Markets: Fixed Income
On Tuesday, Global bonds ended the session narrowly mixed with US yields down about 1 basis point across the curve and the German yields up less than one 1 basis points. It was a rather dull session devoid of major data releases or key events. Many traders and investors are waiting on the central bank meetings and the US payrolls. The reflationary trade continued with strong performances of equities (on good corporate results) and commodities that were hit hard in January and now try to fight back. It is still unclear whether these rebounds are due to the oversold character of the market or whether the underlying sentiment has improved due to a more optimistic assessment of the eco outlook. We are a bit surprised that global bonds barely react to the rally in the riskier assets. Does that mean the bond market has another idea about the eco outlook or that indeed the rally in equities and commodities is expected to go nowhere.
Intra-day, the Bund started little changed, but went thereafter for a (small) trip downward. Equities rebounded after an initial dip, slightly pushing the Bund to intraday lows at 123.18, where some bottom fisher appeared pushing the Bund higher ahead of the US session. EMU eco data, including German retail sales, had no impact. A re-widening of peripheral spreads might have been a small positive for German bonds, as was the strong Dutch new 10-year bond auction that attracted a lot of demand. US Treasuries started to rise late in the European morning session to reach Monday’s closing levels early in the US. Also here, no impact from the eco data (pending home sales, weekly retail sales). US Treasuries managed to make some further gains, but stronger equities kept the advance in check.
In the intra-EMU bond universe, there was some re-widening of the spreads of peripheral countries. The Greek FM warned that Spain and Portugal were experiencing similar problems as Greece in an attempt to take some of the pressure away from the country. That shouldn’t get much applause from these countries but may be a sign that Greece is still fighting to get a more generous treatment from the EU and is concerned that the EU may ask for more stringent austerity measures. The Dutch PM entered the debate by putting pressure on Greece to get its house in order, but also by suggestion that contagion is a real risk. “If Greece doesn’t solve their problems, the market will, and already is, focus on the next weak link. That’s Portugal, Ireland’s next and then Spain. And then you’ll get a domino effect.” Today’s EU assessment report on the Greek stability plan will be eagerly scrutinized. The Greek 10- year yield spread widened 10 basis points to 353 basis points, while the Portuguese spread widened 9 basis points to 129 basis points. Other spreads were less affected. The Spanish 10-year spread went out 2 bps, the Italian one stabilized and the Irish spread even narrowed marginally.
The eco calendar heats up today with the US ADP employment report (January), US non-manufacturing ISM (January), euro zone retail sales (December) and final figure of services PMI (January). Besides the eco data, markets will look out for the EU budget assessment on Greece and a 5-year BOBL bond auction in Germany.
In December, the ADP payrolls and the official payrolls showed a near identical result, what hasn’t been the case for long. The ADP report showed a decline in employment by 84 000, near the payrolls outcome (-85 000). In January, the ADP report is forecasted to show a drop in employment by 30 000, while the payrolls are expected to come out at +10 000. The January report will include the annual benchmark revisions and the sharp drops in the first few months of 2009 might have created distortions in the seasonal adjustment factors. However, the rise in the ISM employment sub-index to 53.3 and the rise in consumer sentiment suggest that there are risks on the upside of expectations. In January, the non-manufacturing ISM is expected to show a slight increase from 50.1 to 51.0. We believe however that the risks are on the upside of expectations after the significant improvement in the manufacturing ISM, even if we have to admit that the service sector until now doesn’t show a similar dynamic than the manufacturing sector. In the euro zone, retail sales are expected to have risen by 0.4% M/M in December, after falling by a record 1.2% M/M in November. We have no reasons to distance ourselves from the consensus as earlier released national (German, French) data showed a slight rebound in December sales. The final figure of euro zone services PMI is expected to confirm the first estimate, which showed a drop from 53.6 to 52.3. After the upward revision in manufacturing PMI, we believe that a higher outcome is not excluded.
