Markets: Fixed Income
On Friday, Bond trading was dominated by the US payrolls release and the concomitant gyration of equities, while upcoming supply played a role too. At the end, yield changes were modest though. The US and the EMU curve steepened, but while the US curve steepened in a bullish fashion, in EMU, the German curve was mixed, as German 2-year yields were down 2.8 basis points but 10- and 30-year yields were up 2 basis points. In the US, yields dropped 3-to-4 basis points with the exception of the 30-year yield that stabilized. The curve steepening was prolonged for the 5th consecutive session. It was certainly affected by the FOMC dovish statement earlier in the week, but also by upcoming supply in both the US and EMU (see below). Inflation expectations, as expressed by the inflation breakevens, that jumped higher in the aftermath of the FOMC decision on Wednesday stabilized on Friday.
Intra-day, global bonds hovered essentially sideways in the European morning session. The September German factory orders were good (+0.9% M.M) but in line with expectations and thus ignored. There was some consternation in late morning as ECB governor Nowotny (Austria) said less than 24 hours after Trichet suggested that the 12 month LTRO tender would be stopped after December that no such decision was made yet. He also stressed the weakness of the recovery and offered the possibility of a Japan-like lost decade for the EMU economy. He also said the ECB had no currency policy. These remarks from one of the governors of the dovish wing inside the ECB showed that the debate on the exit from non-conventional measures is far from over. It supported the 2-year bonds that gained some ground on his comments. However, it was all only a side-show for the US payrolls report that was the eyecatcher. Bonds jumped higher on the release and equities fell lower. The unexpectedly sharp rise of the unemployment rate above the 10% mark (10.2% from 9.8%) grasped initially the attention, but a second reading showed that the report confirmed the ongoing, albeit modest, improvement of labour market conditions. October payrolls declines were slightly deeper than consensus forecasted, but there were sharp upward revisions in previous months’ results and the professional business services payrolls, including temporary help agency payrolls, showed a further recovery. On top of that, the increase in unemployment rate was not due to more workers losing their jobs, but to an increase in the number of unemployed re-entrants into the labour force. So, equities erased initial losses and bonds lost the initial gains. Later on, bonds gradually climbed higher again, but upcoming supply worries weighted on the long end. In EMU, the market edged toward the end of the week without momentum.
Previewing this week’s trading, the dataflow is not so important at least until Friday when EMU GDP and US Michigan consumer sentiment might get full attention. Trading will be very slow on Wednesday, when markets in many countries, including US, are closed for Veteran’s Day. More important will be the new government supply especially in the US and Central Bank talk. Indeed, following ECB, BoE and FOMC meetings last week, central bankers will go out again and explain their decisions. We also might get a better take on how the various fractions (doves, hawks and neutrals) see these decisions. At least ECB Nowotny in a speech last Friday suggested that the debate on the exit strategy is still in full swing.
Today, the calendar contains only data like the German industrial production (September) and the Bank of France business confidence survey (October). In September, German industrial production is forecasted to have risen by 1.2% M/M after increasing by 1.7% M/M in August. The strong order intake in recent months is indeed beefing up production plans. Bank of France business confidence is forecasted to extend its rebound in October. The consensus is looking for an increase from 92 to 93. The French economy is leading the recovery in the EMU area helped by stronger domestic demand. In the US, there is a possibility that the Q4 Senior Loan Officers’ survey will be published. ECB Stark speaks in Germany while the BIS meets in Basel.
Later this week, the US calendar remains thin with only the weekly claims on Thursday and Michigan consumer confidence (October) and the trade balance (September) on Friday. Recent data showed a positive development in both initial and continuing claims. This week, we expect to see a further decline in the number of initial and continuing claims. Nevertheless, an eventual slight uptick shouldn’t change our opinion that the trend is still downward. University of Michigan consumer confidence is forecasted to show a marginal improvement in November after falling from 73.5 to 70.6 in October. It remains to be seen however how households will have been influenced by the mediatised jump in unemployment rate to 10.2%.
