Markets: Fixed Income
On Monday, US and EMU bonds started the week with a profit-taking-related sell off that was more intensive in the US than in the EMU. Supply pressures and technicals were behind the move in a session devoid of market moving eco data. In the end, US yields were up between 2 and 7 basis points with the belly underperforming the wings, while German yields went up between 1.3 and 4 basis points, the shorter end underperforming the longer end.
Intra-day, EMU bonds opened weaker despite a weak opening of equities that felt the impact of Obama’s decision to slam a 35% duties on the import of Chinese tyres and the Chinese retaliation. EMU bonds rebounded sharply on Thursday/Friday of last week, setting the stage for some profit taking early this week. Supply was an issue too. The Italian 5-year BTP didn’t went too well and the market is preparing for another €14B of government supply this week. Also in the US there was quite a slew of supply often coming from EMU governments or semi-government issuers. The profit taking gathered speed in the US markets. The recent rally had brought Treasury yields near key technical levels, which incited market participants to book some profits. US equities turned north following a weak start, which isn’t of course a positive for bonds even if the inverse correlation broke down in recent trading.
There were some speeches by Central Bankers, but they didn’t really impact the market. In EMU, Wout Wellink, a traditional hawk, sounded soft on the economy, while in the US, San Francisco Fed Yellen showed herself concerned about disinflation or even deflation and downplayed the impact of the huge Fed balance sheet expansion. She recognized the economic recovery, but thought it would probably be tepid and suggested the recovery might turn out jobless. Richmond Fed Lacker, a hawk, said the recovery was on track and questioned whether the Fed programme buying mortgage debt should be completed. He wasn’t satisfied either by the plan of the Obama administration to make it easier to wind down a big financial firm, which was insufficient clear and should exclude the use of taxpayer money.
US retail sales in the focus today
Today, the US calendar heats up with the retail sales (August), NY Empire State manufacturing index (September) and PPI data (August). In the euro zone, the German ZEW (September) is scheduled for release. In July, US retail sales showed a slight decline, while the consensus was looking for an increase (0.8% M/M). In August, retail sales are forecasted to have risen by 0.4% M/M. We believe that the risks might be on the upside of expectations due to a significant increase in car sales, boosted by the “Cash for Clunkers” programme. Excluding cars, retail sales are expected to show a marginal increase (0.1% M/M). The NY Empire State manufacturing index is forecasted to extend its rebound in September, after showing its first positive reading since April 2008 in August. If confirmed, this provides further evidence that activity is picking up in the US. In August, US producer prices are forecasted to have risen by 0.8% M/M largely due to higher energy prices, while food prices might have dropped somewhat. The yearly figure however, is forecasted to stay firmly into negative territory (-5.3% Y/Y). Also the German ZEW is expected to extend its rebound in September. Last month, the ZEW climbed to its highest level since April 2006, but for this month, a more limited increase (60.0 from 56.1) is expected. The market will take its clue from the activity data, especially in the US and probably will look closely to the retail sales excluding cars. The huge rise in car sales is well documented, but if other retail sales would surprise too, it might be considered as an indication that the recovery is broadening beyond the restocking (manufacturing).
On the supply front, Ireland will tap two bonds, 4% Jan14 and 4.5% Apr20, for a total amount of €0.75B to 1B. Yesterday, Italy sold €2.919B of its 5-year BTP 3.5% Jun14 at the top-end of the pre-announced range. The bond however underperformed slightly in the aftermath of the auction, as demand was rather tepid. The new 10-year Italian bond future was launched quite successfully, as 8090 contracts were traded on the first day. It remains however to be seen whether there will be enough liquidity in the contract to form a real alternative for the German Bund future.
With regard to monetary policy, Fed president Bernanke will repeat his speech ‘Reflections on a year of crisis’ delivered at the Fed’s Jackson Hole symposium at the end of August. Bernanke will take questions from the public and so the appearance might have some market impact. In the euro zone, ECB executive board member Stark will however speak on ‘monetary and fiscal policy: criteria and timing for the phasing out of crisis measures’. Over the past weeks, several ECB governing council members have spoken about the ECB’s exit strategy, thereby adding that it is currently not the time – yet - to exit. The speeches have nevertheless highlighted that a distinction should be made between the unwinding of the ECB’s unconventional measures and the interest rate policy. As such, the ECB may well withdraw the unconventional measures (full allotment, fixed rate, longer-term tenders) before risks to price stability emerge. Currently, the EONIA futures suggest that the ECB is only expected to do so in the second half of next year, but we wouldn’t be surprised if this would happen earlier next year. Yesterday, ECB’s Wellink however warned that the recovery will be ‘fairly slow’ and added that the global financial situation ‘will remain very fragile for a substantial period’.
The EU Commission made very little changes in its interim forecasts on the European economy, keeping the 2009 forecasts unchanged but admitting some modest upward growth risks for 2010. More interestingly from a market point of view, the Commission fears that the government deficits could be even higher than expected at the time of the spring forecast, mainly due to stronger than expected revenue shortfalls. We wouldn’t attribute yesterday’s spread widening to these statements, but it underlines that the evolution of public finances will stay in the focus of investors when the EU Commission publishes its final forecasts in November.
Regarding US Treasury trading, we were surprised by the strong run of Treasuries last week. Indeed, in the face of signs of stronger eco data, rallying equities and a weakening dollar, the rally looks a bit suspicious. Of course, the auctions went very well (also a bit surprisingly) and the Fed continues to signal its intention to keep policy easy for a prolonged period of time. However, the latter might eventually be considered as negative for the longer end. In these circumstances, we remain suspicious about the upside for the longer end of the curve. Yesterday’s correction plays into our view, but shouldn’t yet be considered as relevant from a longer term perspective.
Technically, the Note future is still toying with the 117-19, neckline of a big double bottom formation with targets more than five points higher. Despite a few trips above this level (high even at 118-16+) the future didn’t really develop a strong momentum. This looks suspicious to us. Our fundamental analysis isn’t supported by the still bullish technical picture, suggesting that the market is not ready to embrace our analysis. In the cash market, key technical support levels (that would paint double tops if broken) aren’t reached yet. These 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 really unclog the market and open perspectives for more gains. As the market is currently not on our side, we keep a neutral view on the longer end of the Treasury market, but keep looking for signs that the month long bull-run is over.
Regarding European bond trading, the Bund failed to build out recent gains and closed even slightly lower on Monday. As such, the Bund couldn’t benefit from the correction on the European equity markets and again failed to break above the recent highs at 121.70. Hence, the break above the necklines of two double bottom formations at respectively 120.84 and 121.12 still fails to generate much upward momentum and the technical picture looks quite indecisive. Therefore, only a sustained break above the previous reaction highs at 121.70 would suggest that a new up-leg is in the offering, as this would also correspond with a break below the recent lows in 10-year yields at 3.20%.
In the UK, the CPI inflation data are scheduled for release. CPI inflation is forecasted to fall further below the BoE-target in August. The consensus is looking for a drop from 1.8% Y/Y to 1.4% Y/Y due to favourable base effects and an ongoing decline in food prices. Today, the MPC will testify on the August inflation report before UK parliament. The testimony will include King, Bean, Dale, Barker and Miles. At the time, the MPC decided to keep interest rates at a record low of 0.5%, but to increase the asset purchase facility by £50B to 175B, while King, Besley and Miles dissented in favour of a £75B increase. Despite the disagreement, we don’t expect them to move the market today.
This morning, the RICS house price balance surprised on the upside rising into positive territory for the first since July 2007 at 10.7. The upward surprise adds to recent housing market data, which do suggest that the UK housing market is bottoming out.
