Markets: Fixed Income
On Thursday, global bonds enjoyed a very strong run with US and German bonds breaking above key resistance levels, which if confirmed, would open the road for another up-leg that may go in the case of German benchmarks towards the cycle lows. Weaker equities certainly played a big role in the appetite for bonds. The reversal of risk appetite was also apparent in the intra-EMU govies spreads that widened sharply versus benchmark Germany. The eco data were again mostly a bit disappointing versus expectations, even if they do not put the recovery into question. However, following a stellar performance of equities in Q3 and in fact since March 9, a correction was long overdue and the publication of the weaker-thanexpected data was a nice trigger. Weak bond auctions in Spain and France triggered more profit taking on the widely played game of buying peripherals versus Germans. On a daily basis, US yields dropped by 8 to 13 basis points, the belly outperforming. German yields fell between 4 and 7 basis points, also here the belly outperforming. Italian, Irish, Belgian and French spreads versus Germany widened by 16, 14, 9 and 8 basis points respectively.
Intra-day, EMU bonds traded sideways with a negative bias ahead of the French and Spanish bond auctions. Those auctions went poorly, leading to a short-lived dip of the Bund. However, at that time, intra-EMU spread had widened already and that would continue to be the case throughout the session. These spreads were already modestly higher on Wednesday, following a big, long narrowing that spanned several months and went hand in hand with a revival of risk appetite. So there was one sided positioning combined with the availability of a trigger, notably weak auctions and equity sell-off. Returning to the German and US bonds, these started to rise respectively after the French and Spanish auctions for the Bund and in the run-up for the US data releases for the Treasuries. The data were mixed to weaker compared to expectations. Claims were higher than expected, but personal spending was stronger, while the mid-morning ISM was weaker-than-expected, but in line with previous surveys, while pending home sales were much stronger. On the releases themselves there was no distinct, sustained move higher, but the general upward trend played out during the whole US session. Sharp moves were visible at 15h and at 16h40. Technicals played a role, as the break above the key 118-16+ at 15h incited technical-inspired buying. Equity weakness certainly added to the buying of bonds. Both the Bund and Treasuries closed near session highs.
US and German bonds break above the highs ahead of today’s US Payrolls report.
The September payrolls report is the sole focal point of the markets today. Other eco data are few and uneventful.
The market expects a net loss of 175 000 jobs in September, which would follow a decline by 216 000 in the previous month, the unemployment rate is expected to tick up to 9.8%, which would be a new cycle high. Recent indicators, like the ADP (marginal lower job losses), the employment subcomponents of the consumer confidence (down) and the ISM employment sub-index (stable) suggest that the improvement in the labour market might have slowed or even stalled. On top of that, the September payrolls might be influenced by a number of special statistical factors like the Labour Day holiday that fell this year at the latest possible day (Sept.7) while the reference week is at the earliest possible time. This might play havoc with the results of a number of sectors like teachers, summer holiday jobs, retail trade, recreation and others, as the usual seasonal behaviour of payrolls in these sectors might have been distorted. Therefore, the confidence interval surrounding the September figures should be wider than usual and interpretation more difficult. It is less than obvious whether these particularities will lead to an overestimation or underestimation of the overall payrolls or whether the distortions in the various sectors compensate each other. Of course, markets won’t wait for a detailed analysis, but react to the headlines.
Today’s bond markets: Asian equity markets trade with substantial losses and Treasuries got an Asian follow through buying reaction. The outcome of the payrolls might decide the fate of equities and bonds alike. The market probably already discounts a weaker figure, given recent price action, but on the other hand we suspect that after the long, violent up-move of equities there is more scope for a correction. The first key support for the S&P (now 1029) stands at 1006/991 (uptrendline from lows and September 2 low), while mayor support comes in around 950 (neckline inverted head and shoulder). So, while there are no clear MT signals coming from equities yet, yesterday’s correction was the first really serious correction since the low. We are curious to see how the equities react to the payrolls, whether is it weak or strong, because it might give us a clue on the underlying sentiment in all markets and it might also tell us whether Treasuries have indeed started a genuine up-leg, something we didn’t expect.
Regarding US Treasury trading, since the start of September, Treasuries were in a sideways range, digesting the gains eked out since the turnaround on June 10. Since the onset of trading this week, Treasuries were at the top of this sideways range (118-16+ T-Note Future) and in hectic trade broke convincingly through this key resistance level. This reaffirms the bullish picture and opens the way for more gains with 120-13+ (LT breakdown weekly cont. charts and 121-16 (April 15 high) potential targets. We didn’t think bonds would break through these resistances based on our fundamental view, notably our above consensus economic growth outlook and our expectation that while the accommodative Fed stance is a bondsupportive feature, it should be clear that the Fed is slowly coming closer to implementing its exit strategy. So, we concluded that if a break would occur, we would look to build back existing long positions. We keep that opinion, but given the technical break (confirmation needed today), such profit taking could now occur at lower yields (see graph 10-year yield). In the cash market, a return above 3.25% for the 10-year and 4.15% for the 30-year would be a disappointment for the bulls and put the recent break into doubt. The situation at the shorter end is still a bit indecisive as key technical support levels of 0.85% for the 2-year and 2.16% for the 5-year are not broken yet.
Regarding European bond trading, the Bund had also a strong session yesterday in which it broke above the recent highs. The move was also mirrored in yields, as 10-year yields fell below key support at 3.20%. The decline in risk appetite also hit the intra-EMU sovereign spreads, which widened sharply yesterday and dented investors’ appetite for the bond auctions from France and Spain. If the break higher in the Bund would be confirmed after the US Payrolls report, this would be a very important bullish signal for the German bond market, which would bring the historic highs (Bund), lows (yields) again into the picture. Such a move would also raise the odds for more widening of the intra-EMU spreads, as this would indicate that risk appetite is further waning. Besides the general factor, the respective budget situations may start to play a more important role too, after France has indicated that it will do little to reduce its budget deficit over the coming years. Today, Ireland will vote on the EU Treaty and although the polls point to an approval, a rejection of the treaty may further increase risk aversion and lead to a further widening of the intra-EMU spreads. The elections in Greece may also be very important given the huge differences in policy between the current centre-right government and the socialist opposition, as the latter prefers more fiscal stimulus.
