Markets: Fixed Income
On Wednesday, global bonds showed a divergent picture in the US and EMU resulting in a re-steepening of the curve in the US and a flattening in EMU. Overall though, the moves were interesting, albeit not yet very significant from a longer term perspective. In EMU, German yields were up 2 basis points in the 2-year segment and almost unchanged in the rest of the curve. In the US, the curve steepened in a smooth way with the 2-year yield down 4.8 basis points, the 5-year down 2.3 basis points, but the 10- and 30-year up 1.5 and 3.3 basis points respectively.
In the EMU, the market focussed on the supply and liquidity issues. The 2-year Schatz went well, good demand, small tail and not too much retention by the Bundesbank. So, the short end reacted quite positive, but was hit shortly afterwards when the ECB published the results of its 1-year liquidity tender (see further for extensive comments). This caused the underperformance of the short end and the flattening, even if this effect waned later in the session. The EMU data, lower-thanexpected HICP inflation and stronger German labour market data went unnoticed.
In the US, the curve re-steepened, as profit taking on recent flatteners kicked in. The steepening was initiated well before the release of the weak Chicago PMI, but was boosted by that release. Following some hawkish Fed comments in previous days, the market might have been relieved by comments of Atlanta Fed Lockhart who said “I think it may well be some time before a comprehensive exit need be under way”. So, the pretext for the re-steepening move was available. Later on, Vice Fed chairman Kohn reiterated the official Fed view when he said that exceptionally low interest rates are likely to be warranted for an extended period.
Bond markets awaiting Friday’s Payrolls report
The market calendar is extremely busy today. The eco data released are concentrated in the US. We retain the Personal spending figures, the initial claims, ISM and car sales as the most important items. In EMU, the final PMI report should bring little new info, but the UK PMI is more interesting as it will inform us on the state of the recovery, after the albeit small drop in August to 49.7 from 50.2 in July. There are some auctions and some ECB and Fed members will speak, but mostly on issues without immediate interest for the markets we cover.
Regarding the US data, the personal spending figures for August should show a healthy jump (1.1% M/M expected) on the back of higher car sales, but also reasonable good other sales. However, the decent result shouldn’t come out of the blue, as the retail sales report for the month is already published. The new element in the report will be the important, but less cyclical, services. Initial claims are expected to move slightly higher to 535 000 in the most recent week, following a 530 000 result in the previous one. In recent weeks, claims unexpectedly dropped substantially. So, stabilization wouldn’t be bad. However, the series often surprises and some statistics like the ADP and the consumer assessment of the labour market deteriorated recently. The correlation between those isn’t always very strong or time consistent though. The ISM index is expected to have risen to 54 in September from 52.9 previously. Such an outcome would have been great news confirming a strong recovery. However, following the publication of a number of other regional surveys, the risks are firmly on the downside and the market would probable already be happy with an unchanged reading. The car sales are expected to have plunged in September as the cash for clunkers program has been stopped. While the eco data are important to fine-tune the economic outlook as they contain fresh info, we think that the market reaction on the data may after all be subdued, as most traders probably want to wait for the payrolls report
On the supply front, Spain will issue a new 3-year Bono 2.3% April 2013 for a total amount of €3.5-4.5B, while France will tap three longer-term OATs in the 7-, 10- and 16-year maturity spectrum for an amount of 7-8B. Yesterday, the tap of the German Schatz was again successful. This suggests that today’s Spanish and French auctions should also go well, despite the rapid deterioration in public finances. This may make it harder to raise funds once the recovery gathers steam. Yesterday, France forecasted its deficit to rise from 3.4% last year to 8.2% this year and to 8.5% in 2010 and still expects its deficit to remain above 3% at 5% in 2013. Spain on the other hand expects a deficit of 9.5% this year, but expects it to narrow to 8.1% next year and to fall below 3% in 2012. The US Treasury will announce the details of its 3, 10 and 30-year T-bond/Note auctions (and 10-year TIPS), to be held next week.
Yesterday, banks asked for €75B in the second ECB’s 12-month tender. The amount was much smaller than expected and way below the 442B allotted in first tender in June. This may indicate that money market conditions in the euro zone are normalizing and that banks are no longer dependant on the ECB for funding. ECB’s Kranjec said the results show the system is liquid enough and that banks don’t need funds so much’. The number of banks participating in the tender also dropped from 1121 to 589. As such, the excess liquidity available in the money market will decline further, which may put some slight upward pressure on the shortest money market rates. Over the past days, the Euribor fixings showed signs of bottoming, as the 3- month Euribor fixing rose slightly over past two days. The results might also bring forward eventual ECB tightening of liquidity conditions and ultimately higher rates, even if this is of course still quarters away.
Today’s bond markets: Asian markets trade mixed, while also Wall Street’s performance yesterday doesn’t give much clues for today’s equity trading. Gradually, once the payrolls are published, attention on the equity market will turn to the earnings season. A new quarter has started which sometimes leads to some repositioning of funds in various markets, but also here the payrolls report will probably delay such re-positioning. The eco data quite often disappointed and so we might see that repeated in the short term, which would be a positive for bonds. Overall though, we suspect that the upcoming payrolls report will prevent major movements, especially as the bonds are near critical resistance levels, which are under test now.
Regarding US Treasury trading, since the start of September, Treasuries are in a sideways range, digesting the gains eked out since the turnaround on June 10. Since the onset of trading this week, Treasuries are again at the top of this sideways range (118-16+ T-Note Future tested yesterday) 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, even if we admit that pressure is building at the topside of recent trading ranges. . 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 Fisher, Plosser and before Warsh are a reminder of this, even if they are balanced by dovish comments of Kohn and Lockhart. If a break would occur, a much weaker-than-expected payrolls report is a risk in that respect, 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.
Regarding European bond trading, the Bund is also in a sideways trading range. Last week, the Bund extensively tested the downside (120.17) with a new ST intraday low at 119.85, but no sustained break occurred. Recently, the eco data failed to live up to expectations, which helped the Bund to move again to the topside of the sideways range at 121.74, and new highs were set at around 122. Although this may suggest that a new up-leg is in the offering, we are not convinced yet 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.
In the UK, the manufacturing PMI is expected to stabilize at around the boom/bust level of 50, while the BoE will release its quarterly credit conditions survey. Yesterday, the IMF warned that the shortage of credit posed one of the biggest risks to the UK economy.
On the supply front, the DMO will tap its 20-year Gilt 4.75% Dec 2030 for an amount of £2.25B. The results should be closely monitored, as the external deficit means that the UK is dependent on foreign demand to finance its huge budget deficits. A confidence crisis may therefore push up interest rates quite dramatically in the UK.
