Markets: Fixed Income
On Thursday, after three days of downward correction, global bonds found their composure and rebounded in the US session. US bonds ended the session with some handsome gains and yields down between 5 and 9 basis points, flattening the curve in a bullish fashion. In EMU, German bonds more or less erased morning losses. Due to the timing of the closure, compared to Wednesday closure, German yields were up about 3 basis points across the curve. Eco data were no big driver, but technicals (short covering) and US supply factors might qualify more as drivers.
Intra-day, EMU bonds opened weaker and corrected initially lower. However, the selling stopped and two-way trading kicked in keeping the Bund in a sideways range near the intra-day lows. The EMU calendar was light and a higher than expected trade surplus due to strong exports was flatly ignored. Equities, after a strong start faded away giving EMU bonds some support during the morning session. The auctions in Spain and France went well but couldn’t give the overall market a firm direction. In early US dealings, the market tested the downside. Initial claims fell more than expected, while housing data were about as expected. The Note future touched a 116-20 low, near the key 116-18, but no further selling appeared, suggesting traders that the downside was protected. So short covering kicked in. The Philly Fed headline index was reported very strong (see news), but details weren’t and thus after an initial tick lower, bonds climbed higher. Later on in the session another upmove occurred, apparently driven by unwinding of rate locks associated with heavy corporate supply, including a Citigroup deal. The flattening of the curve might have been due to talk that the Fed would use large scale reverse repos as part of its exit strategy. Some however connect it with the Treasury decision (Wednesday) to unwind its SPF which is linked to the nearing of the debt limit in place. This unwinding would push up Bank’s excess reserves, effectively loosening monetary policy still further and might also affect Money Market Funds adversely. The announcement of record size 3, 5 and 7-year Note auctions, to be held next week is another factor behind the curve flattening.
Bond markets set for a technical trading day
Today, the calendar contains only some second-tier data, both in the euro zone and in the US. It might be interesting to take a quick look at the Belgian consumer confidence data to see whether consumer sentiment improved further after the Summer Holidays. There are also no central bank speeches or supply scheduled.
Yesterday, Spain sold €2.45B of its 10-year benchmark, while France sold 7.965B of three short-term nominal bonds and 1.755B of three different inflation-linked OATs. Demand was again decent, as the amounts sold were at the top end of the preannounced range and the bonds continued their recent outperformance compared to German bonds. As a result, the intra-EMU spreads narrowed further, also in the case of Ireland, where the new National Treasury Management Agency (NAMA) may raise public debt by €54B. The NAMA proposes to take over bank’s toxic real estate loans at a discount of 30% of its book value. The agency will pay for the loans with bonds that the banks can exchange with the ECB for cash.
Today, the bond market won’t get new information from eco data or from Central Banks. Traders might start talking about the FOMC meeting and the G-20 meeting that take place next week. Equities had a good run of recent and might be prone to some pre-weekend profit taking, which might be a small positive for bonds, even if the inverse correlation didn’t hold very well in recent weeks. Bunds and US Treasuries are trading not too far away from this week’s opening levels, making the case for some distinct pre-weekend profit taking very weak. So in this context, today’s trading should be mostly technical-inspired. The first key supports of 120.17 (Bund) and 116-18 (US Note future) were approached, but not seriously tested yesterday, which might convince traders the downside is protected for now. So today, we might see some positively oriented price action within existing trading ranges.
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 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. This week’s correction plays into our view, but shouldn’t yet be considered as relevant from a longer term perspective, especially not as the market turned yesterday up when first support at 116-18 was approached. Technically, the Note future couldn’t yet decisively taken out 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 the 117-19 level (high even at 118-16+). Our fundamental analysis wasn’t supported by the rather bullish technical picture (long term uptrend), suggesting that the market is not ready to embrace our analysis yet. 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. However, 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 fourth consecutive day on Thursday. 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 Bund yesterday tested the recent lows. However, only 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, technical picture looks still quite indecisive. On the upside, only a sustained break above the previous 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%. 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 M4 money supply and public finance data. In August, M4 money supply is expected to have slowed again after an unexpected expansion in July. Public finances are forecasted to show another substantial deterioration due to hard hit tax revenues and increasing government spending following the rise in unemployment. Today, the Bank of England will also publish its monthly trends in lending report, which provides timely data covering aspects of lending to the UK corporate and household sectors. The recent sharp slowing in lending by banks is still seen as one of the major hurdles towards a sustainable economic recovery. Therefore, King has now repeatedly indicated that the Bank is considering lowering the interest rate on bank reserves in a new effort to encourage banks to boost lending to the real economy instead of hoarding cash.
