Markets: Fixed Income
On Friday, global bonds had a fairly quiet end-of-week session in the absence of eco data or other important events. The curves in both the US and Germany flattened in a bearish to mixed way. It seems that in the US, markets prepared for the upcoming Treasury auctions and consequently the shorter end cheapened, while the longer end (10-to-30-year) limited the losses (10-year) or ended even a tad higher. In the EMU area, German bonds held a tight range with the 2-year yield up 1 basis point and the 10-30-year yields down 1.8 basis points. The German-Greek spread widened by 10 (10-year: 323bps) to 25 basis points (2-year) driving the credit curve again more inverse, as near term events like the EU Summit on Thursday, the Greek threat to ask intervention of the IMF and the Greek need to look for about €20B of fresh cash in the next two months corroborate. The widening was due to Thursday eve’s developments in the positions of Germany (IMF might be the solution) and Greece (we need support to get yields down or we go to the IMF). The other high beta peripherals, Portugal, Ireland, Spain and Italy saw their 10-year yield spread widen by 2 to 4 basis points. Equity markets were moderately hit by profit taking following a long-lasting bull run in the past three weeks. The impact on bonds was only temporary.
Regarding the news flow on Greece, there wasn’t too much news, but certainly also nothing that could ease the tensions at the start of an important week for Greece. We retain that German chancellor Merkel downplayed the importance for Greece of the EU summit, while Italian PM Berlusconi said he is absolutely in favour of EU aid to Greece. Merkel repeated Athens to solve its debt problems alone. A FT poll showed that a third of the Germans think Greece should be asked to leave the euro and 40% believe Germany would be better off outside the euro area.
Today, the eco calendar is thin as it only contains European Commission’s consumer confidence. In March, EC consumer confidence is forecasted to stay unchanged at -17 after a slight deterioration in February. We keep a close eye on a number of speeches of Atlanta Fed Lockhart and ECB Gonzalez Paramo, both after the European closure though. ECB president Trichet speaks at a parliamentary panel.
Later this week, the EMU PMI’s, German IFO and M3 data are scheduled for release in the euro zone. After an upward surprise in February, euro zone manufacturing PMI is forecasted to show a marginal decline (from 54.2 to 54.0) in March. Services PMI, on the contrary, is expected to show a slight increase (52.0 from 51.8) in March, after declining last month. In Germany, the IFO business climate indicator unexpectedly dropped last month, but for March, a slight uptick is expected. For the business climate indicators, we have no reasons to distance ourselves from the consensus as we believe they will continue to point to moderate growth. Last month, euro zone M3 money supply rose again after two months of contraction. For February however, M3 is expected to turn negative again (-0.1% Y/Y). Recently, the lending data showed some encouraging developments as loans to households grew, easing fears of a credit crunch. Lending to businesses, on the contrary, is forecasted to fall deeper into negative territory, but the ECB believes this is rather a demand issue. Lending to business lags the business cycle by about three quarters. Lending to households in contrast usually bottoms at the same time as the economy and its improvement in the previous months is encouraging.
In the US, the new and existing home sales, final Q4 GDP, durables and Richmond Fed survey are on the agenda this week. In January, both new and existing home sales dropped sharply which was probably due to the bad weather and expiry of the first homebuyer tax credit measures. For February, the consensus is looking for a slight increase new home sales, while existing home sales are forecasted to show a small decline. It will be interesting to see whether the expanded and extended tax credit (which lasts until April) is already boosting sales, but weather conditions remained unfavourable in February, which might have dragged sales down. US durable goods orders rose sharply in January due to a 126% M/M increase in nondefense aircraft. For February, a more moderate (0.5% M/M) increase is expected, which might be partially due to the snowstorms. More interest will be the development of the series outside the volatile defence and aircraft sectors. WE hope to see some rebound in these measures as it would suggest that investment in software and equipment remains on track following unexpectedly strong Q1 growth. The Richmond Fed survey is forecasted to show an expansion in activity, for the second consecutive month. The headline index is expected to increase from 2 to 5 and we believe that the risks might be on the upside after the NY and Philly Fed indices showed robust growing activity. The final figure of Q4 GDP is expected to confirm the previous estimate of 5.9% Q/Q (annualised) and initial claims are forecasted extend their modest downward trend.
Fed policymakers will probably restart to talk about the economy and policy as the informal black period surrounding the FOMC meeting ends. The international research forum on monetary policy on Friday/Saturday is co-sponsored by Fed and ECB and will attract a lot of attention. Tomorrow, Fed governors Plosser (Philladelphia) and Yellen (San Francisco), both non-voters in the FOMC this year, will speak. Yellen is rumoured to be candidate Fed vice chairman. This would give her more influence and a permanent vote at FOMC meetings. Yellen is without doubt the most dovish Fed governor, currently in the FOMC. On Wednesday, governors Hoenig (Kansas) and outgoing vice chairman Kohn speak. Hoenig dissented at the last FOMC meeting and will probably defend his dissent. However, his positions are already well known and therefore probably unable to move the markets. Fed vice chairman Kohn is often important for markets, but as outgoing governor markets may lose rapidly interest in his comments. Governor Pianalto (Cleveland) speaks on Thursday. She has a vote at FOMC meetings this year. Pianalto stands at the centre to dovish ledger of the FOMC. Chairman Bernanke will testify before the House financial services Committee on “unwinding emergency Federal Reserve Liquidity programs and Implications for Economic Recovery”. This testimony was originally planned on February 10 but was delayed because of the snow storms. The text has been released at that time. We hope that Bernanke will add more meat to the sequence of the exit strategy, as the Fed should have made progress in the 6 weeks since the original testimony was cancelled.