In the EMU area, the new Dutch 3.5% 10-year DSL (July 2020) got a good reception with €7.76B of bids. The State Agency raised a more than expected €6.42B. The issue was priced 33 basis points above Bund 4% Jan 2020, at the high side of the price guidance at 31 to 34 basis points, suggesting that to get the strong demand some modest price concession was needed. Today, Germany taps its 5-year OBL (Febr.2015, coupon 2.5%) (€6B). We’ll German bonds are often thinly bid, the previous auction went well and given the tensions inside intra-EMU bond market, we might see good, if not exceptional demand as German 5-year bonds are expensive.
The US Treasury will publish its quarterly refunding statement on Wednesday. There probably will be no changes to the calendar this time around, but the size of the 10- and 30-year auction may again be upped from the $25B and $16B at the previous refunding auctions, while the size of the 3-year auction may be unchanged at $40B. This would be in line with the Treasury’s aim to lengthen the average maturity of its debt (target 60 months, now 55 months). The announcement on quarterly borrowing estimates on Monday suggested that the Treasury may resurrect the Supplementary Financing Program.
ECB Weber said yesterday that central banks could be forced into raising interest rates if high budget deficits push up inflation expectations. At the same time, he thought that the German recovery would only take off in 2011 and growth in 2010 would only be contained. Weber showed also a “certain” concern on the recent decline in private lending, even if he didn’t see signs of a credit crunch. Weber wouldn’t make comments on monetary policy ahead of the ECB meeting. Overall, we still see a very cautious Weber on the eco outlook, but who also is concerned about the fiscal deficits. So, while recently he sometimes came out a bit hawkish, we don’t see him pushing hard for an acceleration of the pace at which the exit policy is implemented. Fed governor Warsh warned yesterday that financial reform efforts that focus narrowly on expanding regulation could stifle the economy. He described attempts to strengthen the system as worthwhile, but suggested time should be better spent focussing on the role of Fannie and Freddie. He added that in the global economy, big banks are not bad.
Regarding trading today, Asian equities are trading strongly, putting currently bonds under some downward pressure. However, we have had that situation before, only to see bonds recouped these (modest) losses later in the session. The US eco data have the potential to affect markets, if they are stronger-than-expected. It would confirm the risky markets in their belief that the recovery is becoming broader-based stateside. It would also raise expectations for Friday’s payrolls and incite some bond investors to trim long positions and take a more neutral posture going into the payrolls. The EU assessment of the Greek deficit cutting plan might be a key event. We still belief that ultimately the EU will come up with more outspoken support, but there seems to be a game of hardball between Greece and the EU ongoing that is dangerous. However, in a day-to-day perspective, we don’t risk to make forecasts on the evolution of the spread.
Our weekly view remains unchanged. The Bund approached the contract high at 123.76 and the question is whether it may move through the 123.76/124.06 support area. In yield terms, the 10-year (3.19%) is still about 9 basis points from 9 month lows. The yield was only slightly lower in the midst of the financial crisis. Similarly, the 5-year yield (2.27%) is near key support (2.25%) and has only briefly traded below these levels since March 2009, notably at 2.15%. The 2-year yield is even near the all-time lows. Given these metrics and given that the economic outlook is better and the ECB is taking steps to end the emergency liquidity support that should in H2 push the eonia (currently 0.33%) back above the refi-rate (currently 1%) we don’t favour bonds at current prices. The momentum is positive and should equities correct again and/or tensions inside the intra-EMU bond markets continue, German yields may still go lower. However, this isn’t enough of a reason to go long German bonds. We continue to advice selling German bonds, certainly in case the above mentioned key levels would be broken. More speculative account may even consider shorting German bonds, even if yesterday’s price action doesn’t show even the start of a change in sentiment. Tensions in the intra-EMU market may, at least temporarily, ease further as we expect they can’t stay at the current levels without some intervention of EU authorities (in the case of Greece). Overall, these factors are light to forecast a turnaround in the German bond market, but the bonds are so expensive, we cannot but advice contemplating trimming long positions.
In the UK, the calendar contains January services PMI, besides the Gilt Auction. In January, services PMI is expected to show a marginal decline from 56.8 to 56.5. Although the index is already at high levels, we don’t exclude an upward surprise after the sharp increase in UK manufacturing PMI. The Bund-Gilt spread didn’t change much in a daily perspective. Gilts profited of a good reception of the £3.75B 5.25% 2012 Gilt auction.
