Markets: Fixed Income
On Monday, global bonds ended a rather uneventful, thinly traded session virtually unchanged. This isn’t a bad performance though as equities surged higher and the market had to digest recent stellar performance.
Intra-day, trading showed no momentum in the European morning session and bonds hovered in a very tight range. The European calendar was devoid of market moving issues. There was an attempt to rally ahead of the release of the US Nonmanufacturing ISM survey. The latter surprised on the upside with the headline index jumping into expansionary territory in September, but it had only a very temporary negative impact on bonds. However, later on, US and European bonds faded, as equities surged higher. The 10-year TIPS auction went very well, but couldn’t help the market reverse the slow fading.
Australia is the first major economy to raise rates
Today, the market calendar is extremely thin. There are no economic releases that might drive the market and no central bankers are scheduled to speak. The sole focal point is the 3-year US Treasury Note auction. Of more limited interest is the Austrian bond auction.
The US Treasury will issue a record $39B 3-year Note, up $1 B from the September auction. The auction will raise all new cash upon settlement on Monday and the same is true for the 10- and 30-year re-openings that will take place tomorrow and on Thursday. While there matures a 5-year Treasury ($14.3B), the cash flows surrounding the auctions are highly negative to the tune of about $61 B. In August the 3-year auction was very successful. The auction stopped at 1.487%, below the 1.50% bid in the WI trading with a bid/cover of 3.02 versus a 2.58 average and a very high Indirect bid (31.3 B) with a high 54.2% Indirect takedown.
In contrast to the US, the cash flows in the euro zone will be favourable this week, which should also support demand at this week’s auctions. Today, Austria will tap two bonds in the 5- and 17-year segment for a total amount of €2.2B. Yesterday, the intra-EMU spreads stabilized, as sentiment on global markets improved again. The only exception was Ireland, which bonds underperformed, after the Treasury announced a new 15-year benchmark to be launched this week. As such, Irish bonds couldn’t benefit from the victory of the ‘yes’ camp in the European referendum. A bit surprisingly, Greek bonds yesterday didn’t underperform in wake of the landslide of the Socialists in Sunday’s elections, despite the Socialists program of more fiscal stimulus.
Today’s bond markets. European equities are likely to take their cue from the strong performance of the US equity markets yesterday evening, although Asian equities trade quite lacklustre this morning. The first rate hike in Australia may be a wake-up call that current exceptional loose monetary policy shouldn’t be taken for granted. However, the immediate impact should be rather limited, as the growth performance between Australia and the US and Europe has been totally different over the past year. New rumours about replacing the dollar, as the reference currency for commodity trading, may raise fears that the financing of the US budget deficit may become more difficult, as Asian demand for Treasuries may wane. Until now, however, demand for Treasuries at the auctions has remained very strong and as long as we don’t see more evidence of waning demand we wouldn’t attach too much weight to these rumours. So for today, given the very thin calendar, bonds may continue to trade sideways ahead of the auctions, even though the MT technical picture became bullish last week.
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.
In the UK, the focus will be on the industrial and manufacturing output data, which are expected to post their third consecutive increase. On the supply front, the DMO will tap its 4-year Mar13 for an amount of £5B. Although the financing of the huge deficit remains a daunting task, we would expect any financing problems to be reflected first in longer-term auctions.
