Markets: Fixed Income
On Wednesday, European bonds traded essentially sideways, closing nearly unchanged. US Treasury trading was dominated by curve positioning and the presence of technical resistance (119-29 T-Note future), leaving the curve steeper in the close, unwinding part of the flattening that took place in previous days. US 2-year yields dropped 1.6 basis points, while 5-year yields were up 2.7 basis points and the 10- & 30-year yields increased 4 basis points. Intra-EMU yield spreads with Germany were mostly wider with Ireland and Greece giving back some of the recent gains. Other government credits were only very slightly affected.
Intra-day, the Bund started the session little changed and hovered listless around these levels well into the US session. There were no European eco data releases, no comments of policymakers and the German Schatz auction, while mixed, hadn’t much impact on overall trading either. Contrary to the Bund, the US T-Note future eased somewhat ahead of the eco releases. US CPI and core CPI were a tad above expectations, a move that pushed inflation expectations slightly up, but the market looked more towards weaker housing starts & permits. So Treasuries edged slightly higher after the release. Some more fuel was added by headlines from a speech of Fed hawk Bullard. News agencies reported that he said the Fed may not raise rates until 2012. However, a more thorough reading of the speech put that quote into the right context (see below) and Treasuries and Bund fell to new intra-day lows. Curve positioning was adding to the pressure at the longer end. Bonds rebounded though, but whereas the Bund erased all intra-day losses, closing unchanged, US Treasuries came again under some pressure, and closed the day with modest losses and a steeper curve. The short end saw its yields even somewhat lower in a daily perspective.
Today, the eco calendar remains thin in the euro zone, but in the US, the weekly claims, the Philly Fed (November) survey on manufacturing and the leading indicators (October) are scheduled for release. In the week ended November 14, initial claims are forecasted to show a marginal increase. The consensus is looking for an increase from 502 000 to 504 000, but the figures might be distorted by the Veteran’s Day Holiday. Continuing claims, which are reported with an extra week lag, are expected to extend their downtrend (from 5 631 000 to 5 595 000). In recent weeks, claims have surprised by being lower than expectations. After a bigger than expected deterioration in October, the Philly Fed headline index is forecasted to show a slight increase in November (12.2 from 11.5). However, after the sharp decline in the NY Fed, the risks are on the downside of expectations, but markets should already a below- consensus outcome. Question is how much lower. The leading indicators are forecasted to show the seventh consecutive increase in October.
Today, the ECB holds its non-monetary policy meeting. As usual, no press conference is scheduled, but we suspect that an intense debate will be held about the exit policy in preparation of the December meeting at which decisions will be taken on the exit strategy. So we will eagerly listen to the speeches that will follow today’s meeting for hints about the way the debate is evolving. This evening, ECB President Trichet and the executive board member both take the stage. In the US, Dallas Fed Fisher speaks at the Cato conference. However, Fisher (hawk) has spoken recently and thus shouldn’t be too important for markets.
The results for the German €6B New December 1.25% 2011 Schatz auction were mixed, as demand was modest, but pricing strong. Germany sold €5B at an average yield of 1.31%. The bid/cover amounted to 1.7, which was the lowest of the year despite a reduced size. The Bundesbank retained €997M for market-smoothing purposes. There was only a small tail. Today, the French AFT will hold its BTAN and IL-OAT’s auctions for an amount of $6.5 to 7.5B for the nominal and for 1 to 2% for the IL issues. The AFT taps the 1.5% Sep 2011, the 3.75% Jan 2012 and the 3% Jul 2014. The IL bonds on auction are 1% Jul 2017 and 2.25% Jul 2020. The Spanish government taps the 4.8% Jan 24 bond for an amount of €2B. The cash flows surrounding the auctions are negative this week as no redemptions take place to compensate the €17B issuance. The UK DMO taps the 1.125% Nov 2037 IL Gilt. In the US, the Treasury will announce the details of the end-of-month 2-, 5- and 7-year Note auctions that will be held next week.
St-Louis Fed Bullard (hawk) discussed in a speech three components of monetary policy, the Fed’s liquidity programs, the near zero rate policy and asset purchase program. The liquidity programs are tapering off as the crisis recedes and thus are no inflationary concern. Regarding the near zero rate policy, Bullard said that rates may remain low for some time. Historically, the FOMC didn’t begin policy rate increases until 2.5 to 3 years after the end of each of the past two recessions. If one would assume a similar behaviour this time, the FOMC would not start increasing rates until 2012. However, he added that the FOMC will heavily weigh concerns that stem from criticism the Fed kept rates too low for too long contributing to the housing market bubble. Bullard said he was disappointed that markets were focussing on rates instead of quantitative monetary policy. He said the policy has been considered to have been successful in mitigating the crisis, but had also caused a large and persistent increase in the monetary base, which creates a risk of inflation in the medium term. So the big challenge going forward will be to adjust the asset purchase program without generating inflation and still support the economy by rates close to zero. Bullard wants the FOMC to adopt a state-contingent policy rule that would allow for the adjustment of asset purchases as new info on the economy becomes available. Overall, Bullard remains concerned about the potential negative consequences of QE on inflation, he is after all a hawk, but his remarks don’t give signals regarding the timing of the exit policy, unlike some news agency headlines suggested.
Regarding trading, Asian equities trade mixed to negative, with especially the Japanese equity indices performing very weak, also in a longer term perspective (bearish double top/ Head& Shoulder configurations). The S&P stabilized for second day, above previous cycle high, but should stay at these levels for longer or disappointment kicks in and a more pronounced profit taking may follow. However, given that the correlation with bonds is low currently, it isn’t clear whether bonds would gain that much on such an eventual correction. Besides equities, there is nothing on the Euro- pean calendar besides the French and Spanish auction that may give bonds a distinct direction. In the afternoon, the US eco data may have some impact. If the string of the most recent data is a good precursor, the risks are again on the downside of expectations, intrinsically a bond positive feature. The technicals may play a role. The 122.44 resistance is a hurdle for the Bund and the 119-29 is a hard nut to crack for the US Treasury Note future. Overall, we have no strong inclination regarding today’s market direction, but the presence of strong resistance might lead to some profit taking, if the resistance is not taken out rapidly.
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 few constructive sessions lifted it to 122.34. 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 favoured, 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 up to a 119- 27+high on Tuesday, only a whisker from the 119-29 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 is attractive today with the retail sales (October), M4 money supply and public finance data (October). The BoE also publishes its Trends in Lending report and BoE’s Fisher will speak. After staying flat in September, UK retail sales are forecasted to have risen by 0.5% M/M in October. The latest BRC retail sales survey showed the strongest retail sales for October in seven years and also the CBI was encouraging. M4 money supply is expected to show a further slowing in October, from 11.6% Y/Y to 9.9% Y/Y. October is normally one of the four months in the year that sees a surplus in public finances, for this year however, also October is forecasted to see a deficit. The Minutes of the MPC had only a small impact on gilt trading. The curve steepened modestly, as short dated yields fell 1-to-2 basis points while longer-dated yields were marginally up.
