Markets: Fixed Income
On Wednesday, EMU bonds had an overall quiet day, as US markets were closed in observance of Veteran’s Day and the dataflow was thin in Europe. The Bund hovered sideways in a tight range, closing at 121.71, virtually unchanged from the previous close. In the cash markets, changes were marginal too, except for the 10-year yield that went up by 6 basis points, but only due to a change in benchmark (Bund 3.25% Jan 2020 replaces Bund 3.5% Jan 2019). Equities eked out more gains on the back of another batch of very strong Chinese eco data and signals that Chinese monetary policymakers will keep their dovish stance for longer. The Bund auction was poorly and non-aggressively bid, but neither the auction nor the equity rally has much impact on trading.
In the UK, Gilts rallied after a dovish inflation report and remarks of BoE King. The inflation report showed that inflation would come out well below the 2% target (1.6%) in the policy relevant period based on market rate expectations (1.6% bank rate at end 2010). In case on an unchanged 0.5% bank rate, inflation would be somewhat above target. The output gap would not be closed until 2012, even in case of stronger growth. The BoE expects clearly an upward revision of Q3 GDP, surprisingly set at -0.4% Q/Q in the advance report and sees risks as balanced compared to downside risks in the August report. BoE governor King commented the MPC decision to extent the QE policy by an amount of £25B to £200B. He said it should not be seen as a signal the QE policy would end once these £25B bonds are purchased. The MPC is completely open minded on the subject of QE and will decide in February when the next inflation report will be available. As a result the UK yield shifted downward and steepened, as the report suggests the market had discounted too much tightening.
Global bond market trading resumes in earnest today
Today, the calendar contains the US weekly claims, euro zone industrial production data (September) and Spanish third quarter GDP. Other important events are the US 30-year T-bond auction that concludes the Q4 refunding operation and the monthly ECB report. ECB governors Tumpel Gurerell and Draghi speak early in the morning, while ECB president Trichet speaks late in the evening. However, the subject of the speeches makes us think that it won’t have much overall market impact.
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 (510 000 from 512 000) and continuing claims (5 700 000 from 5 749 000). Nevertheless, an eventual (slight) uptick shouldn’t change our opinion that the trend is still downward. Euro zone industrial production is forecasted to show the fifth consecutive increase in September. National data showed a mixed picture with downward surprises in France (-1.5% M/M) and Italy (-5.3% M/M), while German industrial productions surprised on the upside of expectations (2.7% M/M). The consensus is looking for an increase by 0.5% M/M, but we believe that a weaker outcome is not excluded after the French and Italian industrial production data. In the third quarter, Spanish GDP is forecasted to show the sixth consecutive quarterly contraction (-0.4% Q/Q).
Looking back to yesterday’s German Bund auction (new 3.25% 2020), it wasn’t a success. Indeed, despite a lowering of the size to €6B from €7B, the auction was poorly bid. The bid/cover of 1.4 was below average and below the previous 10-year Bund result. The Bundesbank retained €1.025B for its open market operations, slightly smaller part than in previous auctions. The auction resulted in a large tail which points to non-aggressive bidding. It will be the last German 10-year auction of the year. The new issue will be re-opened in January though. The German issuance plan still projects €16B of supply this year divided between a new Dec 2011 Schatz and the Oct. 2014 Bobl. On Tuesday eve, the $25B US 10-year T-Note auction went well, but not as spectacular as the 3-year T-Note auction on Monday. Demand was strong with record bids from dealers and Indirect bidders, but the auction stopped only marginally below the WI bid at the moment of the stop. Today’s $16B 30-year US T-bond auction will conclude the Q4 refunding operation. It is a new issue that will re-open in December and January. Its size is upped $1B from the August auction. Traditionally, 30-year auctions go more difficult than auctions of shorter issues. Indeed, oversees demand is less and it seems that inflation fears are also playing a larger role. As a result on average the auctions stops well above the WI bid at the time of the auction. The average bid cover amounts to 2.29 since 2006 with bid cover higher for re-openings than for original issuance. So some metrics to compare today’s results with. Of course, once the re-opening operation concluded, the market may be relieved and thus it might push the market higher, if of course the auction is no failure and no other factors come into play.
The ECB continues to prepare the market for a gradual removal of some of its nonconventional measures taken at the height of the crisis. The ECB doesn’t want to be misunderstood when it takes away some of these measures when it meets in December. ECB executive board member Gonzalez-Paramo said yesterday that “moves by the ECB to withdraw emergency measures put in place over the crisis should not be seen as a signal it will raise interest rates. “Our preparations for a gradual exit from these measures, however, do not suggest that a fundamental change in policy is imminent”. Also Gonzalez-Paramo sounded more upbeat about the economy as he hinted the worst was over. Similar remarks by ECB Weber yesterday about the economy. On policy, Weber said again that it is too early to remove accommodative monetary and fiscal policy measures, but added that “the right time for exit must not be missed.”, showing that Weber is a bit concerned that the ECB may not act timely when the time is ripe to do so.
The EU Commission set deadlines between 2012 and 2014/15 for 12 EU countries to slash budget deficits below 3% of GDP. The Commission expect the EMU budget deficit to jump to 6.9% in 2010 from 6.4% this year and 2% in 2008, boosting the debt to GDP ratio to 88.2% in 2011 from 78.2% this year. Nine countries have until 2013 to trim budget deficits below 3%. Italy and Belgium got until 2012, Ireland until 2014 and Britain until 2014/15. Greece will get a special treatment and the Commission will up its disciplinary budget action against the country. We think that in the next months, the evolutions of the deficit and debt situation may have a bigger impact on the intra- EMU spreads and more differentiation is likely.
Regarding trading today, Asian equities are trading mostly (moderately) negative which might lead to a lower opening in Europe too. However, it will be the US equity markets that are worth looking at. The Dow moved already towards new cycle highs, but the S&P and NASDAQ haven’t made a similar step, even if they are testing the highs. They should rapidly take that hurdle of renewed disappointment may kick in and a correction becomes inevitable. That would up the possibility that the uptrend since last March is mutating towards a sideways trend that may last for months. Indeed, technically the higher high, higher low configuration may become under threat, with the uptrend channel also in danger. However, that’s speculation and therefore we wait for a clear signal that may come today and in the next sessions. Key resistances at 1117 (50% retracement) and 1145 (2e target inverted head & shoulder). We have no firm bias for trading today. Bonds are lacking a clear direction.
Regarding the European bond market, re-iterating our view, 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. Earlier this week, the Bund moved further away from the support and put a bullish engulfing pattern on the chart, a short term positive, but more gains are needed to become more enthusiast. The broken uptrend at 122.04 is the first point of reference. Range trading in the 120.51 and 122.04/47 is likely
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 (119-29) since early October and rebounded before a test of the September lows (116-18) occurred. Last and this week, the US T-Note tested but yet failed to break above the neckline of a potential double bottom formation at 118-28+, but kept the Note future still a good distance off the crucial 116-18 support level (more than the Bund). We suspect supply to weigh on the longer end of the curve at least until the 30-year T-bond auction is off the table late today. A break above 118-28+ might brighten the outlook and open the way for a test of 119-29 (October 2 high) level.
In the UK, the eco calendar is empty today, but the DMO will tap its 2032IL for an amount of £1B. Yesterday, the BoE purchased Gilts for an amount of £1.7B in the sector March 2013 to March 2019.