On Friday, Fed governors Warsh and Tarullo and Bullard (St-Louis) will take the floor. We are interested in Bullard’s comments, as before the March FOMC meeting, his comments suggested he supported the dissent of Hoenig, but finally he voted with the majority. What has brought him to do that? We hope he will explain his vote. Overall, this week’s speeches may help us follow the debate that is ongoing in the FOMC about the exit policy.
The ECB speeches should be less interesting as the decisions on the exit strategy have been made public at the March meeting and little new info has arrived since. However, Greece might still be object of declarations, also of ECB governors, even if these should keep a lower profile in the issue, now that a rift between fiscal authorities has come to the surface. Nevertheless, the speeches of board members Gonzalez- Paramo (today), Bini Smaghi (Wednesday ) and Stark (Wednesday) might be worth following. ECB Trichet speaks a few times. We expect him to repeat that the exit of emergency liquidity measures will continue, with the objective to gradually make the banks reliable on markets instead of ECB liquidity. Trichet will also repeat that the fiscal consolidation is of upmost importance. The EU Summit of Head of States on Thursday/Friday will get a lot of attention. Greece will be at the core of discussions, even if it is not clear at all whether it will make it in the final conclusions. German Chancellor Merkel deflated expectations (see higher).
The Treasury $118B end-month financing package includes a $44B 2-year Note, a $42B 5-year Note and a $32B 7-year Note auction to be conducted from Tuesday to Thursday and settled Wednesday March 31. The auction sizes are record ones, but unchanged since November. The 2-year will raise about $16B in new cash, while the 5- and 7-year auctions will raise all new cash. Last month, the 2 and 7-year Note auctions went very well, while the 5-year didn’t go that well, as the bid was sloppy, but demand still fairly healthy. The unusually large and aggressive demand by Direct bidders were a defining feature of recent auctions. It isn’t always easy to interpret the auction results, but it seems that the strong results are due to abating risk aversion and extreme low short rates which forces investors to go out the curve. The steady sharp decline of money market fund investments may be pointing in that direction. There is little reason to expect this week’s auctions to fail. Often the tenors at issue cheapen ahead of the auction, only to become again more expensive afterwards. This might have been at play on Friday.
In EMU, the government supply calendar is very light and issuance is nearly balanced with redemptions/interest payments. Today, Slovakia holds its zero coupon SLOVGB212 auction, while the Netherlands will tap its off-the-runs 3.75% July 2014 DSL and its 4.5% July 2017 DSL for an amount of maximum €2B. Past Dutch auctions went well and we have no reasons to expect a different outcome this time around. There is still a pipeline of possible syndicated issuance including Greece, a new 30-year Dutch DSL, a new Finnish 5-year and an Irish 30-year bond, but these probably won’t be launched this week.
Regarding trading, last week moves were rather limited. In the US, curve positioning was the main item. The long end profited from the strong auctions of the previous week and maybe low inflation data, while the short end lost ground on rumours about a discount rate hike and maybe anticipation on this week’s auctions at the shorter end of the curve. The recent slightly increase in the shortest money market rates will get a lot of attention too. All in all though in a somewhat longer perspective, the technical pictures are still moderately bullish. Only a drop of the June Note future below 116-08+ (March 12 low) would be a cause of concern even if a break below the uptrendline (at 116-31+ currently) would be a disappointment. We see no compelling reasons to expect a sharp directional move this week. In the EMU, German bonds have been very strong, helped by growth disappointments, low inflation and risk aversion linked to the Greek issue. As the global recovery proceeds and get stronger, ultimately bonds should be under downward pressures, even if slow growing EMU. However, the time is not ripe yet, as central banks haven’t yet given the sign that excess liquidity will be absorbed. However, that will be an item for the summer months. In this respect, we think that while German bonds offer little value, it is too early to expect a sell-off. Indeed, currently it is even strong resistance that is under test. (The Bund moved to a new contract high, but after the break no acceleration occurred, suggesting some hesitation.
Also the fact that the 3.09% yield for the 10-year cash is still unbroken might have played a role. Concluding, we stand aside and look how bonds will cope with the 3.09% resistance level. However, we have no reasons to become negative, even if there looks to be little value in the German bond market. The issue of the Greek story may hold the key for the next move.
In the UK, the calendar remains empty today.