In the euro zone, we will receive the German ZEW tomorrow and the EMU industrial production data on Thursday, but the calendar heats up on Friday with the third quarter GDP data (and final CPI inflation). Last month, the German ZEW showed an unexpected decline, while the IFO and PMI’s extended their rebound. But the index has already reached a high level of 57.7 which has to be compared with peak values of 70 to 80 in previous cycles and therefore the correction shouldn’t be taken too serious. For this month, the consensus is looking for another slight decline. On Thursday, industrial production is forecasted to increase for the fifth consecutive month in September, but some national data released early this week might give us a better indication. Most important figure of this week will be euro zone’s third quarter GDP that is expected to show an expansion after five quarters of negative growth. The consensus is looking for an expansion by 0.5% Q/Q and we have no reasons to distance ourselves from the consensus, even if the retail data and Trichet cautious comments last Thursday make us a bit wary about the outcome. The final figure of euro zone inflation is forecasted to confirm the first outcome of -0.1% Y/Y.
The US quarterly refunding operation will be the major factor for the US (and global) bond markets this week. It is the first big issuance since the Fed ended its $300B Treasury purchase program (end October). It will be another test of the resilience of the market in the face of ever increasing size of the auctions. The Treasury will sell $81B of debt, a record for a quarterly refunding. The refunding will raise $42.5B in new money, as $38.5B of issues mature, but the Treasury will also pay-out about $17.5B of coupon interest. This leaves still a hole of roughly $25B that the Treasury needs to finds. The deterioration of the deficit and debt position in recent quarters has changed the previous very positive cash flows surrounding the refunding. The refunding consists of $40B 3-year T-Notes today, followed by $20B of 10- year T-Notes tomorrow and $16B of 30-year bonds on Thursday. The Treasury is deliberately, but gradually, pushing supply towards the longer maturities as it wants to lengthen the average maturity of its debt that is considered too short currently (53 months) towards 74-to-90 months in the next few years. The Fed wants to profit from still low long term yields. However, the end of the Fed’s purchase program means that at least one known buyer will be absent in the secondary market and this might make the dealer community more cautious in their bidding and put more importance on the appetite of overseas investors. The supply may keep the longer end under pressure, maybe extending the steepening trend of recent. However, the 2-to-10- year spread of 265 basis points is close to the cycle high of 276 basis points and in case of a further spread widening, traders and investors might be tempted to take profit on those steepeners maybe towards the end of the refunding operation.
In EMU, the issuance calendar is thin, but the cash flows are unsupportive. Indeed, governments will issue bonds worth €15.7B, but there are no redemptions or coupon payments scheduled. On Tuesday, the Dutch Agency issues the Jan 2012 DSL (€3B), on Wednesday the Bundesbank auctions the new Bund Jan 2010 (€6B) and Portugal taps the 5-year (< €1B), while an Italian BTP auction (€6B) and a small Slovenian tap are scheduled for Friday.
Regarding the European bond market, the longer-term bullish technical picture of the Bund started to deteriorate after the Bund fell off the highs at around 123.00 and broke below its long-standing uptrend channel. It didn’t however come yet to a real test of the September lows at 119.85 (which if broken would violate the higher low higher high configuration), but a break through 120.51 would already be an omen that such a test might be in the cards. With little eco data on the agenda in the next few days and in the face of more supply, we keep a negative bias at the onset of trading this week that only may be reversed if equities would again turn south. Such a possibility clearly exists as the S&P couldn’t yet regain its uptrendline and the index moved up four days which is usual the maximum number of days the index rises if the current move would be a countertrend rally.
Regarding the US Treasury market, the technical picture of the US T-Note future is still quite similar to the Bund future, as the T-Note future has also fallen off the highs (119-729) since early October and rebounded before a test of the September lows (116-18) occurred. Last week, the US T-Note tested but failed to break above the neckline of a potential double top formation at 118-27, which is a bearish signal, but kept the Note future still a good distance of the crucial 116-18 level (more than the Bund). We suspect supply to weigh on the longer end of the curve for much of the week, but a sustained, if unexpected, break above 118-18+ might brighten the outlook and open the way for a test of 119-29 (October 2 high) level.
