Markets: Fixed Income
On Monday, in a thinly traded session, global bonds held up very well in the face of a strong rebound of equities. There was little eco news and no important headline news to guide the price action. In this context, EMU bonds stabilized, while US Treasuries eked out still some more gains, extending the latest up-move to 5 sessions. Curve re-positioning was still the theme in the US as hawkish comments of Fed Warsh on Friday still resonate. In a daily perspective US yields fell by 1.6 to 5.8 basis points, the longer end outperforming.
Intra-day, the Bund opened strongly and immediately tested the upside, hitting 121.91. However, there was no follow through buying and the Bund gradually slid lower to below the key 121.74 resistance level, singled out as difficult to take out especially in a first attempt. The Bund traded unchanged when US traders joined the fray. After having tested the downside at the onset of US trading, prices popped up, without a specific news item behind. Trading was very thin which might have exacerbated moves on Monday. Indeed, later on Treasuries fell back, only to jump higher once more near the end of the session. Curve positioning, while less outspoken than Friday played a role. The strength in equities had surprisingly little impact. So overall, we wouldn’t deduct many conclusions from Monday’s trading.
Bund
Today, the market calendar heats up: in the US, attention goes to the S&P house prices (July) and the consumer confidence (September), while in EMU, the EU confidence indicators are released. National eco data include Belgian and Spanish CPI and some Italian confidence data. Italy will hold its BTP auctions and Central bankers on duty are Dallas Fed Fisher on the economy and ECB Liikanen and Constancio. The Fed will purchase Treasury securities in the 05/2012 to 11/2013 sector.
Regarding the data, US Consumer confidence is expected to have strengthened in September (57 from 54.1). The Michigan measure of consumer sentiment, published a few days ago, already showed an improvement. So the odds are indeed in favour of a rise in the Conference Board measure too, even if the Conference Board measure is more influenced by the labour market conditions. The S&P house price index rose in both May and June, raising hope that the house price slump that started in mid 2006 is over. So the market will verify whether the improvement continued in July. We think that indeed the housing market is bottoming out, even if Y/Y measures remain in deep negative territory. The EMU economic confidence index is expected to have risen to 82.5 in September from 80.6 previously. While the EMU PMI index disappointed slightly, even if it progressed moderately, the EU economic confidence survey should show a more convincing improvement of confidence. Indeed, this survey often lags the PMI in time and might thus more resemble the August PMI that rose sharply.
Regarding Central Bankers, Dallas Fed Fisher voted in the previous easing cycle several times against an easing or preferred a less aggressive easing. However, since the financial crisis he has shown himself as quite dovish. In a WSJ article, he argued yesterday that the problems at the huge struggling banks hurt the Fed’s efforts to turn around the US economy. Too big to fail banks pushed the Fed into more risky policies and financial reform should aim at preventing this from happening again. He didn’t elaborate on the economy or inflation. In recent speeches, he saw deflation as a bigger risk than inflation. It will be interesting to hear whether this is still his view. We suspect that Liikanen and Constancio won’t move the market, after Trichet confirmed yesterday that it is too early to implement the exit strategy.
Today, Italy will auction its 2.5% July 2012 and new 4.25% March 2020 BPT’s and the July 2016 CCT. The Italian spread has increased slightly last week, but not more than the other weaker sovereigns. The supply in the euro zone will mount to €29B in total this week compared to a redemption and coupon payments of around 16B, which means that the net cash flow will again be negative this week to the tune of €13B. This might be a hurdle for the EMU bond market, but at least it didn’t hinder yesterday’s Belgian OLO auctions. These went very well, especially for the 5-year OLO, that received strong demand and was bid aggressively.
Today’s bond markets: We might see mostly technical trading. Asian equities trade positively following the lead of Wall Street, but we doubt it will give a strong impulse to the European equities. However, BNP will launch a capital increase and repay the government’s capital injection and also Unicredit is expected to announce a capital increase today. This might help equities taking a good start in Europe. The eco data probably won’t bring us much new info. The supply from Italy and the Fed purchases of Treasuries probably won’t be a major and lasting factor, while month-end extension trading is a small positive (extension in indices is however minor). So the technical might be the driving force behind the price action. The Bund tested important resistance levels at 121.74 (3.20% 10-year yield) yesterday, but couldn’t take it out while the US T-Note future closes in on a similar 118-16+ resistance (3.25% is corresponding level of the 10-year yield). Following a five day winning streak and strong resistance, we might see bonds stabilizing to correcting slightly lower.
Regarding US Treasury trading (unchanged), since the start of September, Treasuries are in a sideways range, digesting the gains eked out since the turnaround on June 10. At the onset of trading this week, Treasuries are again at the top of this sideways range (118-16+ T-Note Future) and thus markets are pondering whether another up-leg is in the offering. We don’t think such an up-leg is likely, because of our above consensus economic growth outlook. Of course, the accommodative Fed stance is still supportive, but it should be clear that the Fed is slowly coming closer to implementing its exit strategy. The remarks of Fed Warsh are a reminder of this. If a break would occur, we would look to build back existing long positions. in the cash market, the key technical support levels (that would paint double tops if broken) 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, which happened for the 30-year, would really unclog the market (see graph above).
Regarding European bond trading (unchanged), last week, the Bund extensively tested the downside (120.17) with a new ST intra-day low at 119.85, but no sustained break occurred. The reversal on the equity markets accompanied by a decline in risk appetite helped the Bund to move again to the topside of the sideways range at 121.74, which was tested on Monday morning with a new ST intra-day high at 121.91 set. For now, we don’t anticipate a sustained break higher and do expect recent sideways trading to continue. In case we are wrong and a break rekindles the rally, we would consider taking profit on existing long positions.
