Markets: Fixed Income
On Monday, in thin trading conditions and devoid of much market-driving news, European bonds erased initial losses to close higher, steepening the curve.
Trading was volatile, as a US market holiday thinned trading. European bonds opened weaker reflecting the price action on Friday after the official close and imme-diately weakened further. The Bund seemed on its way to test the 120.84 level, but the market rapidly turned and spent the remaining of the session grinding higher, eventually even erasing all initial losses. The G-20 decision in the weekend that it is too early to start unwinding fiscal, monetary policy and special banking measures might have been a factor at the margin. However, we shouldn’t look too deep for an explanation. The existing bond bullish sentiment remained well in place and higher equities, like was the case yesterday, had no noticeable impact on the bond market. Markets seem to be in a sweet spot where all assets fare well. Can this be sustained for much longer? The yield curve steepened with the 2-year German yield setting a new low at 1.05%, down another 4 basis points, while the 10-year yield fell 1 basis point. The ultra-long end once more underperformed sharply after the Italian Treas-ury announced the issuance of a new 30-year benchmark. The Italian 30-year yield rose by 6 basis points, while the German 30-year yield closed 4 basis points higher. German order intake exceeded expectations but were no item in trading.
Trading resumes in the US
Today, the calendar remains thin as it only contains the German industrial production data (July) and the US consumer credit (no market mover). In June, German indus-trial production dropped slightly (-0.1% M/M) after an impressive rebound (4.3% M/M) in May. For July, the consensus is looking for an increase by 1.6% M/M indicat-ing that the worst looks over for the German economy.
Attention will also focus on the Dutch 4% July 2019 DSL auction (€1.5-2.5B), the Italian 30-year issuance by syndication and a $38 B 3-year US Treasury Note. The latter will be followed by a 10- and 30-year re-opening on Wednesday and Thursday. In August, the re-financing package including the $37B 3-year Note went surprisingly smoothly, but was helped by high redemptions. The package this time will get much less support from redemptions. The size of the 3-year Note is also expanded by $1B and the 3-year yield dropped about 30 basis points compared to August 5 when the previous 3-year Note was auctioned. Against these “negatives”, there are recent as-surances from the Fed that the very accommodative policy will stay in place for an extended period in time. So, the results will tell us whether supply is again a more important issue. We don’t anticipate any problems for the Dutch auction.
US Treasury markets (and Wall Street) resume trading following Labour Day holi-day, the unofficial end of summer trading. We suspect, given the dearth of the eco calendar that trading will be slow, especially in the run-up to the 3-year Note auction. Mildly positive, over the week-end G-20 reassured markets that accommodative fiscal and monetary policies will be carried into 2010. This supported all asset classes dur-ing trading on Monday. We have no strong opinion on the near term outlook for Treasuries, but after the good run of the last month, it looks difficult for Treasuries to make much more headway. In yield terms, the market tested the necklines of poten-tial double top formations, but at least for now without success. These necklines stand at 0.85% for the 2-year, 1.35% for the 3-year, 2.16% for the 5-year, 3.25% for the 10-year and 4.15% for the 30-year. Only a break below these levels would unclog the market and open perspectives for more gains. However, we think such a move is difficult to sustain given our positive outlook for the economy and the rather low levels reached.
Regarding European bond trading, despite the general improvement in the eco-nomic outlook, government bond markets have performed strongly over the past two months. Recently, there have been signs of fatigue, as bonds failed to break deci-sively above key resistance levels 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. However, on the other hand, yesterday an attempt to trigger a correction was easily undone and initial losses were easily erased. We took a more neutral stance for both the Bund and Treasury markets late last week and keep it intact, even if we feel that a correction could be lurking around the corner. Supply might be a trigger and so are equities. Bonds and equities rose hand in hand recently, as official talk pushed the end of the accommodative policies out in time. However, this factor may have been discounted by now.
Also in the UK, the calendar contains the industrial production data. In July, indus-trial production is forecasted to show the second consecutive increase. On a monthly basis, industrial production is expected to have risen by 0.2% M/M. Overnight, the BRC reported a drop by 0.1% M/M in August sales. These sales still rose 2.2% Y/Y, down from 3.6% Y/Y previously. Today, the DMO will tap its 10-year benchmark 3.75% Sep19 for an amount of £3.75B. Longer-term auctions need to be closely monitored in the UK, as they disappointed already several times this year.
