Markets: Fixed Income
On Wednesday, Global bonds ended the session lower and the curves steepened. In the US, Treasuries declined from start to finish. The eco data, the ADP employment and the Challenger layoffs were better than expected, suggesting that Friday’s payrolls may be stronger too. On top of that, the refunding announcement reminded markets that the longer end of the curve will be tapped, while also corporate supply (Kraft) weighed on the market. Equities closed with modest losses, but weren’t a main driver for US Treasuries. In a daily perspective, yields increased by 2.4 to 7.9 basis points.
In EMU, German bonds were under pressure too and climbed by 1 to 3.6 basis points, also steepening the curve. The intra-day moves were partially driven by developments in the peripherals. The Bund initially lost ground on the easing of tensions following the EU announcement of the Greek stability plan, but regained most of the losses when tensions re-intensified as Portugal came in the focus. Later on, after the official closure, renewed pressure in sympathy with US Treasuries pushed the Bund lower.
In the intra-EMU bond universe, there was initially some easing of tensions after the EU Commission reluctantly gave conditionally green light to the Greek stability/ austerity plan. However, the EU will be closely watching the implementation with monthly reviews initially (March 15) and said that supplementary measures (on wages and taxes) might be needed. The Greek 10-year yield spread initially dropped by about 30 basis points, but re-widened later on, to close only 4 basis points lower (349bps). The renewed intensification of tensions left Portugal as the main victim. Its 10-year yield spread to Germany widened 18 basis points to 149 basis points on a daily basis. The Portuguese debt agency sold only €300M out of an indicative €500M on offer for its Jan 2011 Treasury bill at an average yield of 1.379%, as it deemed the bid too expensive. There were bids totalling €1.195B. The market took it badly, which isn’t surprising in the current environment, but as such, one might say it is a good decision as it shows the debt agency isn’t ready to pay too much and thus not desperate for funds. Spain revised its fiscal deficits for 2010 to 2012 towards 9.8%, 7.5% and 5.3% respectively, which got a cold reaction, even if it didn’t really contain new info. Later on, Moody’s brought good news, saying that it wouldn’t place the Spanish rating under review. Spanish 10-year yield spread widened 3 basis points yesterday (89 bps) and Irish ones 2 basis points (162bps). The Italian spread narrowed 1 basis point. Overall, the situation on the intra-EMU markets remains volatile and peripherals stay under pressure, even if only the Portuguese spread really blew out, but the trigger for that could have been interpreted differently.
European
Today, the eco calendar contains the US and German factory orders and the US weekly claims. But markets will have more attention for the central bank meetings of the ECB and Bank of England.
In December, US factory orders are expected to increase for the fourth consecutive month. The consensus is looking for an increase by 0.5% M/M, but we believe that the risks might be on the downside of expectations after the weaker than expected durables and also non-durables might come out somewhat weaker due to the lower petroleum prices. In Germany, factory orders are forecasted to have risen by 0.2% M/M in December. In the week ended January 30, US initial claims are expected to drop by 15 000, to a total number of 455 000. In the previous two weeks, a backlog in processing claims rendered a bubble in claims in California, but this backlog might have largely been worked off. Continuing claims, which are reported with an extra week lag, are forecasted to decline from 4 602 000 to 4 581 000.
In the EMU area, Germany sold €4.822B of its 2.5% Feb2015 BOBL at an average yield of 2.31%. Demand was slightly disappointing at €6.635B (bid/cover 1.4) with the Bundesbank retaining 19.6% of the issuance (€1.178B) for its market regulating activity, which was above the previous amount retained. However, bidding was quite good (small tail), despite the expensiveness of the issue. Another reopening will take place on March 3. Today, France issues a new 10-year and taps its 6- and 25-year OAT’s (€8B), while Spain taps its 3-year bond (€3B). Especially the auction of Spain will get much attention, as the country raised its 2009 budget deficit yesterday and is under pressure on the market. However, as the Spain eyes the shorter end (3-year) damage may be limited.
The US Treasury published its quarterly refunding statement. The Treasury held the size of all three auctions unchanged versus the previous refunding operation, contrary to our expectation for an increase of the size in the 10- and 30-year sector. So, the Treasury auctions a $40B 3-year note, a $25B 10-year note and a $16B 30- year bond next week. It might be that the announcement of a bank to repay $7B TARP played a role in keeping the size unchanged. The auctions will raise about $32.6B in new cash, less than the $42.5B raised in the November refunding. The Treasury announced considering raising the frequency of its TIPS auctions, but left open the possibility to resume issuing SFP CMBS. The steepening of the curve recently, might partly be due to upcoming supply at the longer end, a phenomenon that was apparent before previous auctions that targeted the longer end.
Regarding the ECB, initially it was certainly Trichet’s aim to hold a low profile meeting in February, as he pointed to March as the next “rendezvous” on policy. In March, the new staff forecasts are available and new steps to end the liquidity measures would be under consideration. Markets will be interested in Trichet’s view on Greece, and may also scrutinize the comments of Trichet on marginally changes in the eco/inflation assessment.
Regarding trading today, Asian equities trade modestly lower overnight following Wall Street’s direction yesterday. However, Asian equity trading doesn’t contain information for equities in Europe and the US today. We expect EMU bond markets to trade quietly ahead of the ECB press conference, even if one cannot exclude wild moves in the edgy peripheral bonds. There is most likely no new info to expect from Trichet on monetary policy, but comments on fiscal policy might have impact on the bond market. All in all, we would nevertheless think that Trichet knows it is no time to add to volatility. So, if there would be special comments, which we doubt, they may be intended to calm down the tensions. We closely look to the December German orders, while the US initial claims may still entice investors to reposition ahead of the payrolls. However, by and large, the shadow of the payrolls will loom above the markets, keeping volumes low and price action limited. The Bund opened lower this morning, but only showing the after closure moves of yesterday eve. The technicals ask for some comments. The March US T-Note future fell below the bull flag bottom and the medium term moving average (but needs to be confirmed), which are negatives, but only a drop below 117-08 (Jan 28 low) would deteriorate the bullish picture. Similarly, the Bund yesterday showed some early signs that some correction (broken medium term moving average) might be forthcoming, but also here only a break below 122.81 (28 Jan low) would deteriorate the bullish picture.
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.
