Markets: Fixed Income
On Tuesday, global bonds consolidated previous gains in a relatively calm session. In the US, yields dropped 1-to-2 basis points in a daily perspective. In EMU, German yields fell somewhat more between 0.2 and 5.8 basis points, leaving the curve a lot flatter. The unwinding of steepeners in the euro area caught up with developments in the US. Bonds ignored the intra-day gyrations of equities, were little affected by central bank talk, but may have profited from some weaker-than-expected US data. However, trading seems to have been driven by market-internal considerations (curve, technicals, spread supply).
Intra-day, the Bund started little changed but fell prey to some modest profit taking and fell towards Monday’s official closing levels, where sideways trading kicked in. Following some modest profit taking, bonds found a bottom and lingered listless around going into the US session. US Treasuries at first ignored the bond-friendly data (production, PPI, see news section), but soon after started to rally, bringing them just above Monday’s closing levels, where the movement ended and sideways price action kicked in that lasted until the close, leaving US Treasuries (and Bunds) somewhat higher on the day. In the EMU market, the intra-EMU yield spreads with Germany narrowed for the first time in several sessions. There was a strong Irish bond auction, while the nervousness surrounding Greek debt ebbed away.
Today, the US calendar is attractive with the October CPI inflation data and housing starts and permits. In the euro zone, the calendar is empty. In the US, CPI inflation is expected to show a significant increase in October (-0.3% Y/Y from -1.3% Y/Y) due to an increase in oil prices and base effects from last year’s sharp increase in energy prices. Also core CPI is expected to show a slight uptick (1.6% Y/Y from 1.5% Y/Y) in October. While headline CPI will probably stay in negative territory, it should be clear that in a few months time, headline CPI will show substantial increases, due to higher commodity prices and base effects. At that time, it will be interesting to see whether markets will get nervous or whether they will concentrate on subdued and even declining core inflation. Last month, the expiration of the fiscal stimulus for the housing market coming closer had a mixed impact on the housing market data. Both the housing starts and permits showed an unexpected decline, but for October, a slight increase is forecasted. Housing starts are expected to have risen from 509 000 to 600 000 and building permits are forecasted to have increased from 575 000 to 580 000. As it is difficult to guess the impact of the programmed ending of the stimulus measures, we have no clear reasons to distance ourselves from the consensus. In the mean time, the homebuyer tax credit has been extended by Congress.
St-Louis Fed Bullard, a hawk, will speak on the economic outlook Bullard stands behind the current accommodative policy, but he is clearly one who is afraid that this policy may be kept for too long. He concentrated recently on the exit policy and defended the thesis that the Fed should choose, when time has come, for outright sales of assets as a way to unwind its non-conventional policy measures. He is also a critic of the too big too fail concept that he wants to fight. Remarks of Fed Yellen, Lacker and Pianalto were interesting, but not shocking and unable to affect markets. San Francisco Fed Yellen (dove) said there was a need to monitor asset prices, but saw no bubbles in equity and corporate bond markets. Cleveland Fed governor Pianalto (centrist) sounded very cautious on the economy, echoing comments of Bernanke on Monday, stressing tight credit and bank lending as a hurdle for the recovery. Atlanta Fed Lacker (hawk) obeyed to his reputation and said that “if we hope to keep inflation in check, we cannot be paralysed by patches of lingering weakness, which could well persist into the recovery”. He said there were risks to inflation particular in this cycle, given the massive and unprecedented expansion in bank reserves. While he too is not ready to raise rates, he said that “in assessing when we will need to begin taking monetary stimulus out, I will be looking for the time at which economic growth is strong enough and well enough established, even if it is not especially vigorous.” Regarding the exit strategy, there were two small developments to mention. The Fed decided to reduce the maximum maturity of primary credit loans (discount window) to 28 days from 90 days effective January 14 2010. The Fed lengthened during the crisis the maturity from 1 day to 28 days and later on to 90 days. Secondly, fhe TAF (term auction facility) through which the Fed gives 28 days credit to the financial sector is used less and less. On Wednesday, banks asked and got $31.1B of funds. The ceiling has already been lowered a few times and stands currently at $75B. A further reduction is likely after the turn of the year, we think.
