Markets: Fixed Income
On Wednesday, global bonds sold off after the release of the BoE Minutes dented the prospects for an extension to the Bank’s quantitative easing program. Bonds lost further ground throughout the session, as US equities rose to new highs on the back of another basket of forecast-beating corporate earnings. A late sell-off on the US equity market offered no respite and bonds closed the session near the lows. European bonds again underperformed US Treasuries despite the continued fall of the dollar against the euro, which pushed the currency pair above the 1.50 level. German yields were up between 3.5 basis points in the 2-year sector to 9.3 basis points in the 30-year sector compared to 3.2 to 5.8 basis points in the US. It were however mainly German bonds that underperformed after press reports hinted at a substantial increase in this year’s borrowing requirements. As a result, the intra-EMU sovereign spreads narrowed.
In the UK, the BoE MPC decided unanimously to keep policy, rates and the amount of quantitative easing unchanged. The MPC said that monetary policy reconsidering would happen in November when the inflation report was available. There was little new in the Minutes, but some observers correctly noted that in contrast to September the more dovish MPC members didn’t re-state there preference for more QE, making such an expansion of the QE unlikely, especially as some members including governor King in a Herald newspaper yesterday morning, had become slightly more optimistic on the economy. We are not sure whether such an interpretation of the Minutes is correct and we probably only know at the next MPC meeting in early November. Whatever the case, without any doubt, it was on the release of the report that bonds were heavily sold, not only in the Gilt market but also in the European market.
Bund falls below uptrend channel
Today, the US calendar contains the weekly claims, leading indicators (September) and house price index (August). After the French business confidence indicator early this morning, we will receive the Belgian business confidence indicator in the afternoon. The consensus is looking for a slight improvement, but the risks might be on the downside of expectations after the unexpected decline in the German ZEW and also Belgian consumer confidence yesterday. A decline in business confidence would however be considered as a disappointment, as we are still in the early stages of the recovery during which the confidence indicators usually show a steep rise. Therefore, this wouldn’t pass unnoticed in the markets.
In the previous weeks, the US weekly 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. The consensus is looking for a marginal increase (from 514 000 to 515 000), but if they would show another decline, it might have a negative impact on the Treasuries. The leading indicators are expected to show the sixth consecutive increase in September due to rising stocks and falling claims. The house price index is forecasted to have risen by 0.3% M/M in August, the fourth straight increase, but no market impact is expected as the data are rather outdated.
With regard to monetary policy, the ECB will hold 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. In Sweden, the Riksbank will decide on rates, but no change is expected. In the US, there are again a lot of Fed speakers, including Rosengren, Lockhart, Dudley and Evans. Yesterday, the Beige Book indicated that the recovery is still going at a very slow pace, as it stated that ‘reports of gains in economic activity generally outnumber declines, but virtually every reference to improvement was qualified as either small or scattered’. At the same time, the Beige book noted ‘little or no’ price pressures, while demand for bank loans was ‘weak or declining’ and many districts reported a ‘further erosion of credit quality’.
On the supply front, the US Treasury will announce the amounts for next week’s 5- yer TIPS, 2-, 5- and 7-year Note auctions. In the euro zone, there are no auctions scheduled for today, but there are some press reports that the German coalition talks may result in a doubling of Germany’s new borrowing requirements for this year from around €50B to almost €90B.
Regarding trading today, sentiment on the equity markets is likely to dominate trading again, as investors will be eager to know whether yesterday’s late session selling wave in the US is the precursor of more downward correction on the equity markets. This morning, Asian equity markets are only moderately lower after the Chinese GDP figures confirmed the remarkable rapid rebound of the Chinese economy. In recent days, bonds have been trading quite volatile and the correlation with the equity markets has not always been consistent, as the decline in the equity markets yesterday morning didn’t prevent bonds from falling lower on the back of the Minutes from the BoE. The latter may signal that bond markets are afraid that the end of the central bank purchases of government bonds will have a negative impact on bond prices. Taking together, the correction on the equity markets along with the nearing end of the bond purchases may keep bonds more sideways oriented.
Regarding European bond market, the longer-term bullish technical picture of the Bund started to deteriorate last week after it fell below a previous reaction high at 121.74. This is a first warning signal that the underlying sentiment is deteriorating. Yesterday, the Bund also fell below its long-standing uptrend channel, which if confirmed would be an additional signal that sentiment is deteriorating. However, only a fall below the September lows would put an end to the higher high, higher low pattern and suggest that a substantial downward correction is looming.
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. A break below 117-19 would be an additional sign that sentiment is deterioration.
In the UK, the calendar contains the September retail sales. After a flat outcome in August, retail sales are forecasted to have risen by 0.5% M/M in September after also the latest BRC an CBI surveys pointed to a notable jump in UK retail sales.
On the supply front, the DMO will tap its 5-year benchmark for an amount of £4.75B. It will be interesting to see whether demand for Gilts remains solid now that the Bank of England’s asset purchase facility is coming to an end (unless they would decide to expand it again at their November meeting). Yesterday’s Minutes provided little new info on the chances of new expansion, but this couldn’t prevent a sell-off on the Gilt market after the doves didn’t re-state their preference for more QE.
