Markets: Fixed Income
On Wednesday, the downward correction on the bond market continued for a third consecutive day, but only after an initial rally had petered out in the US. On a daily perspective, US yields were up about 5 basis points at the short end of the curve, while the 10-year yield limited its rise to 1.5 basis points and the 30-year yield was flat. In EMU, German yields were 1 to 4.5 basis points higher, the belly underperforming. The eco data were probably not the reason for the vola-tile trading session, even if the US industrial production was very strong and well above expectations. A strong Bund auction helped bonds in the first part of the ses-sion, while a report of Medley Advisors, suggesting a growing split among Fed mem-bers on how quickly they should raise rates, was behind the steep correction in the second part of trading. Equity strength was unable to rein in the bond rally early in the session, but later on probably prevented a rebound of bonds. The Fed purchased Notes in the 2010/11 sector, while the Treasury announced a sharp decrease of the Fed’s Supplementary Financing Program. While the latter measure isn’t without in-terest for markets, there was little reaction noticeable.
Intra - day, EMU bonds started the session little changed, but soon buyers showed up hoping that the two-day correction offered good entry opportunity. A strong German 10-year Bund auction did of course nothing to bring the bulls on other ideas. The eq-uity rally was once more no obstacle for stronger bond trading. Ahead of the US CPI release, bonds jumped higher, but these gains were erased after the release that showed headline CPI a tad higher than expected. The production data were stronger, but these are no typical market mover. However, about ten minutes after release, US Notes and EMU bonds fell off a cliff, the movement starting in the US. Afterwards it seemed that a research report on the divide in the Fed about the timing of rate in-creases was the trigger. The report suggested that two governors were ready to sup-port higher rates immediately. Later on the market tried to rebound, but the attempt failed and Treasuries reverted to the intra-day lows. Strongly rallying equities might have been the reason.
Today, the calendar remain interesting with the euro zone trade balance (July), US housing starts and permits (August), weekly claims and Philly Fed (September).
In July, the euro zone trade surplus is expected to expand again after a slight con-traction in June. The consensus is looking for an increase in the surplus from €1.0B to €1.2B, as exports are forecasted to show a sharper increase than imports. As the recovery should in the first period be underpinned by exports (besides inventories), a strong result would support our view that the recovery, also in Europe, will be stronger than consensus (and ECB) still put forward. In July, both US housing starts and permits showed a slight decline. For August however, housing starts and per-mits are forecasted to show an increase, providing further evidence that the US resi-dential real estate sector is improving. Last week, both initial and continuing claims came out significantly below the consensus estimate. In the week ended September 12, initial claims are forecasted to have risen by 5 000 to 555 000 and also continuing claims are expected to have increased (from 6 088 000 to 6 100 000). Nevertheless, distortions in initial claims are not excluded due to the Labour Day Holiday. Initial claims are a leading indicator for the labour market and thus also for income and consumption. Therefore, it is a crucial indicator at this stage in the cycle. We are a bit disappointed about the only small improvement shown in recent months and expect a stronger improvement soon. However, this week’s release may be misleading (distorted). In September, the Philadelphia Fed is expected to extend its rebound after returning into expansionary territory in August. The consen-sus is looking for an increase from 4.2 to 8.0, but the risks might be on the upside of expectations after the better than expected NY Fed.
With regard to monetary policy, the ECB will hold its non-monetary policy meeting, but usually no comments or statement are made afterwards. In the next days how-ever we might get some eventual change in tone in the talk of some governors. Is the renewed ebullience in the markets a concern for the ECB?
On the supply front, France and Spain will tap the market. Spain will tap its 10-year benchmark 4.3% Oct19 for an amount of €2-2.5B, while France will tap three dif-ferent bonds with a maturity of about 2 to 5-year years for a total amount of €7-8B. France will also tap three inflation-linked OATs for an amount of €1.3-1.8B. Yester-day, the German Bund auction attracted strong demand. In the US, the Treasury will announce the amounts for next week’s 2-, 5- and 7-year Note auctions.
Today, the bond market probably won’t react too much to the EMU trade figures, but the US eco data should get more attention. Auctions nowadays aren’t a negative for bonds. Equities had a strong run and Asian stocks are trading positively overnight. The dollar is testing key support levels (versus the euro), but there is still little fuss about. The technical pictures of the Bund and US Note future haven’t deteriorated yet despite the correction, but first key supports of 120.17 (Bund) and 116-18 (US Note future) are now within reach. This will give us a better take on the current underlying sentiment.
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 looked a bit suspicious. Of course, the auctions went very well (also a bit surprisingly) and the Fed continues to signal its intention to keep pol-icy easy for a prolonged period of time. However, the latter might eventually be con-sidered as negative for the longer end. In these circumstances, we remain suspicious about the upside for the longer end of the curve. This week’s correction plays into our view, but shouldn’t yet be considered as relevant from a longer term perspective. However, the first support levels are now within sight, which makes trading more in-teresting. 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 and above the 116-18 (previous low). Despite a few trips above 117-19 level (high even at 118-16+) the future didn’t really develop a strong momentum and is currently again below. Our fundamental analysis wasn’t supported by the rather bullish technical picture, sug-gesting 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. How-ever, following the recent correction, it is now interesting to look for signs that the month long bull-run is over. A fall below 116-18 would be such a first sign.
Regarding European bond trading, the Bund failed to build out recent gains and closed lower for the third consecutive day on Wednesday. Hence, the technical break higher above the necklines of two double top formations at respectively 120.84 and 121.12 has failed to generate additional upward momentum and the technical pic-ture looks still quite indecisive. Therefore, only a sustained break above the previ-ous reaction highs at 121.70/74 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%. On the other hand, a break below last week’s lows (120.17) would suggest that the upside is rejected and would open the door for more downward correction. For now, the appreciation of the euro hasn’t had much impact on the European bond market, but in case the euro would move closer to the record highs on a trade weighted basis, this would in first instance be a supportive factor for the short end of the curve.
In the UK, the calendar contains the retail sales. UK retail sales are forecasted to show the third consecutive increase in August. On a monthly basis, retail sales are expected to have risen by 0.1% M/M after increasing by 0.4% M/M in July. On the supply front, the DMO will tap its 5-year Gilt 2.25% 2014 for an amount of £5.25B. The auction result should be closely monitored, as the weakness of sterling may dent investors’ appetite for UK Gilts.
