Markets: Fixed Income
On Friday, in a session devoid of eco releases, global bonds traded rangebound with intra-day moves mostly driven by the gyrations of equities. US yields ended up a couple of basis points, while German bonds were narrowly mixed and its curve flatter. For the German bund, it was nevertheless the fifth consecutive daily (modest) gain. The short end of the EMU bond curve and money market rates were negatively affected by the ECB tightening of collateral rules (cf. lower). The intra-EMU government yield spread widening versus Germany continued, but the pace slowed with the Greek and Irish 10-year yield spread up by respectively 3 and 4 basis points.
Intra-day, the Bund opened nearly unchanged and hovered in an insignificant 10 ticks range for a few hours. Technical resistance played its role. However, equities which had opened quite strongly, started to fall late in the morning with some watchers pointing to rumours about a potential default of Ukraine as being the trigger. The Bund tried to regain ground, but could never generate solid momentum and when equities found a bottom and started to struggle higher, the Bund lost its minor gains. Also in the US session, there were no eco reports to guide trading. So when US equities slid again lower shortly after the opening of cash trading, US Treasuries and the Bund went north again. The Bund set new intra-high highs, but the US T-Note future that tested the contract high earlier in the day, but failed, couldn’t muster enough momentum and fell again later on when equities staged a late session come-back. This left US yields 2-to-3 basis points higher on the day, while German yields were narrowly mixed, the 2-and 5-year yield up 2-to-3 basis points, the 10- and 30-year yield down 1-to-2 basis points.
Regarding bond trading, the Thanksgiving market holiday in the US on Thursday and the traditional very thin trading conditions in US markets on Friday will have a profound impact on trading this week. The US eco calendar is extremely busy on Tuesday/Wednesday, but uneventful on Monday and even empty on Thursday/ Friday. The eco data may be mixed for trading with Q3 GDP revised lower and the housing data a wild card, but claims may drop below the eye-catching 500 000 threshold and consumption should be strong too. In EMU, the PMIs (and German IFO) should show some, albeit moderate, further advance in business confidence, while the first national CPI data may demonstrate inflation is again in positive territory, even if base effects are the main factor. This is intrinsically bond-negative news, but the impact may be limited. The Central banks calendar of speeches is thin, with ECB governors unlikely to speak after Wednesday when the black period ahead of the key December ECB meeting kicks in. In the US, the Minutes of the November FOMC meeting may be of interest and support the recent drop in yields. In the US, the Treasury will issue a record of $118B of 2-, 5- and 7-year bonds. While recently these auctions went well, they may weigh on the market until they are finished, especially given the very low absolute yields at the shorter end. The technical pictures of the Bund and the T-Note future are bullish, but despite the advance last week, they showed little momentum. The T-Note future failed to take out the contract high twice, while the Bund had difficulties to recapture the broken uptrendline and move above the 122.44 previous high. Ultimately, the Bund closed a few ticks above these levels, but without dash. In this context, we hesitate to come out with a firm view at the start of the week. Nevertheless, we keep our long term view that rallies can still be used to offload long positions as the bond friendly climate may turn gradually less promising once 2010 started. Indeed, year-end liquidity motives that may be a bond supportive factor in the next weeks will fall away, supply will remain heavy next year and the Fed will gradually stop its support via the Agency MBS purchases. On top of that, the eco data should confirm the recovery is progressing. This might convince Bernanke and fellow governors to prepare for a gradual winding down of the non-conventional policy measures taken in the crisis, but most likely not before the semi-annual testimony in February at the earliest.
Looking into more detail, The US eco calendar is well-filled during the first part of the week, but empty on Thursday and Friday in observance of Thanksgiving and Black Friday. Today, the October existing home sales are scheduled for release. In September, the expiration of the fiscal stimulus for the housing market coming closer had a mixed impact on the housing market data. The existing home sales surprised on the upside of expectations, while new home sales showed an unexpected decline. In October, existing home sales are forecasted to have risen by 2.3% M/M. We have no reasons to distance ourselves from the consensus as the pending home sales, a leader for the existing home sales performed extremely well of recent. Also new home sales, scheduled for release on Wednesday, are forecasted to show an increase in October. However, here are more doubts on the downside.The renewal of the new homebuyer’s tax credit early this month might give some additional support to housing market activity in the future. Tomorrow, we will receive the S&P Case Shiller house prices and house price index, both are forecasted to show an increase in home prices in September. Besides the housing data, also some confidence indicators (Conference Board’s and final Michigan consumer confidence, Richmond Fed) are scheduled for release. In November, Conference Board’s consumer confidence is forecasted to show the third consecutive decline, indicating that consumer sentiment remains fragile as unemployment is at historically high levels. The Richmond Fed survey is expected to show a slight increase in November after falling from 14 to 7 in October. Tomorrow, the second estimate of US GDP is forecasted to show a significant downward revision from 3.5% Q/Q to 3.0% Q/Q due to downward revisions in inventories, non-residential investments, personal consumption and net exports. On Wednesday, the durables are forecasted to have risen by 0.4% M/M in October, while the claims are expected to show a slight decline in the previous week.
In the euro zone, the manufacturing PMI’s (business confidence) are on the calendar today. After jumping into expansionary territory in October, euro zone manufacturing PMI is forecasted to extend its rebound in November. Manufacturing PMI is forecasted to have risen from 50.7 to 51.2. We have no reasons to distance ourselves from the consensus. Also services PMI is expected improve further (52.8 from 52.6). Later this week, also the German IFO and European Commission confidence indicators are forecasted to show a further improvement in November. On Thursday, the M3 money supply data are expected to show a further, significant slowing in M3 from 1.8% Y/Y to 0.7% Y/Y. In recent months, the lending data showed a monthly increase in household lending. This is interesting as household lending usually bottoms at the same time as the economy, contrary to corporate lending that lags the cycle by 3 quarters. Another increase would be an encouraging sign for the economy.
