Markets: Fixed Income
On Friday, global bonds ended mixed, as profit taking kicked in when the market couldn’t sustain a disappointing-payrolls-induced spike. The buy-therumour, sell the fact reaction dominated, at least partial also a consequence of equities recovering most of the initial losses. Given the recent strong gains, there was a “natural” tendency for pre-weekend profit taking, which was more outspoken in the US versus EMU. In the US, upcoming supply may have weighed too. So, the US curve steepened with yields up to 4 basis points at the very long end. In EMU, also due to timing differences, yields actually fell compared to Thursday’s closing levels by 2 to 4 basis points, flattening the curve.
Inside EMU, calm returned on the bond market. The spreads that still widened sharply on Thursday were little changed with the exception of Ireland that was trading wider on the Lisbon vote (see further).
Socialist victory raises concerns about Greek’s public finances
Today, the market calendar contains the US Non-manufacturing ISM, the final EMU services PMI and August retail sales, besides the Slovakian bond auction and the 10- year $7B US TIPS auction.
The US non-manufacturing ISM is expected to have increased to 50 in September from 48.4 in August. Given the good correlation with the manufacturing ISM the risks are on the downside of expectations. The final EMU PMI won’t get too much attention, as changes are usually limited, just like August retail sales. The latter are expected to have declined by 0.4% M/M, but following very bad German retail sales, released last Wednesday, the risks are on the downside of expectations.
Later this week, the eco calendar remains fairly thin and uneventful. We only retain in the US, the weekly initial claims on Thursday and the August trade balance on Friday. The latter is interesting to fine-tune Q3 GDP expectations, but usually it misses market moving potential. In the euro area, there are no eco releases worth mentioning, but German orders and production, and French production and business sentiment (BdF) are interesting.
Supply might be a bigger issue than the eco data this week, especially in the US. Indeed, after today’s $ 7B 10-year TIPS auction, which shouldn’t affect the overall market, the Treasury will issue a $39B 3-year Note on Tuesday and re-open its 10-year Note and 30-year Bond for an amount of respectively $20B and $12B. These reopenings take place on Wednesday and Thursday. The auctions will raise all new cash upon settlement on Monday. However, there matures a 5-year Treasury ($14.3B). The size of the 3-year Note auction is increased by $1B (new high), while also the size of the 10- and 30-year re-openings is also increased by $1B to new record highs for re-openings. In the previous months, the auctions went very well. Strong bid/covers, aggressive bidding (stops below the bids in the WI) and strong participation of the buy-side. The European auction calendar is thinner. Besides today’s Slovanian auction, Austria will issue on Tuesday, Germany will tap its 4.75% July 2040 on Wednesday for €2 B and the Netherlands will tap its January 2015 for €1.5-2.5B on Thursday. The net cash flow will be favourable in the euro zone this week, due to the redemption of a German Bobl (18.63B) and coupon payments from Greece and Germany. This should support demand after last week’s French and Spanish auctions disappointed and the intra-EMU sovereign spreads widened.
Over the weekend, Ireland has approved the EU treaty in a referendum with a strong majority. The focus now shifts to the Czech Republic and Poland that still have to ratify the treaty before it comes into force. The Irish approval may reduce the Irish spread over Germany after it still widened slightly on Friday and more substantially on Thursday. In Greece, the Socialists won a landslide ending the rule by the centreright New Democracy party. The Socialists have proposed a new €2.5-3B stimulus package to combat the economic crisis. This may raise concerns about the debt level in Greece, as its debt to GDP ratio is already the second highest in euro zone after Italy and is expected to rise again above the 100% by 2010. This may lead to an underperformance of Greek bonds today.
Regarding monetary policy, the ECB meeting and especially the ECB press conference is the highlight of the week. In the US, there are speeches by governors Dudley (NY) on Tuesday, Hoenig (Kansas) on Thursday and board governors Bernanke and Kohn on Friday. Bernanke speaks on the Fed’s balance sheet. The focus will still be on exit strategies and its tools. However, on the timing of the exit there should be no new info. We have recently seen that the Fed ups its exit rhetoric’s when equities looked overstretched and started to show some signs of euphoria appearing. If the equity correction would deepen, we might see the Fed’s talk about exit strategies fizzle out.
Today’s bond markets: we still few signposts. Asian equities trade lower, but it is unclear whether this points to further weakness later on. The newsflow was rather unexciting over the weekend with the exception of the Irish vote on Lisbon and the socialist election success in Greece, which might be more of local than of global significance. The calendar is thin too. The MT technical picture became bullish last week, but upcoming US supply and the strong run of recent, the Bund is up for 8 consecutive sessions, suggest that some ST consolidation might be in store.
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. Last week however, Treasuries broke through the top of this sideways range (118-16+ TNote Future) in a convincing way, opening the way for more MT gains with 120-13+ (LT breakdown weekly cont. charts) and 121-16 (April 15 high) potential next targets. In the cash market, the 10- and 30-year yield levels fell below key support levels (3.25% for the 10-year and 4.15% for the 30-year) confirming the break in the future market. The 2- and 5-year yield on the contrary couldn’t make such a technical important step (0.85% and 2.16%respectively), which at least for the 2-year is not really a surprise, given that monetary policy shouldn’t be loosened any further. We didn’t expect the technical break at the longer end of the curve based on our fundamental view, notably our above consensus economic growth outlook and our expectation that while the accommodative Fed stance is a bond-supportive feature, it should be clear that the Fed is slowly coming closer to implementing its exit strategy. So, the MT bullish technical picture makes us think that more gains are possible, but given our fundamental view, we would build back long exposure at lower yield levels (3% for the 10-year looks not bad).
Regarding European bond trading, the Bund gained further ground on Friday, thereby confirming Thursday’s technical important break higher. The session however ended with a doji-like signal, which indicates that short-term the market is overbought and that some correction is likely. However, following the break above 121.74 and below 3.20% in 10-year yields, the medium term technical picture has become bullish. This week, the data calendar looks uneventful, while the ECB meeting isn’t expected to announce any change to the current exceptional loose monetary policy stance. Supply should also be no major issue, as the net cash flow is positive for the first time in several weeks. As such, we suspect that following last week’s break higher, the underlying sentiment will remain positive, although some correction in the short-term is likely.
