Markets: Fixed Income
On Monday, global bonds held up very well despite equities rallying again to new cycle highs, allowing US Treasuries even to close the session with small gains as the recent re-steepening was undone, while in EMU, the market ended nearly unchanged compared to Friday. Technical elements certainly played a role as a re-test of key support in the Bund in the morning session failed. Also in the US, technical oriented traders had noticed that a test of the downside on Friday (117-19 Note future) failed. Intra-EMU spreads narrowed slightly as risk appetite increased.
Intra-day, there were very few drivers in the bond markets as the eco calendar was near empty and the supply was limited to a small Slovakian auction. So, it was initially equities that were driving the price action. This meant that equity strength in the European morning session pushed the Bund down to recent lows, but these held, allowing Bunds to recover in lockstep with US Treasuries when US traders joined the fray. The US session was more volatile, but unmistakably with a positive bias, allowing Treasuries and Bunds to recoup morning losses, even in the face of stronger equities. In the US there was also curve activity that reversed some of the recent steepening. Interestingly, the NY Fed published a statement on the reverse repo tests stating that these are a matter of prudent advance planning and no inference should be drawn about the timing of monetary policy tightening or about its later use as a tool to withdraw liquidity. The NAHB homebuilders survey disappointed as the headline index dropped one point, the first drop in four months. While Treasuries were rising after the release, we wouldn’t draw the conclusion that it was due to this release.
Euro countries agree ending their stimulus from 2011
Today, the euro zone calendar contains only some second tier data. In the US, the housing starts and permits (September) and PPI data (September) are on the agenda. In August, both US housing starts and permits extended their rebound, which was fully based on the multi-family component. For September, the consensus is looking for a further improvement in both housing starts and permits. Housing starts are forecasted to have risen from 598 000 to 610 000 and the permits are expected to have risen from 579 000 to 590 000. We have no reasons to distance ourselves from the consensus, but if the data would show another improvement, this indicates that also the market of new houses is recovering. After a sharp increase in August (mostly energy related), producer prices are expected to stay flat (at -4.3% Y/Y) in September. Core PPI (excluding food and energy) on the contrary, is forecasted to decline further from 2.3% Y/Y to 2.0% Y/Y. However, no market impact is expected after the CPI data last week.
On the supply front, Ireland will tap two bonds in the 3- and 7-year sector for an amount of €0.75-1B. Despite the huge number of euro zone government bond auctions this year, demand has kept up quite well and no governments have faced real problems to finance themselves. Concerns about the sustainability of the public finances have however prevented intra-EMU spreads from narrowing further over the past months, despite the overall positive sentiment with regard to risk appetite. Indeed, despite the ongoing rally on the equity and commodity markets and the narrowing trend in corporate spreads, the intra-EMU sovereign spreads haven’t set any new lows since the beginning of August. Yesterday evening, French Finance Minister Lagarde said that the euro area countries agreed to begin ending their economic stimulus programs in 2011, provided conditions stabilize, which may be an important positive step towards fiscal sustainability after France first showed little commitment to bring down their deficits. At the same time, EU Commissioner Almunia issued a stark warning to Greece, which won’t succeed in scaling back its deficit to below 3% next year, Officials also showed their dissatisfaction with the ongoing statistical differences between Eurostat and those of the Greek government, with Eurogroup chairman Juncker warning that such discrepancies risked undermining Greece’s credibility. Yesterday, Greek government bonds once again underperformed its peers.
In the US, two Fed governors, Warsh and Plosser, are scheduled to speak today. Warsh, a hawk, who said in September that interest rates may need to rise ‘with greater force’ than it has in the past to keep inflation in check, will moderate sessions at the San Francisco Fed Asia Economic Policy conference, while Plosser, a hawk too, but non-voter this year, will speak in a panel on monetary policy after markets have closed. Yesterday, Fed president Bernanke spoke already at the San Francisco Fed conference about global imbalances. There, he urged global policymakers to prevent the imbalances to reassert themselves, as these had helped cause the crisis and needed to be corrected. Therefore, US policymakers should develop a fiscal exit strategy, while Asian nations should build up domestic consumption. His speech didn’t contain new info with regard to US monetary policy.
In an interview with Germany’s Badische Zeitung, ECB Bini Smaghi is quoted as saying that ‘he doesn’t see any risk of inflation at all’ and added that ECB will raise interest rates and recoup liquidity when appropriate. Therefore, he said ‘we need to monitor very close credit and monetary developments as they are useful indicators to avoid being behind the curve’. He also said that international moves to encourage banks to boost their capital had to be carefully implemented, so that they did not cut off lending to firms. He also urged German banks, in particular Landesbanken, to focus on raising liquidity and to refrain from investing in complicated high-risky assets.
Regarding today’s bond trading, Asian equities are trading slightly higher this morning, in response to the overnight gains on the US equity markets. Yesterday, key technical support levels prevented bonds from extending their recent downward correction. But if the current bullish sentiment on the equity and commodity markets prevails, the pressure will remain on the downside. Another technical break lower would further deteriorate the technical outlook. For now, we hold on to a sell-on-up-ticks approach.
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 (121.30 today). In German 10-year yields, the move corresponded with a rebound above 3.25%. A sustained break below the uptrend channel (today at 121.30) 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 testing 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.
In the UK, the calendar contains the M4 money supply and public finance data. In September, M4 money supply is forecasted to show a further slowing (from 12.5% Y/Y to 11.4% Y/Y). The public finances are expected to show another significant worsening in September (19.0B from 10.4B) due weak VAT receipts and rising unemployment.
This evening after close, BoE governor King will speak in Edinburgh. His comments will be closely monitored to see whether he still supports a further extension of the asset purchase facility. Over the weekend, BoE Posen appeared to hint at such an extension.
