Markets: Fixed Income
On Friday, global bonds profited modestly from equity weakness and pre-weekend short covering in a rather dull session devoid of major new developments. Bonds were hit in previous sessions on equity strength and when the results of GE and BoA didn’t fulfil market expectations, a long overdue profit taking in equities occurred. This caused some short covering in bond markets. In a similar vein, the curve flattened following a steepening in previous sessions.
Intra-day, the Bund opened weak, catching up with the overnight price action in the US Treasury market, but slid immediately in a tight sideways trading range, mirroring a similar price action in European equity markets that opened well but couldn’t generate a positive momentum. Equities slid lower after the GE and BoA earnings results didn’t convince, giving the signal to bonds to grind higher. The US industrial production data were much stronger than expected, but after a spike lower, bonds easily recovered and moved slowly higher. Later on, a weaker Michigan consumer sentiment survey had little impact, but of course went with the sentiment, allowing bonds to move further up and close with moderate gains. Intra-EMU spreads narrowed slightly with the exception of the Greek spread that actually widened on rumours that the Greek government will need to tap the market soon in the longer segment.
The eco calendar is thin today as it only contains the US NAHB housing market index, which is no market mover. In October, the NAHB housing market index is forecasted to show the fourth consecutive increase (from 19 to 20), but the figure remains significantly below the benchmark level of 50. Later this week, we will receive a more complete view on the US housing market with the housing starts and permits and existing home sales. In August, both US housing starts and permits extended their rebound, while existing home sales disappointed somewhat (for the first time in five months). For September however, the consensus is looking for a general improvement in the US housing market, providing further evidence that the trough in the US housing crisis is behind us. In the previous weeks, the claims developed in a positive way, providing further evidence that the number of job losses is declining. It will be interesting to see whether this trend can be sustained, but please keep in mind that figures might be distorted by the Columbus Day Holiday. In the euro zone, the calendar heats up only on Friday with the October PMI’s and German IFO. Last week, the German ZEW showed an unexpected decline for October, but we didn’t take it too serious as the ZEW ran already far ahead of the other euro zone confidence indicators. Both the PMI’s and IFO might give us a more reliable indication. Markets are looking for a slight improvement in both indices, but if they would show a deterioration, this might come as a disappointment to the markets.
From the FOMC Minutes we learnt that the Fed would work harder to explain its policy to the public and markets, especially on the subject of its exit policy (out of the quantitative policy). Already last week, we indeed saw many governors taking the stage and their “offensive” will continue this week with not less than 15 public appearances. Tonight, chairman Bernanke and San Francisco Fed governor Yellen will give welcome remarks at the San Francisco’s Fed Asia Economic Policy Conference and the chairman will also talk on Asia and the financial crisis. We don’t expect to get important new info at this conference, but it is a risk though. The FOMC showed that governors had upped their growth forecast, not only for H2 2009, but also for subsequent years. There were however divergences in opinion about the size of the output gap with some hawks suggesting that the gap might be less big than usually estimated (due to the financial crisis), which might induce the Fed to keep its policy too accommodative for too long. The majority seems to be less concerned as they think that the gap is anyway huge, even if it might currently be overestimated, making it unlikely that it would lead to eventual policy mistakes (too slow removal of stimulus) with adverse consequences (higher inflation). Secondly, there are also some divergent opinions on the pace at which the large scale asset purchase program should be completed with at least one governor pleading to immediately end the program, while others didn’t apparently exclude an expansion of the program. We will look what the individual governors will tell about these specific subjects, especially as the November 2-3 FOMC meeting is coming closer.
With regard to the ECB, there are few public appearances of which we are aware. However, on Thursday, the ECB holds its monthly non-monetary policy meeting. Informally, they will exchange views on the economy and policy, but it is unlikely that they will feel the need to come out with a particular message after the meeting, as there are no new economic or monetary developments since the ECB meeting at the start of the month. Bundesbank president Weber speaks at a panel discussion on Monetary policy in times of crisis and he is thus in theory the first ECB governor that may convey a new message following the meeting on Thursday.
On the supply front, this week’s euro zone government bond issuance will fall sharply compared to the previous week, as only Italy, Slovakia and Ireland are planning to tap the market. Italy plans to issue a new 30-year inflation-linked BTPei via syndication for an amount of €3B, while Slovakia will tap its 20-year benchmark for an amount of €1B today. Tomorrow, Ireland will tap two bonds in the 3- and 6-year sector for €0.75-1.5B. This means that the net cash flow will be slightly negative, as there are no redemptions, but only some coupon payments scheduled for this week. Last week, the large number of auctions was well digested, but the intra-EMU spreads didn’t narrow any further despite the rise in risk appetite. Indeed, the technical break higher in the equity and commodity markets did result in a further narrowing of the corporate spreads, but not in the sovereign spreads, which may reflect the rising concerns about the outlook for public finances (see graph below). These concerns were recently highlighted by ECB president Trichet and in a report of the EU Commission about fiscal sustainability. In the US, the Treasury will announce the amounts of next week’s 5-year TIPS, 2-, 5- and 7-year Note auctions on Thursday.
Regarding today’s bond trading, Asian equities are trading moderately positive, while equity investors are waiting for more earnings results, but have to wait until after market when Apple and Texas Instruments report. The eco calendar won’t give direction either, leaving chairman Bernanke speaking on Asia and the financial crisis the sole item of interest on the calendar, but also here we doubt it will give much direction. This makes us think that equities will be in the driver’s seat. There is scope for the correction to go somewhat further, but on Friday, equities ended lower, but were upwardly oriented in the second half of the session, suggesting that the buy-ondips mentality might still be alive. So, overall we bet on a typically low volume Monday trading day in the bond markets with technically oriented sideways trading dominating.
Regarding European bond market, the longer-term bullish technical picture of the Bund started to deteriorate last week after it fell below 121.74. This is a first warning signal that the underlying sentiment is deteriorating. However, the correction stopped at least for now at 121.12 (neckline LT double bottom), keeping it also above the channel bottom (121.27 today). In German 10-year yields, the move corresponded with a rebound above 3.25%. A break below the uptrend channel (today at 121.27) and the neckline (121.12) would be an additional negative that might bring the 119.85 (Sep 22) into focus. On the upside, a sustained break above 121.74 would be constructive.
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 the risk is for a further sell-off that would push the 10- year yield again to levels closer to 4%. The Note future is currently tested important support at 117-19 last but it held. A drop below 116-18 (previous low) is however needed to really downgrade the technical picture to outright bearish.
