Markets: Fixed Income
On Monday, bonds lingered with a positive bias in a tight sideways range for the whole session. The closure of US markets and the absence of economic data or other events kept most investors sideways. At the close, the daily changes of German yields across the curve were at most 1 basis point.
Interesting, the Bundesbank said in its monthly report that the economic recovery is slowing as spending on cars and retail purchases tails off. The Bundesbank’s assessment, that growth continued, contrasts with the latest statistical annual growth forecast that suggests growth stalled in Q4. The IMF Europe chief said that the European economy still needed fiscal and monetary support, but added that the financial system supports can be removed in line with their built-in expiration dates. ECB’s Nowotny sounded more optimistic as he ruled out a double dip recession when stimulus from governments and ECB wears off.
On Greece, Nowotny said that the country, at a rather late stage, had taken the right steps to cut the deficit. He added though that other countries would not come to the rescue as the EU treaty has a strict non-bailout clause. However, these news items had little impact on trading. The euro group of Finance Ministers met also and debated on Greece. Chairman Juncker, confirmed as chairman of the euro group for the next two years, said that “ the Greek government will do what is necessary and we have to support them in their efforts because the program concerns Greece first and foremost, it is true, but it also concerns the whole euro zone.” Some other Ministers like Schaeuble (Germany) and Bos (Netherlands) made clear that it was up to Athens to sort out the problems, even if it could count on their backing. The Ministers wanted also more details about the Greece austerity package amongst others about the pension reforms and the measures for the public sector. Concluding, the pressure remains on Greece to solve its fiscal problems, but we think that in case of solvency risks there is still some room for the EMU to come to the rescue, probably in exchange of stringent conditions and close supervision from the EMU authorities. The meeting of the euro group came too late to influence the markets yesterday, but it probably won’t change sentiment yet. There is a kind of catharsis needed that drives Greece to the abyss or that convinces markets to cover shorts and drives the spread back down. Today, the Ecofin council of all Finance Ministers of the EU meets. The German-Greek spread at the 2-year maturity widened still 3 basis points while at the 10-year maturity the spread narrowed 5 basis points. Portugal, one of the other euro credits under market scrutiny, saw its spread widen an extra 2 basis points across the curve.
Today, the market calendar contains the German ZEW (January) and US NAHB housing market index (January). The German ZEW is forecasted to decline for the fourth consecutive month in January. The consensus is looking for a marginal decline from 50.4 to 50.0 as fears grew that growth might slow in the coming months. In January, the NAHB housing market index is expected to show a slight increase from 16 to 17 after an unexpected decline in December. Nevertheless, the index remains still rather close to its all-time low of 8 early last year. Beside the eco data, attention may go to the Irish bond auction and the Citigroup Q3 earnings results. BoE’s King speaks after closure.
In the EMU bond universe, the traditional flurry of new issuances started last week. The auctions/syndicated issuance went well supported by generous cash flows. Redemptions and coupons largely exceeded the amount of new issuance. This week, supply remains busy, but this time without support of redemptions/coupons. Indeed, supply amounts to €23B, while no redemptions and only a very small Italian coupon payment are scheduled. Today, Ireland will tap the market with 4- and 15- year auctions for an amount of €1-1.5B. Tomorrow, Germany taps its Schatz for €7B, while on Thursday Spain auctions a 20-year bond (€2B) and France issues a new 5- year BTAN and a new 10-year IL-bond together with 2- and 3-year issues for a combined amount of about €12B. So overall, supply is again heavily skewed to the longer side of the curve.
The US earnings season gets into full swing. Last week, the markets looked very critical to the first results. Alcoa’s earnings were indeed rather weak, but stellar Intel results and JPMorgan’s above consensus profits (albeit combined with weaker revenues) couldn’t muster enthusiasm either, leaving equities down on Friday and down on the week. Some profit taking on buy the rumour sell the fact is always a fact of life in markets, but it raises attention for the price action this week. Today, Citigroup announces its Q4 results.
ECB’s Bini Smaghi warned that the recession should not be considered as just a somewhat sharper cyclical slowdown. There has been a major structural shift and therefore the world economy will look very different once the crisis is over. This means there is more than usual uncertainty and also the use of eco models based on the pre-crisis situation that was not in equilibrium is not without risks. We seemed concerned that many are already behaving as if there would be a return to the past situation and not taking into account the structural shifts. He was concerned about bank lending hampering a recovery. The decline in lending until now was driven by weak demand for credit, but he feared that once demand comes back, bank credit supply restrictions may become more binding. Therefore he pleaded that banks would use the current favourable environment to raise their capital. He also warned against the illusion that monetary and fiscal policies will be able by themselves to restore eco activity to its pre-crisis level, precisely because the pre-crisis situation was not in equilibrium, excessive level of private debt. Structural reforms are needed. Concluding, Bini Smaghi sees the economy on a growth path, but with a lot of hurdles that will keep growth (too) low and many uncertainties. Interesting speech that broadly fits with the ECB position, as explained by Trichet at the ECB press conference.
Regarding trading, the situation isn’t very difficult from yesterday. Overnight Asian equities traded down, which might be reflected in a weaker European equity opening, but the Citigroup earnings may set the trend in the US market. The eco data, in particular the ZEW will receive some attention, but unless it deviates sharply from consensus, it shouldn’t have too much lasting impact. A downward surprise would nicely fit into the current sentiment. The short term outlook for bonds looks good. The recent eco data were weaker suggesting that the recovery may proceed at a slower pace. We are not sure about that, but adverse weather conditions in both the US and large parts of EMU may weigh on near term eco releases. The technical pictures improved too with Bund and US T-Note above the 122.34 and 117-00+ levels. This potentially opens the road towards the upper part of the existing trading range, at least for the longer end of the curve. So while current levels are not particularly enticing for new long positions, existing long positions should be maintained.
Should we approach again the upper boundaries of the range, profit taking on longs may be appropriate and new shorts may be established, as we only believe that the market is range-bound and further out yields should back up again on stronger eco data, the end of QE in the US and the absorption of liquidity in EMU. However, that episode could be still some distance away. At the shorter end of the curve, the situation is different as the rally has pushed yields already towards the lower end of the range. We advocated already profit taking on the 2-year Schatz on Friday, maybe a bit too early, but we would keep that advice. Similarly, in the money market, we might see the longer end backing up, steepening the money market curve.
In the UK, the calendar contains December CPI inflation. In December, CPI is expected to have risen from 1.9% Y/Y to 2.6% Y/Y, partially due to last year’s 0.4% M/M energy related decline, which falls out of the calculation. But also core CPI, excluding food and energy, is forecasted to show a significant increase (2.3% Y/Y to 1.9% Y/Y).