The US Treasury will sell $118B of notes this week, including $44B of 2-year notes, $42B of 5-year notes and $32B of 7-year notes. The size of the 5- and 7- year note auction was upped by $1B each compared to the previous one, while the size of the 2-year note was kept unchanged. The auctions take place from Monday to Wednesday. The 5- and 7-year note will raise all new cash, while the 2-year will raise approximately $23B new cash. The Treasury will however pay €1.1B in coupon interest. Last month’s 2-year auction went extremely well. Demand was very strong with the highest bid/cover in a long time. The buy-side showed up in force and bid aggressively. The auction stopped a few basis points below the WI at the stop. Regarding today’s 2-year Note auction, the absolute (low) level of yields is a hurdle. Indeed, the active 2-year traded Friday intra-day at the lowest (0.67%) since December 2008 and more than 20 basis points about levels just before last month’s auction. On the positive side, the FOMC and Bernanke have assured markets that interest rates will remain at exceptional low levels for an extended period of time. Recent eco data turned out a bit more mixed than last month. On top of that, the market is screaming for shorter dated paper, as evidenced by T-bills and Notes maturing early 2010 that are trading near zero and sometimes at negative rate levels. So while there are no fundamental reasons to be nervous about the auction, the absolute low level of yields may temper the aggressiveness of the bid.
The EMU government auction calendar is moderate this week. The Netherlands tap their 6- and 9-year bonds (3.25% Jul 2015 & 4% July 2018) on Tuesday, while Germany re-opens its 2.5% Oct. 2014 OBL for an amount of €5B. Italy is the biggest issuer of the week with a total amount of approx. €9B with a CZT auction on Wednesday, some IL-bonds on Thursday and 3- and 10-year BTPs alongside a 7-year CZT on Friday. The EMU net cash flow is positive to the tune of about €15B, as no redemptions and only a small amount of coupon payments are scheduled. This may weigh somewhat on the auction results.
The Minutes of the November FOMC meeting might be interesting as it should contain info about the reason for some major changes in the most recent statement compared to the previous one. More in particular, the Fed may clarify the reason why they think that rates would remain exceptionally low for an extended period, notably because of “low rates of resource utilization, subdued inflation trends, and stable inflation expectations”. We think the Fed wanted to nip in the butt market expectations that the extended period of time would soon disappear from the statement. Indeed, the conditions remind the markets that the Fed is very focussed on its dual objective of maximum employment and price stability. In other words, the real economy is what matters not the markets with the exception of inflation expectations. This was put into context very forcefully by vice chairman Kohn, who downplayed the importance of potential bubbles for the implementation of monetary policy. If only the real economy would play a role (output gap), a tightening would indeed be still a long way off. So, the market reacted to the statement and subsequent central bank talk by lowering and pushing out of time tightening expectations. Secondly, the Minutes will show us the updated economic projections. We expect little changes for inflation, and subdued growth forecasts. Indeed, Bernanke recently emphasized that the recovery might be modest with downside risks. So the Minutes will only reinforce perceptions that the Fed might tighten policy later rather than earlier. However, the markets have discounted in the mean time such an interpretation and therefore shouldn’t react too much.
The ECB has decided to amend the rating requirements for asset-backed securities (ABSs) to be eligible for use in Eurosystem credit operations. The Eurosystem will require at least two ratings from an accepted external credit assessment institution for all ABSs issued as of 1 March 2010. In determining the eligibility of these ABSs, the Eurosystem will apply the “second-best” rule, meaning that not only the best, but also the second-best available rating must comply with the minimum threshold applicable to ABSs. As of 1 March 2011, the second-best rule and the requirement to have at least two ratings will be applied to all ABSs, regardless of their date of issue. The decision may affect (tighten) liquidity conditions further out.
The market reacted by pushing 3-month euribor futures implied yield up by 5 to 8 basis points. This should be reflected in today’s euribors which were recently stable at around 0.67% (3-month), 0.97% (6 months) and 1.21% (1-year). In the US on the contrary, Libors continued to decline, reaching new lows for the 3-, 6- and 12 month (0.266%, 0.48% and 1.02%).
ECB Trichet, Weber and Bini Smaghi made some interesting comments on Friday. We limit ourselves to Trichet’s comments directed at the European banking congress. Trichet said the crisis is not fully over and therefore it is too early to remove monetary accommodation. However, the banking system’s need for emergency support is now reduced and keeping the support for bank funding unchanged risks to make the bank’s addicted to such support, which is bad for banks for also for longer-term price stability. Therefore, these measures need to be phased out and Trichet asked banks to take measures to stand on their own two feet and thus minimise the risks that accompany the redraw for the overall economy. He was also clear that Central Banks should take asset price surges into account when setting policy, admitting though that this cannot happen in a mechanical way. Judgment is necessary and mechanical reactions cannot be used, but leaning against the wind strategy means that rates can be used against the emergency of asset price booms as well as dealing with the consequences of asset price busts. Bini Smaghi even went one step further by specifying that also asset price bubbles not stoked by excessive credit growth and leverage are dangerous. So the ECB clearly participates on the renewed debate on asset bubbles and central banks. We see current ECB talk as a message that the ECB won’t keep the current exceptional policy settings for too long if the situation changes. It fits in the stability-oriented framework and strategy of the ECB and will help anchoring inflation expectations. It clearly distances itself from the Fed’s and BoE more voluntarism in their strategy and implementation. While we don’t suggest that Trichet’s speech had much impact on Friday’s curve movement, it fits well with a curve flattening. However, Trichet’s suggestion that it was too early to unwind the accommodation was and remains the hurdle for a genuine flattening.
