Markets: Fixed Income
On Friday, US Treasuries were lower, as equities overcame early weakness to end the session on a strong note. Upcoming supply might have been a factor too. In EMU, the picture was different with short term yields even down, while longer term yields flat to slightly higher.
The US payrolls failed to give the market clear guidance. The outcome was a bit mixed. The trend of declining pace of job losses was confirmed, but downward revisions of the results of previous months and an unexpected rise in the unemployment rate gave the report a more neutral spin. So, while bonds had lost some ground before the release, they recouped it afterwards following some minutes of indecisive volatile moves. However, later on equities recouped early (small) losses and rallied nicely which led to selling in the US Treasury market and the longer-dated European bonds. The upcoming US auctions added to the selling. At the end, US yields were up between 1.5 basis points at the shorter end and 10.6 basis points at the longer end of the curve. The steepening suggests that supply was an issue. The payrolls may have eased some concerns about the timing of a tightening of monetary policy. In EMU, the longer end followed Treasuries lower, but losses were small, while the short end surprisingly ended the session with some good gains. The German 2-year yield actually fell 4.6 basis points, while the 10-year yield ended nearly flat.
US payrolls cannot give EMU bonds clear guidance
Today, the calendar is thin as US markets are closed in observance of Labour Day. In the euro zone, the calendar contains the German factory orders (July). In July, German factory orders are forecasted to show the fourth consecutive increase. On a monthly basis, factory orders are expected to have risen by 2.0% M/M after increasing by 4.5% M/M in the previous months. This would be a confirmation that the German export-oriented economy is on the mend.
During the remainder of the week, the calendar remains rather dull especially in the euro zone with only the German and French industrial production data worth mentioning. In the US, the trade balance and Michigan consumer confidence are scheduled for release, on respectively Thursday and Friday. In July, the US trade balance is forecasted to show an unchanged reading (-$27.0B) compared to the previous month. University of Michigan consumer confidence is expected to improve again in September after falling unexpectedly in August. An increase from 65.7 to 67.0 is expected.
As we enter the last week before the black-out period that surrounds the FOMC meeting of September 22-23, markets usually are more attentive to Fed speakers, but we are afraid that this won’t be the case this time. Recent speeches taught us that the Fed is discussing the ‘how’ of the exit strategy, but that there is unanimity that it is currently too early to discuss the ‘when’. On Wednesday, Chicago Fed Evans and Dallas Fed Fisher speak on respectively the “Great inflation debate” and “today’s economy”, while Atlanta Fed Lockhart will speak on Thursday on “the US and global economic interactions”. Both Lockhart and Fisher spoke recently in a dovish fashion. Governor Evans has been silent for longer.
ECB speakers include Gonzalez-Paramo on Monday, Mersch, Nowotny and Liikanen on Thursday and Ordonez on Friday. Following last week’s ECB meeting and press conference and the speeches of last Friday, it would surprise us should the speakers move the markets. On Friday, several executive council members participated at the eleventh ‘ECB and its watchers conference’, which was attributed to the monetary and fiscal exit strategies. Although several ECB governing council members stressed this was not the time to exit, they outlined a set of principles that would be guiding the unwinding of the various non-standard measures implemented during the crisis. ECB’s Stark indicated that while ‘our actions will be guided by our mandate to maintain price stability, the specific steps we take to reestablish the main features of our operational framework will also depend on the money market’. Once the problems in the money market disappear, the nonstandard measures could be unwound, even before any upside risk to price stability emerges. But in the alternative scenario where upside risks to price stability emerge while the problems in the money market persist, one will have to reassess the situation as the ECB cannot accept excess liquidity to constrain the ability to steer money market rates to higher levels. In the end, Stark indicated that the ECB wants to revert to its pre-crisis operational framework where the one-week main refinancing operation is the main tool for steering money market rates and where the ECB is a ‘rate-taker in the longer-term money market. It’s clear that the money and credit growth data will play an important role in the timing of the exit strategy. Like Trichet said ‘the exit strategy in the end will need to be invoked at the precise time in which the traditional link between broad money and our provision of liquidity to the banking system will re-establish itself’.
In the absence of an exciting eco data calendar, attention in the US Treasury market will surely turn to the auction calendar. The Treasury will hold a $ 38 billion 3-year Note auction on Tuesday, followed on Wednesday and Thursday by a $20 billion reopening of the 10-year Note and a $12 billion dollar re-opening of the 30-year bond. The size of the package of $70 billion dollar is $5 billion dollar smaller than in August. At that time, the auction went surprisingly well, which is no guarantee for a similar success in August though, especially as the upcoming auctions aren’t partially matched by redemptions like in August. In the EMU, attention will focus on the new German Schatz (€7 billion) on Wednesday. The 2-year German government yield closed on Friday at the new historical low level of 1.09% and it is the question whether investors will feel these levels enticing enough to bid aggressively or in size. Given the signs of economic improvement, we think there is very little downside (in yields) anymore and even a correction wouldn’t surprise us. Other auctions include a €1 billion 5-year Slovakian Note today and a 10-year Dutch Note on Tuesday.
Regarding trading, despite the general improvement in the economic outlook, government bond markets have performed strongly over the past two months. But recently, there have been increasing signs of fatigue, as bonds failed to break decisively 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 121.12 (Dec contract) didn’t cause an acceleration of the uptrend, while in the US the T-Note future reverted back below the neckline of a similar double bottom (117-19). The payrolls didn’t really give the market longer term guidance. Indeed, the report had positives and negatives that cancelled each other largely. We took a more neutral stance for both the Bund and Treasury markets late last week and keep it intact at the onset of trading this week, while even some profit taking wouldn’t surprise. Supply might be a negative initially, while the eco data should be fairly neutral. Equities took the payrolls into stride and following some hesitations closed Friday’s session on a strong note, suggesting that the correction that took place at the start of last week is over. While the calendar is unexciting, trading becomes traditionally livelier as the US Labour Day holiday closes the summer season on the markets. So we will verify whether the trend over the summer of strength in equities and bonds will hold in higher volumes.
