Markets: Fixed Income
On Tuesday, US and EMU bonds lost some modest ground in a quite volatile global session dominated by dollar weakness amid ongoing signs that the recovery continues. Curves steepened, as markets are not convinced that stronger growth will generate a timely reversal of the current ultra-easy monetary policy stance. The US 3-year Note (and the Dutch) auction went very well, but couldn’t prevent some late session selling, while the Fed purchased in the 7-to-10-year sector.
Intra-day, the Bund opened unchanged following a quite strong session on Monday. However, ongoing strong eco news from Asia underpinned equities, with Chinese car sales surging and exports very strong. The continuation of the impressive equity rally soon pushed the Bund modestly lower before sideways trading kicked in. However, it seems that dollar weakness and the move of gold above $1000 might have played a bigger role in early dealings. The dollar and gold move didn’t escalate though and therefore its effect on US treasuries and EMU bonds was after all limited too. Should dollar weakness really become a theme, which is certainly a risk, it should affect US Treasuries negatively in a more pronounced and sustained way. German industrial production disappointed showing an unexpected decline in July, but following strong orders published on Monday, the market shrugged the figures off. The Bund made a second shift lower in sympathy with US Treasuries in early US trading, as commodities and equities did well. Later on these markets stabilized though, permitting US Treasuries in the run-up to the 3-year Note auction to stage a rally helped by Fed purchases of longer-dated Notes. The auction was highly successful, but soon after selling kicked in pushing Treasuries back down, as traders started to eye today’s 10- year Note auction. The Bund didn’t reflect these developments in the US Treasury market. At the close, US yields had gone up between 1 and 5 basis points, while German bonds rose by up to 4 basis points, steepening the curve in both markets.
Impact dollar weakness on US Treasuries still limited
Both in the euro zone and in the US, the eco calendar contains only some second tier data today. Therefore, most attention will go out to the Fed’s Beige Book, several Fed and ECB speeches as well as fresh supply in the US and Germany.
Chicago Fed Evans and Dallas Fed Fisher speak on respectively the “Great inflation debate” and “today’s economy”. 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’. Governor Fisher spoke recently in a dovish fashion, while Governor Evans has been silent for longer. The Fed’s Beige Book, a preparatory document for the September 22-23 FOMC meeting, describes the state of the economy via anecdotal evidence from the various regional Fed banks. It will be published late in the session. It might get more attention than usual as the economy is at a turning point and opinions on the power of the recovery diverge quite sharply. Should the book be a very optimistic reading it might be negative for Treasuries. However, supply might be more important as is the sentiment on equity markets.
On the supply front, the US Treasury will re-open its recently issued 10-year Note (August 2019) for an amount of $20 B, while the German Debt Agency will issue a new 2-year Schatze for an amount of €7B. Yesterday, the record-sized $38 B US 3- year Note auction went very well. The auction stopped at 1.487%, well below the 1.50% WI trade at the moment of the stop. The bid/cover of 3.02 compares to a 2.58 average despite the increased size and the buy-side showed up as evidenced by the Indirect bidding and takedown statistics. While the 3-year Note auction yesterday prolonged the success of the August auctions, today’s 10-year and tomorrow’s 30- year auctions (re-opening) face a higher hurdle. Indeed, signals of a strong global recovery might make investors more reluctant to buy longer-dated issues that are less influenced by monetary policy that is assumed to stay accommodative for a longer term. The size of the 10-year Note auction is $3 B lower compared to last month’s auction, but as stated in our previous Sunrise report, the cash flows surrounding the auctions are much less favourable than in August. Therefore the auction might be more difficult than yesterday’s.
The 2-year German government yield is currently traded at historical low levels questioning whether investors will feel these levels enticing enough to bid aggressively or in size. Last week’s very successful Spanish 2-year auction however suggests that demand is still strong for short-term bonds. Short-term bonds are currently supported by the outlook that ECB rates will remain low for a prolonged period of time. Yesterday evening, ECB’s Weber underscored this view when he said that interest rates are ‘appropriate’ and that the economic recovery will be ‘protracted’. At the same time, he stressed that a timely exit is vital and indicated that the timing should be guided by signals from money supply and credit data. Overall, even in case today’s German auction may indeed go pretty well, we still think there is very little downside (in yields) anymore and a correction wouldn’t surprise us, given the recent signs of economic improvement. Today, ECB’s Trichet, Tumpel- Gugerell and Gonzalez-Paramo are scheduled to speak, but we don’t expect them to move the market.
Regarding markets, Asian equities trade with a negative bias, but no distinct moves yet preventing equities of having a big influence in early bond trading. Also gold and oil are little changed. The Bund opens in line with expectations little changed too. We will eye dollar developments closely together with the supply.
Re-iterating our view, we have no strong opinion on the near term outlook for US 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 potential 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 economic outlook, government bond markets have performed strongly over the past twomonths. Recently, there have been signs of fatigue, as bonds failed to break decisively 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. We took a more neutral stance also for the Bund markets late last week and keep it intact, even if we feel that a correction could be lurking around the corner.
