Markets: Fixed Income
On Friday, global bonds finished mixed with the curve flatter.
Following an uneventful European morning session, bonds came under pressure in the run-up of the publication of the US retail sales. The latter were unexpectedly strong, but equities that stood at key technical resistance levels, couldn’t take these out. This also prevented the US and German government bonds to break sustainable through key support. So, shorts were covered and prices started to rise, a movement that got more momentum after Michigan consumer confidence came out below expectations. However, we wouldn’t draw too much conclusions from this report. The bond and equity moves were technically inspired. The strength of the US bond auctions until Friday convinced markets that a flattening was appropriate. The longer end had underperformed the shorter end in the run up to the auctions.
Previewing the week, it might turn out to be an interesting one. In the US, attention focuses on the FOMC meeting, with various signals that the Fed may change the forward looking guidance on rates. In EMU, the Greek drama once more remains on the forefront. Indeed, the EU/IMF will publish on Tuesday their report on the Greek implement of its austerity package and with the euro group (today) and Ecofin (tomorrow) meeting taking place, markets are again looking for a more concrete support package for Greece. Indeed the country did its homework (that it now should implement scrupulously), but still has to pay a very high spread to get its bonds issued. In April/May, Greece has a heavy calendar of redemptions that needs to be re-financed and without help from other countries, which looks an insurmountable and overly costly task. Rumours suggested that guarantees and purchases by other E(M)U states and semi-national lenders like KfW and CADES would play a role. Besides Germany and France, it seems that other countries, that aren’t themselves plagued by deficit/debt problems, would have to do their part, based on the share they hold in the ECB capital. However, we have seen these rumours come and go a few times without concrete initiatives following. Will it be different this time around? At least not, if comments from Ms. Lagarde and Mr. Schaeuble over the weekend are reliable. Both said there was no reason to make any decision on financial aid for Greece. Lagarde said there was no request from Greece and secondly because Greek fiscal outlook is regarded as less threatening. However, at the same time, it seems that technocrats are working on a mechanism to act in case financing problems would threaten the EMU default of countries. Both finance Ministers agreed though that the IMF should not be part of the solution.
The FOMC will convene on Tuesday for their 6-weekly meeting on monetary policy. In January, the FOMC statement didn’t contain too many surprises. The Fed upgraded its eco outlook and unwound its emergency policy measures further, but confirmed its intention to keep rates very low for an extended period of time. The dissent of Kansas Fed Hoenig certainly was a surprise. The statement said: “Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.” The Minutes of the January FOMC specified that Hoenig was looking for more policy flexibility by not retaining the extended period of time language and suggesting the phrase that rates would be low for some time. Another regional FOMC voter, St-Louis Fed Bullard later on showed sympathy for the view of Hoenig and while less clearly also Lockhart and Evans seem to favour a change in the wording to give the Fed more flexibility going forward. Against these voices, most other governors seemed still comfortable by keeping this language in the statement. So, the debate on the language of the forward-looking rate guidance will be central at the FOMC meeting. We think there is a real chance that it will be changed or at least to appease hawks and doves a compromise is found to change it at the April 27-28 meeting. The January FOMC Minutes showed large divergences on the issue of potential asset sales. Most participants judged a future program of gradual asset sales could be helpful in shrinking the size of the balance sheet and interestingly, several thought it important to begin the program in the near future and shrink the balance more quickly than could be achieved by solely redeeming maturing securities. No decisions were taken though. In the mean time, officials of the influential NY Fed suggested that the Fed shouldn’t actively sell the assets it purchased as an emergency support measure during the crisis. Maturing assets wouldn’t be replaced, shrinking the pool of assets gradually. We think that the Washington-based Board is of the same opinion, contrary to a number of regional Fed presidents who want to start selling assets quite fast. We think that the NY Fed opinion will prevail. Selling assets might unsettle the mortgage market that is still very weak. The question of selling assets is not a theoretical one. Indeed, if the Fed doesn’t sell assets, it will have to conduct its policy via its rates (FF, interest paid on excess reserves). If it does sell, the tightening will happen via the longer end of the curve, allowing the Fed to keep official rates very low for longer. The Fed asset purchase programme nears completion (end of March) and given the uncertainty surrounding it, we don’t expect the Fed to add to the uncertainty by introducing the perspective of asset sales.