ECB policymakers gave few new insights in their appearances yesterday. Trichet spoke again about the dollar (see FX part) and confirmed in an interview that the 0.4% Q/Q increase in Q3 GDP confirmed the ECB baseline scenario of a progressive and gradual revival of the economy. Quaden and Stark repeated that the exit strategy is in preparation, but shall be implemented gradually. Today, ECB Trichet will speak in Frankfurt, but he will probably stay near the manifold comments he gave in recent days.
The Irish Debt Agency tapped the 4% Jun 2014 and the Oct 2019 for €1B, the top of the target range. The auction went very well suggesting that confidence is returning. The bid/cover of respectively 7.9 for the €200M sale of the Jun 2014 and 2.5 for the €800B sale of the Oct 2019 bond were excellent. Ireland bonds outperformed. The 10-year spread with Germany fell to 139 basis points from 148 basis points previously. Also other intra-EMU spreads, including the battered Greek one, narrowed for the first time in several sessions. Today, the German Bundesbank will auction the new 1.25% Dec 2011 Schatz for an amount of €6B. German debt issues often get a cold reception in the market for various reasons (CTD, lowest yielding).
Regarding trading, Asian equities trade mixed giving us no clues about equity trading in Europe. Positively, US equities didn’t give back the gains of Monday, keeping them above previous cycle highs. So, the outlook for equities remain bullish, even if we would like to see fast some further progress. However, recently the impact of equities on bonds has lessened. The eco data might be bond-friendly with maybe some downside risks on the housing data and still subdued inflation figures. However, we might see again market-internal factors driving the price action, like the fate of the German Schatz auction, spread supply, curve play and the technicals. Regarding the latter the 122.24/44 (broken uptrendline/Nov 3 high) resistance (Bund) is a hurdle. The yields at the shorter end have dropped substantially in recent days making still lower yields unlikely. Overall, we expect sideways trading.
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 to a real test of the September lows at 119.85 (which if broken would violate the higher low higher high configuration). The Bund managed to move away from these lows and a constructive session yesterday lifted it to 122.34 for an intra-high. The broken uptrend at 122.24 is still the first point of reference. The longer end of the bond market seems to be in a wait-and-see period from which we don’t see it exit in the near future. Sideways trading in the 120.51/119.85 to 122.44 range is still likely, but if the 122.44 resistance is broken, it would open the road for a retest of the 123.04 contract high, where profit taking should be considered.
Regarding the US Treasury market, the technical picture of the US T-Note future improved on Monday as Bernanke’s comments pushed the contract to a 119-23 high, only 6 ticks from the contract high. A bullish inverted Head and shoulder formation with neckline at 118-28+ is now reigning and has final targets around 120-30. The short term picture is bullish, but we have still some second thoughts about the upside. We wouldn’t jump on the bandwagon, but use eventual retests of the contract highs to offload long positions.
In the UK, the calendar contains the Bank of England Minutes and the CBI industrial trends survey. On the 5th of November, the BoE Monetary Policy Committee decided to leave rates unchanged, but to continue with its programme of asset purchases and to increase its size by £25B to a total amount of £200B. The BoE Governor noted already a “range of views” on the MPC. This might indicate that there was a three-way split between no expansion, an increase by £25B or by £50B. BoE Sentance was relatively optimistic on the economic outlook in a speech he gave, downplaying also the surprise drop in Q3 GDP that was reported last week. Sentence clearly sees an upward revision of the figure as very likely. The Minutes may show that Sentence was one governor voting against an extension of QE. UK Gilts outperformed on Tuesday helped by successful BoE purchases of £1.7B of ultra-long Gilts above market prices. The offer cover was 1.79. The curve flattened and shifted down by 5 to 8.2 basis points.
