for near-term outlook bonds
Today, all eyes will be on the US payrolls report (August). Since the start of the year, we’ve seen a clear positive trend in the official payrolls report. The number of job losses reached a peak in January (741 000), but has come down significantly in the first halve of the year. Last month, the payrolls surprised on the upside of expec-tations showing a decline in employment by 247 000, while a job loss of 325 000 was forecasted. For August, the consensus is looking for a further improvement to -230 000. Despite the disappointing ADP report, we believe that a positive surprise is not excluded as recently the ADP report constantly overestimated the number of job losses. In the previous four months however, the payrolls always surprised on the upside of expectations and this might indicate that analysts are still too pessimistic about the current state of the economy.
Today, several ECB governing council members, including president Trichet, Pa-pademos, Stark and Gonzalez-Paramo, will participate at the annual conference ‘The ECB and its watchers XI’. After yesterday’s monthly ECB policy meeting, we don’t expect them to move the market. Yesterday, ECB president Trichet sounded cau-tiously more optimistic about the economic outlook, which was reflected in the modest upward revision of the ECB staff growth projections. These now project the euro zone economy to contract by 4.1% Y/Y this year and to grow by just 0.2% Y/Y next year instead of the contraction of respectively 4.6% and 0.3% still expected in June. At the same time, Trichet reaffirmed that inflation is expected to remain ‘subdued over the policy relevant horizon’. The new staff projections point to an inflation rate of only 1.2% Y/Y next year compared to 0.4% this year. This suggests that current ultra-accommodative policy can still be maintained for a consider-able period. To reassure markets in this regard, Trichet announced that no premium above the main refinancing rate (1%) will be imposed when the ECB will provide the next tranche of 12 month money at the end of September. With regard to the deposit rate, Trichet said that the ECB had no intention to cut the deposit rate into negative territory to encourage lending.
The outlook for a prolonged period of low interest rates and cheap liquidity continued to support the short end of the curve, with German 2-year yields falling to their lowest level since March this year. Current huge demand for short-term bonds was also reflected in the strong Spanish 2-year auction yesterday. The bond maturing in 2011 draw the highest bid/cover ratio of any Spanish bond sale this year. But with German 2-year yields currently at 1.14%, one can reasonably question whether there is still much more downside available, the more as the ECB dismissed the possibility of negative deposit rates, which have helped to push UK 2-year yields to new all-time lows.
Regarding trading. Despite the general improvement in the economic outlook, gov-ernment bond markets have performed strongly over the past two months. But re-cently, there have been increasing signs of fatigue, as bonds failed to break deci-sively above key resistance levels both in the US as well as in Germany. Indeed, the break above the neckline of a double bottom formation in the Bund at 122.50 didn’t cause an acceleration of the uptrend, while in the US the T-Note future yesterday failed to confirm the Wednesday’s break above a similar neckline at 117.19. Today’s Payrolls report may be decisive whether a sustained break will occur and bonds will extend their recent rally or whether it’s time to book profits.
In the UK, the DMO will tap its 30-year Gilt 2.25% 2039 for an amount of £2.25B. The auction results need close monitoring, as several longer-term Gilt auctions went rather difficult earlier this year.