Concluding, a change in the wording of the FOMC statement might be a further step in the normalization of policy. It gives the Fed more flexibility and keeps the outlook on rate hikes in H2 alive, on condition that the economy improves further and the recovery becomes broad-based and self-supportive.
Besides the FOMC and “Greek” events, the eco calendar in the US contains a few interesting releases, but the EMU one is fairly light with only the ZEW economic sentiment (Tuesday) and the final CPI report (Tuesday) worth mentioning. In US, the NY Fed and the Philly Fed surveys on manufacturing (today/Thursday), industrial production (today), housing starts & permits (Tuesday) and the inflation data (PPI &CPI, Wednesday/Thursday) will give us a more complete picture on the economic developments during February. Contrary to expectations, the winter storms seems to have had less of an impact than expected, with payrolls doing not too bad and the retail sales being very strong. However, the housing market may have been hit sharply, while the regional manufacturing surveys should give us a clue to whether the weather has caused some damage. On inflation, in January core CPI dropped on a monthly basis, the first drop since 1983 and thus another downward surprise (consensus: 0.1% M/M) wouldn’t go unnoticed and may raise fears of deflationary risks.
Regarding supply, there are no auctions in the US, but several ones in EMU. Total issuance amounts to about €21B this week, while no redemptions and coupon payments to the tune of €2.3B are scheduled, making the cash flows surrounding the issuance negative to the turn of about €18.5B. On Tuesday, Ireland will tap 6 and 10- year bonds (€1.5B), while Germany taps its 10-year Bund (€5B) on Wednesday. On Thursday, France and Spain will come to the market; France with 2-, 4-, and 5-year BTAN auctions and with 10-and 30-year IL-OAT (€9.8B); Spain taps its 10-and 30- year bonds. So, supply will be heavily skewed to the longer end of the curve, with only France tapping the belly of the curve. This development was already apparent during the whole first quarter.
Countries are eager to increase the average duration of their debt, after circumstances forced them to issue especially shorter-dated debt last year. Current difficulties on the intra-EMU bond market (Greece) have shown the roll-over-risk is certainly a factor that debt agencies should take fully into account. In this respect, the UK now profits from its very long average duration that allows them (with the help of the BoE) to get their enormous financing needs through the market, even if it is only at a price of higher spreads versus Germany and other countries.
Regarding markets, risk appetite has in recent weeks made a comeback, reflected in equities near cycle highs and bond spreads near the lows of the year. The yen weakened, but so did the dollar to some extent. The global data flow has been encouraging and while the Greek situation isn’t solved, at least tensions abated somewhat. Rating action in emerging markets was positive with upward revisions in Indonesia and Ukraine. However, at the same time US and especially German bond yields barely rose. This sets the stage for a possible interesting week. Will the market continue to trade on the reflationary theme and thus equities move to new cycle highs or will hesitation creep into the minds? In the former case, bonds should be under pressure, while in the latter they may stay strong. After having pondered the various factors in play this week, we keep our bearish view on the government bonds. A surprise package for Greece would be negative for safe-haven Germany, while the FOMC might change its wording in a sense that reminds markets that the days of absolutely low rates are counted. Supply is a modestly negative factor for European government bonds, while the data is a question mark, given the snowstorms that may have affected some data. However, our bearish view for the week is conditional as no major technical signals appeared. The Bund tested the downside on Friday, but managed to recoup the losses later on. First support level stands at 122.20 (neckline double bottom) but a sustained drop below the uptrendline at 121.92 today would be a clearer signal. Therefore, our advice is to take profit on rallies, preferable near the contract high of 123.05.
In the UK, the eco calendar remains empty today.
