Markets: Fixed Income
On Monday, US and German bond markets had a quiet trading session, as the calendar was nearly empty and traders and investors remained sidelined ahead of a number of events, like the EU summit, for which ECB president Trichet has been called back from Sidney. Yield changes in both the US and the German market were small and insignificant.
Bonds traded sideways but with a slight negative bias for most of the day, with US ones getting better support when US equities slid again lower late in the session. In the EMU area, German bonds got some support from rumours about a European bank lending freeze to Greek banks in the repo market. There was no evidence of the latter though, but it drove Greek yield spreads versus Germany again wider by about 12 basis points (to 362 bps) in thin trading though. The announcement that Greek civil service workers would join private workers in strike actions added to the deterioration in sentiment. In general, there happened little in the intra-EMU bond market, even if there was some intra-day volatility in the spreads. While Ireland saw its yield spread going up by 4 basis points, there was little change in Portuguese, Italian and Spanish 10-year yield spreads. In Spain, PM Zapatero said he was sticking with a plan to raise the retirement age despite threat of union protests. Pension reform is a very important item for the long term health of the economy and government finance.
Today, the eco calendar is thin as it only contains the US wholesale inventories (December) and ABC consumer confidence survey. On the supply front, the US Treasury will hold a 3-year note auction for an amount of $40.0B, while in the euro area, the Netherlands and Austria will tap the market and the UK DMO holds it Sep 2034 gilt auction.
Interestingly for EMU bond markets, ECB Trichet leaves a meeting of central bankers in Sidney early to attend the EU Council special summit meeting on Thursday that has been called to discuss the EU growth prospects and safeguard its social model in the longer term. However, speculation is rising that Trichet’s presence is a sign that more thorough measures (plan) will be taken to restore calmness in the intra-EMU bond market. We suspect that these rumours will support peripheral countries in the run-up to the summit.
Overnight, NY Fed Dudley pleaded for harmonization of banking regulation across the world to prevent regulatory arbitrage and a “race to the bottom”. On the US financial system, he said it was in much better shape than a year ago and that markets were open with the exception of some securitization markets. Smaller banks are likely to remain under pressure from loan losses for some time to come, which means credit availability to households and small businesses will still be curtailed, he concluded. Yesterday, St-Louis Fed Bullard spoke about monetary policy. He showed himself optimistic saying growth could be above 3% in H1 2010 and adding unemployment may have peaked. He emphasized his concerns about inflation as he said inflation expectations are at or above the Fed’s implicit target range. If the data come in as expected and the economy keeps improving, inflation expectations will continue to ratchet up, he said, unless the central bank sends some signals that it will keep inflation close to target. If inflation expectations began to look troubling, the Fed could discard its pledge to hold rates exceptionally low for an extended period of time, even if unemployment remained high. So, Bullard showed again sympathy with Kansas Fed Hoenig who dissented at the January FOMC meeting on that point. Bullard again showed his preference to sell some assets to normalize the bloated balance sheet and to create room of manoeuvre for the next downturn. He thought smaller scale sales might take place in H2 2010 in a gradual way and indicated this was being discussed currently. He prefers to sell assets ahead of raising rates and doesn’t believe that the end of the asset purchase program would lead to a substantial jump in mortgage rates.
Today, the Dutch Debt Agency taps the January 2015 DSL for an amount of 2-to-3 B euros, while Austria re-opens its 4.85% March 2026 RAGB and 3.9% July 2020 RAGB for a total of €1.65B. Both are strong credits that kept up very well with bellwether German Bunds. We don’t expect problems with the auctions. The cash flows surrounding this weeks auctions are unfriendly as no redemptions are scheduled, but that shouldn’t be a too high hurdle. Yesterday, Spain’s Treasury unveiled its 2010 issuance plans. It plans to issue €97B in gross long term debt issuance (net long term issuance of €61.6B) down from €115.1B in 2009. The Treasury considers reopening its Oct 2012 floater and issuing European-inflation linked issuance, besides additional foreign currency issuance.
The US Treasury will hold its $40B 3-year Note auction. The Treasury held the size of the auction unchanged versus the previous refunding operation. The 3-year is currently trading at 1.34% in the WI trading, well below levels that prevailed at the previous auction, which is a negative. However, risk aversion is a theme which probably more than offsets the negative impact of the current low yield level. In recent months, the 3-year auction attracted strong demand and this might also be the case today. On average the yield stopped 0.8 basis points below the bid in the WI and the bid/cover amounted to 2.72 on average in 2009, giving us some yardsticks to judge the success of today’s auction.
Regarding trading, the calendar shouldn’t give many clues for price action. The return of ECB president Trichet (see higher) and the better sentiment in Asian equity markets overnight are small negatives for the Bund trading, but inconclusive. Reiterating our weekly view, German yields fell lower last week and the curve steepened as risk aversion became the main theme. Other sovereigns saw their yield spread with Germany widen, with especially Portugal and to a lesser extent also Spain, Ireland and Italy hit. Uncertainty about the sustainability of the finances of a number of mostly Southern countries spooked investors. The green light of the EC for the Greek stability plan (that included some extra measures) wasn’t able to restore calm. On the contrary, some clumsy comments of the Greek FM drew the attention to the situation of some other countries shifting speculation towards these credits. The flight-toquality benefited German bonds mightily. The 2-year Bund yield dropped below 1% to the lowest level ever or at least in “modern times”. The 5- and 10-year yield at respectively 2.16% and 3.12% are still above historical lows, set in March 2009, but the situation looks a bit different too. In March 2009, depression looked to be the real risk. Currently, there is hope the situation is after all better now. So, we still think that the German bonds are too expensive, but in a short term perspective, it will be risk aversion that drives the action and other considerations are second tier. The technical picture of the Bund improved further by taking out the 124.06 high on the continuation charts. In yield terms, the 10-year is near tough support at 3.09%, which if broken would open the road for a return to the all time low at 2.849%. For the 5-year yield support stands at 2.146% and 2.03% (all time low)
In the UK, the eco calendar contains the December trade balance. In the December, the visible trade balance is forecasted to show a contraction in the deficit from £6784 to £6700. The UK government will action conventional Gilt (2.0B, 4.5%, Sep2034). Overnight, the RICS house price balance was reported up to 32% for January from 30% previously, beating expectations. Looking in a longer term perspective, the price index is stabilizing around 30%, after having recovered from recession deep levels of -94%, the trough in April 2008. However, real estate activity dropped sharply in January as snow and freezing temperatures hit. The BRC survey showed retail sales grew at the slowest annual pace in at least 15-years during January, similarly hit by harsh winter weather.
