Markets: Fixed Income
On Wednesday, global bonds had a fairly quiet, but nevertheless positive session, as investors continued to chew on the FOMC’s dovish decision on Tuesday eve. The big winner was equities that rose further, in the US confirming the technical break higher. Also global equities profited as investors were relieved that the liquidity spigot remains open and the Fed wants to give the recovery all chances to broaden and strengthen. In such a context, stabilizing US bonds is really a positive development. In the US, yields were narrowly mixed, as yields at the shorter end were up about 1 basis point while yields at the longer end dropped 1 to 2 basis points.
In EMU, German yield changes were more pronounced and lower, from about 4 basis points at the 2-to-5-year tenor to 3 at the 10-year and 1 at the 30-year maturity. However, one should take into account that the cash market had still to react on the FOMC decision. Price action in the Bund was interesting. In after-market trading following the FOMC meeting, the Bund traded around 123.20, above the cycle highs, but in the first hours of Wednesday trading, the Bund remained again below the cycle highs of 123.05, but later on, helped by a strong German Bund auction, the break did occur after all and the future closed at 123.16, in fact matching levels witnessed in the wake of the FOMC meeting.
Besides the strong Bund auction, concerns of the EU Commission about the budget plans of EU countries as the eco growth figures, underlying the plans, may be too high benefited safe haven German bonds. Whereas in the intra-EMU bond market, yield spreads with Germany initially narrowed, they later re-widened. The unexpectedly sharp decline in headline US PPI was largely ignored as it was energy driven and core PPI rose slightly, in line with expectations. In the end, the 10-year German- Greek yield spread stabilized at 299 basis points, the 2-year spread was marginally narrower. Elsewhere in the intra-EMU bond universe, yields spreads were generally wider in a daily perspective.
The political rift between Greece and German seems to have widened further and reaches dangerous levels. News agencies report that Merkel told parliament yesterday she wants a mechanism that could in the future exclude euro zone countries that repeatedly fail to abide by its standards. It follows a chilly column of Finance Minister Schaueble who wrote that the possibility of a country leaving the euro area, in case it couldn’t redress its fiscal situation, but staying in EU. Merkel’s words of course only give more weight to the “hard” position of Germany. PM Papandreou is still looking for an EU plan that would allow the country to finance its deficit at a more reasonable interest rate than currently available. However, overnight Dow Jones reported that a Greek official said the country would seek financial help from the IMF over the April 2-4 Easter weekend, as Athens holds out little hope for aid next week from the EU, as the EU summit on March 25 is probably the last occasion to agree a rescue operation. Papandreou still insisted on Wednesday that an EU solution was the best one. ECB’s Trichet yesterday and others before, ruled out an IMF intervention, other than technical, in the Greek case, as it would greatly diminish the credibility of the euro area. Of course, all these talk is part of the usual horse trading, but we fear that the risks of the process running out of hand are rising rapidly. The credibility of the EMU is already infected, but it might be hit a lot more if no solution is found in the next 10 days and Greece would go to the IMF. Indeed, it lays bare various views on how the euro area should be governed. It goes much deeper than the German-Greek rift. Other countries like France, Spain, Italy have also different views on budgetary policies and the role of the euro area than Germany. The critique of the French Finance Minister Lagrade on the German external surplus and the suggestion Germany should stimulate demand to allow the other EMU countries to redress their finances in a more growth-positive environment is but an example of the difference of opinion.
Today, the US eco calendar is well-filled with the CPI data (February), Philly Fed survey (March), weekly claims and leading indicators (February, while in the euro zone, only the January trade balance is scheduled for release. Several Fed Governors (Duke, Lacker and Pianalto) will speak at the American Bankers Association Government Relations Summit and France and Spain will tap the market today.
In February, US CPI inflation is forecasted to drop from 2.6% Y/Y to 2.3% Y/Y. On a monthly basis, consumer prices are expected have increased by 0.1% M/M, limited by a decline in energy prices. 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, but the consensus is looking for a 0.1% M/M increase in core CPI. Last month, the Philly Fed index rose slightly (17.6 from 15.2), but the details were even more encouraging. For March, the consensus is looking for an improvement to 18.0 and we believe that the risks might be on the upside of expectations as new orders rose last month to the highest level in five years. In the week ended March 13, US initial claims are forecasted to decline further. The consensus is looking for a drop from 462 000 to 455 000 and we have no reasons to distance ourselves from the consensus. Also continuing claims, which are reported with an extra week lag, are forecasted to have dropped (4 516 000 from 4 558 000) after an unexpected increase last week. In December, the euro zone seasonally adjusted trade surplus rose to its highest level since May 2004 as exports showed a sharper increase than imports. For January, a contraction in the surplus to 5.5B is expected.
Germany sold successfully €4.09 billion at its 3.25% Jan 2020 bund tap, attracting a strong 2 bid/cover. Today, the auctions of France and Spain should go well too. France comes 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. The Spanish auctions are the more interesting ones. Despite its budgetary problems, Spain recently attracted good demand for its 15-year bond. Spreads have come in though, making the auction another test case. However, there are only small risks for the auction as Ireland tapped the market earlier this week and attracted good demand.
Regarding Fed governors, we suspect them to keep close to the FOMC statement as is usual in the aftermath of the FOMC meetings. Yesterday, Dallas Fed Fisher kept to the script, saying that the commitment to an extended period of low interest rates is not yet in need of change. He said the Fed is aware of the risks and at some point language will change, but we are not at that point yet. He also showed respect for dissenter Hoenig’s view, but said the FOMC don’t want to tighten or give the impression we are going to tighten sooner than is required. Is there some agreement to change the language conditional on maybe the creation of sufficient jobs? We will look closely at governors Duke, Lacker and Pianalto who speak today. Will they have something to add? Bernanke yesterday defended the Fed’s role in supervision before Congress. Interstingly for markets was his observation that he expects that current Fannie and Freddie’s MBS are likely to retain US government backing, when Congress would create a new system for financing US homes.
Regarding trading, we were sceptical that bonds still had much upside, but were taken awry by the dovish FOMC decision. We acknowledge, as we did before, the fact that bonds showed strength and saw subsequently no reason to row against the tide, certainly not until a clear technical signal occurred, which didn’t occur. The Bund broke above resistance, which is a positive, but we need a similar break of the German 10-year yield below 3.09% (now 3.10%), level that acted as bottom of the 3.09-to-3.43% sideways trading range that holds already for months. The downside was in vain tested four times intensively. So, the technicals are bullish, but an important hurdle remains for the time being. However, we wouldn’t go against the trend and speculate the level will continue to hold. Indeed, fundamentally, the FOMC decision will resonate over the market for some time and inside EMU, it seems that the conflict surrounding Greece may mount again in the next few days giving further support for the safe haven Bunds. Equities did very well in the past month and the break to new cyclical highs in the S&P keeps the picture bullish, but after closing higher thirteen times in the last fourteen sessions, there is definitely scope for a correction, which is never bad for bonds. Concluding, we stand aside and look how bonds will cope with the 3.09% resistance level. However, no reasons to become negative, even if there looks to be little value in the German bond market.
In the UK, the eco calendar contains the public finance data, M4 money supply and the CBI industrial trends survey. Last month, the UK posted a record budget deficit for the month January. For February, public sector net borrowing is forecasted to increase from £4.3B to £14.0B. M4 money supply is forecasted to slow further from 4.9% Y/Y to 4.3% Y/Y.
