Markets: Fixed Income
On Thursday, global bonds corrected lower with technical considerations (Bund) and eco data the main driving forces. Equities hovered mostly sideways following a stellar performance on Wednesday, but late session buying pushed indices further up, confirming the technical break. A similar positive price action occurred in commodities with the CRB indices confirming the break higher. These developments certainly helped to determine the picture for global bonds. In EMU, the bear steepening continued with yields up between 5.3 and 7.5 basis points. In the US, the belly underperformed with yield changes between 3.6 and 5.1 basis points.
Intra-day, the Bund opened lower to reflect the overnight price action in the US, but once more couldn’t find its composure, drifting lower. The Bund dropped below the eye-catching 121.74 (the 10-year yield rose above 3.20/25%) support level attracting more selling. In mid-morning a bottom was found around 121.30, helped by good auctions in France and Spain. Global bonds edged higher, following the results of Goldman. These were well above the consensus estimate, but following the bumper results of JPM the day before expectations had apparently been upped and thus equity markets reacted somewhat disappointed as these upped expectations weren’t fulfilled. So, modest profit taking in equities helped bonds higher. The tide turned following the early US eco data releases. Initial claims unexpectedly fell, the NY manufacturing survey showed an unexpected bullish business sentiment and (less important) CPI was slightly above consensus estimates. The US Treasury Note future dropped to new intra-day lows while the Bund re-tested those. There was a new turnaround though following a disappointing Philly Fed survey on manufacturing. The latter didn’t confirm the bullishness of the NY survey and traders felt wrong-footed, triggering short covering and pushing the Note future towards the highs of the day. However, the absence of follow through buying was well noticed and exemplary for the change to the worse of sentiment. Soon the market retreated in a movement that accelerated when late in the session equities broke into positive territory. It left Treasuries and Bunds at the lows and with substantial, but unspectacular daily losses in the close.
Bund falls below first key support level
Today, the calendar contains the euro zone trade balance (August), US industrial production (September) and Michigan consumer confidence (October). In July, the euro zone trade surplus rose to the highest level since May 2004, due to an increase in exports. For August however, the consensus is looking for a contraction in the seasonally adjusted deficit from 6.8B to 4.9B due to a decline in exports and an increase in imports. In the US, industrial production is forecasted to show the third consecutive increase in September. An increase by 0.2% M/M is expected, but we believe that the risks might be on the downside of expectations as the index of aggregate hours worked dropped in September. Last month, University of Michigan consumer confidence surprised on the upside of expectations, while Conference Board’s consumer confidence deteriorated somewhat. The latest weekly indications of consumer confidence were not so good, putting indeed the risk for a slightly weaker outcome. For October, the consensus is looking for a slight decline in Michigan consumer confidence (73.1 from 73.5).
As regards the earnings season, the earnings from General Electric and Bank of America will guide trading on the equity markets today. Yesterday, US equity markets closed higher for the eighth time in nine sessions, although the earnings from the earnings from Nokia disappointed and the higher than expected profit at Goldman Sachs and the smaller than expected loss at Citigroup failed to drive the equity markets immediately higher. Overnight, the earnings from both Google and IBM beat expectations, but it remains to be seen whether this will be able to drive equity markets still higher after the recent rally. Most Asian equity markets opened higher this morning, but moved gradually lower throughout the session. As such, we wouldn’t be surprised if there would be some end-of-week profit-taking in global equity markets.
On the supply front, there are no auctions scheduled today. Yesterday, both the French and Spanish auctions were well digested. From a relative point of view, Greek bonds underperformed after a senior finance ministry official unexpectedly said that Greece will have to borrow more this year.
