Markets: Fixed Income
On Wednesday, global bonds rallied again higher following two days of consolidation. Bonds benefited from the slightly more cautious sentiment on the equity markets ahead of the start of the Q3 earnings season and strong auction results both in Germany and in the US. The data calendar was quite uneventful, while the Fed purchases of $1.3B Treasuries hadn’t an immediate impact on trading.
The successful 30-year Bund auction resulted in an outperformance of the very long end, as German 30-year yields fell by 4.9 basis points compared to respectively 3.5 and 3.1 basis points in 10- and 5-year yields. 2-year yields bucked the trend and rose by 0.8 basis points ahead of today’s ECB meeting. In the US, the belly of the curve outperformed, with 5- and 10-year yields falling by 7.3 basis points. 2-year yields fell by 4.8 basis points, while 30-year yields decreased by 6.4 basis points in advance of this evening’s 30-year Bond auction.
Intra-EMU government yield spreads versus Germany were little changed, despite the EU Commission starting an excessive deficit procedure against nine EU member states.
Strong performance confirms underlying bullish sentiment
Today, the market calendar is more interesting than in previous days. Indeed, the ECB meeting and press conference is every month a highlight for traders and investors. Fed speakers are many, including Lacker, Tarullo, Bernanke and Hoenig. However, only the hawkish governor Lacker speaks during the trading session and as he spoke very recently, we don’t expect him to unveil new thoughts. Last week, he warned that “the Fed may need to raise interest rates before the unemployment rate starts falling”. Hard stuff, we would think, for a governor of the Fed that has a dual mandate of providing stable prices and maximum employment. Economic data include German industrial production and US initial claims. Following a long string of sharp increases in new orders, it shouldn’t surprise that a 1.8% M/M increase in production is expected for August. Even then the risks may be on the upside of concensus, even if the August results are for statistical reasons always a bit difficult to forecast. US initial claims unexpectedly jumped higher to 551 000 following an unexpected decline in the previous week. The somewhat weaker September payrolls report has made traders nervous about the underlying conditions in the labour market. So it would be good if claims decline again, as the consensus estimate of 540 000 presumes.
Regarding the ECB policy meeting in Venice (Italy), no change in monetary policy is expected. Hence, all attention will be focused on the ECB press conference afterwards. Overall, we don’t expect many changes compared to the statement last month, as the September data supported the ECB’s view of a very gradual economic recovery and low inflationary pressures over the medium term. As such, interest rates will still be called ‘appropriate’, which implies that no change should be expected over the coming months. At the same time, Trichet will welcome the normalization in the money markets, as reflected in the lower demand at the second 1-year tender. He is however expected to repeat that this is not the time yet to exit from their enhanced credit support measures. Markets currently expect the non-standard measures to phase out gradually till the middle of next year and forecast the ECB to start raising interest rates after the summer. A first rate hike of 25 basis points is discounted by September next year, which looks reasonable to us. During the Q&A, Trichet may however sound more concerned about the strength of the euro, as he and some of his colleagues recently complained about the decline of the dollar vis-àvis the euro.
On the supply front, the US Treasury concludes its weekly issuance by a $12 B 30- year T-Bond. It concerns the second re-opening of the 08/2039. The size has been upped by $1 B to the new record for a re-opening. The odds are for a good auction, following strong 3- and 10-year Note auctions. Indeed, yesterday, the Treasury reopened its 10-year Note 3.6.25% 08/2019 for a record size (for a re-opening) of $20 B. The auction was strong. The auction stopped at 3.21%, well below the 3.22% bid in the WI trading at the stop. The bid/cover was strong too at 3.01, well above recent results and above average. The dealers’ bid was a record $42.9, but the hit ratio light at 22%, resulting in a 47.5% dealer takedown. Re-openings are traditionally dealer dominated. The Indirect bid dipped to $14.3B from $15.4B in the previous reopening. Indirect bidders took down 47.4% of the auction, slightly below last month’s takedown, but well above average. So, overall, we would qualify the auction as being strong. In the euro zone, the Netherlands will tap its 5-year benchmark 2.75% Jan15 for an amount of €1.5-2.5B. Yesterday, the German tap of the 30-year Bund attracted strong demand. This again indicates that investors are not yet too concerned about the outlook for public finances, despite the start of the excessive deficit procedure against Germany (among eight other countries) by the EU Commission yesterday. Yesterday’s strong German auction along with the positive net cash flow this week suggests today’s Dutch auction should also go well.
Today’s bond markets. The calendar is much more interesting today, even though the immediate impact from the data and central bank meetings may prove quite limited. Both the ECB and the BoE are not expected to rock the boat and leave their policy unchanged. Yesterday’s trading session confirmed that the underlying sentiment is bullish, as bonds rallied higher once the rally on the equity markets slowed. Strong auction results in Germany and the US supported the rally too. Ahead of today’s 30- year Bond auction, bonds may be more sideways oriented, as equities are doing rather well in Asia this morning. But if the auction goes well, some relief that this week’s auctions have passed successfully may push bonds still higher afterwards. Both the Bund and the US T-Note future have however come close to the post- Payrolls highs, which may prove difficult to break above on a first attempt.
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, following a period of sideways trading, the Bund broke higher too last week. The break above 121.74 was also confirmed in German 10-year yields (below 3.20%), which implies that the medium term technical picture has become bullish again. This brings the all-time highs in the Bund (126.53) and lows in yields (2.85%) again in the picture. Although the underlying sentiment is positive and more gains may occur, we remain cautious about the upside potential and wouldn’t install new long positions at current levels.
In the UK, the Bank of England will also hold its monthly monetary policy meeting today. But also here no change interest rates or the asset purchase facility is expected, which should leave the immediate impact of the decision limited.
