Markets: Fixed Income
On Monday, global bonds ended narrowly mixed, a very strong performance in the face of buoyant equity markets. US yields were flat to 2 basis points lower, the curve flattened, while German yield ended up 2-to-3 basis points, the very long end underperforming. A soft comment of the Fed hawk Bullard, late on Sunday, on the desirability of the continuation of the MBS Agency assets purchase program after its planned expiry at the end of March might have played a role in the increased risk appetite, but also signs that firms are becoming more aggressive (Cadbury takeover battle, battle between Microsoft and Google on news content and the expansion of BBVA in China) might have spurred equity buying. Commodities initially joined the equity rally, but with the exception of gold, gave back most of their early gains. The ITRAXX CDS index fell modestly, but remained above recent lows. Economic data were bond-unfriendly, but couldn’t really affect bond trading. The US 2-year T-Note auction went well, but wasn’t as exceptional as last month’s amazing auction. Intra- EMU yield spreads with Germany narrowed slightly for the first time in several sessions, while the EMU money market saw still some selling following Friday’s ECB decision on collateral (see graph below).
Intra-day, the Bund opened nearly unchanged, but started to slide lower when equities started strongly. The latter settled in a more sideways trading range after an hour of trading and this also marked the low of the Bund that also moved sideways until well into US session. The EMU PMI’s were constructive, showing an ongoing improvement in business sentiment, but failed to impact markets. The losses of the Bund of about 20 ticks at most were insignificant when compared to the gains of equities. In the US markets, equities started to rise at 15.00 CET, but instead of losing more ground, Treasuries (and the Bund) grinded higher. The Existing Home sales were very strong, but when there was no follow through selling after a spike lower, Treasuries moved higher in lockstep with equities. A minor dip occurred in the run-up to the 2-year T-Note auction, but when the result showed good appetite and aggressive bidding, Treasuries moved again higher, slightly supported by a gradual easing of equities, as some traders were disappointed the S&P couldn’t break above the cycle highs. This left Treasuries flat to slightly higher for the day, while German bonds closed with surprisingly small losses.
Today, the market calendar is enticing with interesting eco releases in the US and EMU, supply in the US (and the Netherlands & UK) and the Minutes of the November FOMC meeting. The testimony of BoE King and other governors will attract attention too.
Regarding the eco calendar, in the US the second estimate of Q3 GDP, the Conference Board’s consumer confidence (November), the Richmond Fed (November) surveys and S&P Case Shiller home prices (September) are up for release. The first estimate of US Q3 GDP surprised on the upside of expectations showing an expansion by 3.5% Q/Q (annualized). The second estimate is forecasted to show a significant downward revision from 3.5% Q/Q to 2.8% Q/Q due to downward adjustments in inventories, non-residential investments, personal consumption and net exports. The Conference Board’s consumer confidence index is forecasted to show the third consecutive decline in November. The consensus is looking for a drop from 47.7 to 47.5 as consumer sentiment remains fragile due to historical high unemployment. We have no clear view on the risks as Michigan consumer confidence surprised on the downside of expectations, while ABC consumer sentiment improved recently. The Richmond Fed manufacturing survey is expected to show a slight increase in November after falling from 14 to 7 in October, but also here the divergent picture of the earlier released NY and Philly Fed surveys make an assessment of the risks surrounding consensus difficult. S&P Case Shiller home prices are forecasted to show a further slowing in the (yearly) rate of decline in September, but the data are rather outdated and therefore, no market reaction is expected. In the euro zone, the eco calendar contains the German IFO indicator. In November, the IFO business climate indicator is forecasted to extend its uptrend. An increase from 91.9 to 92.5 is expected due to an improvement in both the current assessment and expectations. The German PMIs, released yesterday, point to such a modest improvement.
ECB Trichet largely repeated his recent comments on the exit policy. An unwinding of the Bank’s extra-ordinary stimulus is still premature as the crisis has not completely subsided. However, when time is ripe, there should be no concern about the ECB’s determination and ability to exit, he said. Ordonez, the Spanish ECB member, sounded pessimistic about the Spanish economy that may still register a negative growth figure for 2010, even if a recovery would take place. He warned that both a too early and a too late exit would be detrimental for the economy and added it was not clear whether the economy was already strong enough to start withdrawing the stimulus measures. He called rates appropriate and saw no risk of deflation. It was clear he wouldn’t anticipate the important decisions that will be made at the December meeting.
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 intra-EMU government yield spread mostly narrowed versus Germany following a few days of widening on increased risk appetite. However, changes were very modest for most credits, even for the weaker credits. Italian spread dropped 2 basis points, while Irish and Greek spread fell respectively 4 and 6 basis points, reversing only small part of the recent widening. The Netherlands tap today their 6- and 9-year bonds (3.25% Jul 2015 & 4% July 2018) for an amount of about €1B. We don’t expect difficulties to place the issues. Austria cancelled its December auction due to reduced borrowing requirements
Yesterday, the US $44B 2-year T-Note auction went well, but not as well as last month when demand was overwhelming and bidding very aggressive. Indeed, the auction stopped at 0.802%, in line with the WI bid at the moment of the stop. The bid/cover of 3.16 was well above the 2.78 average, but down from last month’s 3.63. The Indirect bid dropped to $33.9B from last month’s record $40.5B. Indirect bidders took down 44.5% of the auction, matching last month’s result. So, still a very strong auction, but the absolute low level of yields still left some traces in slightly diminished demand and slightly less aggressive bidding. Today, the Treasury holds its $42B 5- year T-note auction, the second leg of its end-of-month $118B financing package that will be concluded tomorrow by a $32B 7-year T-Note auction. The size of the 5- year Note auction has been upped by $1B and is a record. It will raise all cash upon settlement next Monday. However, a $2.1B coupon interest payment is associated with the 5-year auction. Last month’s results were mixed with a stop above the WI bid at the stop, but overall demand was strong and Indirect takedown of 54.8% was well above the 30.7% average. The active 5-year is currently trading at 2.14%, the lowest level since May 2009 and more than 20 basis points above where it was trading immediately ahead of last month’s auction. This is a negative and while the results of the 2-year auction aren’t always a good precursor for the fate of the 5-year, we suspect that demand will be good, but the bidding may be less aggressive resulting in a stop above the WI bid.
Regarding bond trading today, bonds traded strong in the light of pronounced equity strength. However, Wall Streets’ optimism is not transmitted to Asia overnight and also the fall in commodities from intra-day highs during yesterday’s session put doubts whether the risk appetite trade will continue further out this week. The US Minutes might be a bond positive, but comes too late to affect European trading. Bonds started the European session on a strong footing this morning with the Bund slowly and gradually nearing the contract high at 123.04. The US eco data might be mixed, but given the positive bond mood, the market may react more to any weakness than to eventual strength in the eco data, as was also seen after the release of the Existing Home sales yesterday. The technical picture of the Bund remains bullish as the Bund is still above the uptrendline at 122.60 today and above 122.44, neckline double bottom. We started the week on a cautious note, not completely trusting the recent up-move and suspecting that the contract highs for the Bund (123.04) and the T-Note future (119-31+) would be difficult to break. Recent price action hasn’t certainly supported our view, even if no break of the highs occurred yet. So, we stick to it for now, but our conviction. Indeed, year-end liquidity motives that may be a bond supportive factor in the next weeks may have a bigger impact than thought.