With regard to monetary policy, ECB Bini Smaghi and Fed Fisher are scheduled to take the stage. Bini Smaghi spoke already earlier during the week, and shouldn’t be expected to move the market today. Yesterday, ECB president Trichet sounded satisfied with the results of their monetary policy decisions, as he said that ‘their decisions on interest rates and liquidity have been transmitted reasonably well to the rest of the economy, despite the crisis.’ He also dismissed suggestions of a credit squeeze in the euro zone, as recent developments in lending do not appear unusual compared to previous downturns. Trichet however stressed that ‘for a sustained recovery to set in, banks will need to repair their balance sheets’ by strengthening their capital bases. With regard to the exit strategy, he repeated that it still premature to declare the crisis over, but called on to governments to prepare fiscal exit strategies, as ‘the debt and budget deficits of a number of euro area governments have reached worrying levels’. A report of the EU commission on the sustainability of public finances showed that the euro zone has a sustainability gap of 5.8% of GDP, which means the governments have to adjust its tax and spending plans by 5.8% of GDP on a durable basis to put its public finances on a sustainable path. There are however large differences between the member states. According to the Commission, only one euro zone country can be classified as low risk (Finland), while Belgium, Germany, France, Italy, Luxembourg, Austria and Portugal face medium longterm risks and the other 8 countries high long-term risks with a sustainability gap of over 6%. In the case of Ireland, Greece, Slovenia and Spain the gap even surpasses the 10% level of GDP. In an interview with Market News, ECB Mersch yesterday said that ‘if we had to do a mechanistic update (of the staff projections) today, we might maybe slightly revise upwards the figures’, but added that the ECB’s baseline view of the economy and inflation had not changed. As such, we wouldn’t draw too many conclusions out of his comments.
Dallas Fed Fisher already gave an interview yesterday. He pointed out that the recovery will be slow (no V-shaped one) and was concerned about the high unemployment and more general the enormous amount of slack in the economy. Therefore, it shouldn’t be a surprise that Fisher, traditional an ultra-hawk on inflation, declared inflation is not a risk. Worth noting, he said it was not him who was advocating an expansion of the Agency MBS purchase program at the September FOMC meeting that was revealed in the Minutes of that meeting released on Wednesday eve. Paul Volcker, advisor of Obama and famous former Fed chairman said the enormous amounts of liquidity in the system is currently not inflationary, but will become so at some point. Therefore, he said, that it was difficult but necessary to start draining the liquidity even while unemployment rate remained high.
Regarding today’s bond trading. Yesterday, the downward correction on the bond markets continued, as the equity and commodity markets confirmed their technical break higher. In the US, the T-Note future had already fallen below its first key support level at 118-16+, but yesterday also the Bund fell below a similar level at 121.74. The technical break lower indicates that the bullish sentiment on the bond markets is waning. The change in sentiment hit both the short and longer end of the curve, but is still most reflected at the longer end, as central bankers have given no signal yet that the time to exit has come and investors may start to fear that central bankers are falling behind the curve given the strong rally on the equity and commodity markets. On the European bond market, the strength of the euro should also help to keep the losses at the short end still more limited. Therefore, we think it’s too early for a substantial flattening of the yield curve, but hold on to our sell-on-up ticks strategy both at the short and longer end. Today, it will be interesting to see whether any profit-taking on the equity markets would be sufficient to halt the downward correction on the bond markets.
Regarding European bond market, the longer-term bullish technical picture of the Bund started to deteriorate yesterday after it fell below 121.74. This is a first warning signal that the underlying sentiment is deteriorating. In German 10-year yields, the move corresponded with a rebound above 3.25%. A break below the uptrend channel (today at 121.22 and under test) would be an additional negative.
Regarding the US Treasury market, early October Treasuries broke key resistance levels suggesting that another up-leg was in store. However, recent price action has been disappointing and the confirmed drop below the previous high at 118-17+ (TNote future) only confirmed the corrective move. In the cash markets, the re-break above 3.30% (10-year) and 4.15% (30-year) confirmed the technical picture of the futures. We see the recent negative price action against the important break higher of equities and commodities, supported by stronger eco data, especially in Asia and strong corporate earnings results. While commodities and equities might be in for some consolidation/correction, it may give bonds some respite. The 10-year yield should stay below 3.53/60% or a further sell-off might occur pushing the 10-year yield again to levels closer to 4%. The Note future is currently testing important support at 117-19, but a drop below 116-18 (previous low) is needed to really downgrade the technical picture to outright bearish.
