Markets: Fixed Income
On Tuesday, global bonds continued to consolidate, following last week’s technical break higher, ending another unexciting session with some modest losses. In both the US and Germany, the curve slightly bear flattened. In the US, yields went up by 3-to-5 basis points, while in Germany, yields rose 2-to-3 basis points.
In a session devoid of eco releases, prices hovered sideways but with a clear negative bias. Following, last week’s gains, there was scope for consolidation/correction and as a trigger became available, it shouldn’t surprise bonds lost some ground. Indeed, riskier assets like commodities, including a record run of gold, and equities performed strongly. The dollar was under pressure because of the Australian rate hike (a wake up call) and an article about the potential replacement of the dollar by a basket of currencies in oil trading. Finally, traders eyed the fresh supply, especially coming from the US Treasury, but also from some European governments and corporates. The Austrian and US 3-year auction went well, if not extraordinary, giving US Notes a temporary boost, but attention rapidly went to the 10- and 30-year US Note auctions to be conducted today and tomorrow. Also the German’s tap for the 2040 Bund, to be held today, albeit for a smaller amount got some attention. The mix of all these factors explains the modest losses and the bear flattening.
Intra-EMU government yield spreads versus Germany broadly stabilized, as markets are still digesting last week unexpected, temporary, but sharp spread widening.
Bonds consolidate following last week’s break higher
Today, the market calendar remains thin, but the German orders for August may help us fine tune the outlook for the German economy. In the US, only second tier reports (mortgage applications and consumer credit) will be released. Beside these, the bond market will look out for a €2B bund auction and a $20B 10-year US T-Note auction. The Fed will also purchase Treasuries in the 02/2020 to 02/2026 sector. After closure, Alcoa will kick off the Q3 earnings season.
Regarding the German new orders, the market expects a 1.1% M/M increase. If confirmed it would be the 6th consecutive monthly increase. German industry was hard hit in Q4 2009 when trade came to a near standstill. As the world’s largest exporter, the country was one of the main victims of the economic fallout of the Lehman debacle. However, as the world economy is on the mend, the German industry is one of the big beneficiaries of the resumption of trade. So, we look for the German data to show robust, maybe above consensus, intake of new orders. August is a holiday month and thus prone to some statistical volatility.
On the supply front, yesterday’s US record $39 B size 3-year T-Note auction went well. The auction stopped at 1.445%, below the 1.451% bid in the last WI trade. The bid/cover of 2.76 was below last month’s 3.02, but slightly above the 2.62 average. The Indirect Takedown of 49.1% was well above the average, but the lowest since the change in the bidder classification rules initiated in June. The Indirect bid declined to $25.6 B from last month’s very high $31.3 B. All in all, quite strong results that fell slightly short of the bumper auction last month. Today, the Treasury will reopen its 10-year Note 3.6.25% 08/2019 for a record size (for a re-opening) of $20 B. Like the 3-year, it will raise all new cash upon settlement next Monday. Given the success of last month’s auctions and of yesterday’s 3-year Note auction, the odds are for a decent success of the 10-year re-opening. However, there are a few minuses. It is the second re-opening, which is not so enticing for buy-side investors and the cash flows surrounding the auctions show that the success will depend on the new cash invested. The 10-year yield is also moderately lower than in September.
Germany will tap its 30-year Bund for an amount of €2B. The highly favourable cash flow surrounding the auction suggests that this should pose no problem, as there is redemption of a German Bobl worth 18.63B. Yesterday, Austria sold €2.2B of two bonds in the 5- and 17-year segment.
Today’s bond markets. Asian equities are trading strongly throughout the session, building on Wall Street’s stellar performance yesterday, but adding some regional strength on top of it. That might keep European markets supported in the opening. Later on the calendar doesn’t give us many clues about trading, even if the German orders data might be equity supportive. All this should be regarded rather bond negative. However, following two days of equity gains and ahead of the earnings season, we suspect equities to consolidate. Supply should be negative at first but may be positive as the auctions go well. This leaves us without a strong conviction for today’s trading that may again turn out range-bound. The correction in the bond markets has still some space before important support levels are reached.
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. Today, the data calendar looks uneventful, while tomorrow’s 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. As such, we suspect that following last week’s break higher, the underlying sentiment will remain positive, although some further correction in the shortterm may occur.
