Markets: Fixed Income
On Monday, global bonds reversed a large part of Friday’s substantial losses in a session that was devoid of important eco data or events. In a similar move, equities lost their substantial gains. Friday’s moves were triggered by Bernanke’s comments at the Jackson Hole conference, but contained also a large technical component. Indeed, global bonds had rallied for a whole month, making them ripe for a correction, whereas oversold equities were an item too. Friday’s movements cleared the overbought/oversold conditions allowing the reigning sentiment to impose itself again. Both US and German bond yields are now again near their lows. In the US, yields declined by 5.5 to 11.5 bps, the short end lagging the belly and long end of the curve. In Germany, yields at the wings dropped by 3 bps, while the belly saw its yields fall by 6.5 to 7 bps.
At the margin, the eco data were even bond unfriendly. EMU confidence data were a tad stronger than expected and up for the fourth consecutive month, while US PCE (consumer expenditure) for July showed that consumption made a solid start in Q3. However, we admit that they aren’t market movers, as they are not very timely. Month-end extension buying was a minor positive for bonds, as were a modest amount of bond purchases (TIPS in the 2017-2029 sector).
In the intra-EMU markets, things calmed down with Irish and Portuguese bond yield spreads versus Germany little changed, but now Italy and Spain ceded some ground with their yield spreads versus Germany up by 7, 8 bps at the 10-year sector and slightly less at the 2-year. We have no immediate good explanation for the underperformance. Mounting political tensions, but more likely supply may have played a role. The BTP auction went reasonably well (see below) but price concession might have been needed. Spain’s inflation was in line with expectations, but the Treasury announced it will sell between €3 and 4B in 5-year bonds on Thursday. Please note that the UK market holiday thinned trading which is already shallow on Mondays in the summer.
Today, the eco calendar is well-filled with US conference board’s consumer confidence, the Chicago PMI, S&P Case Shiller home prices, the first estimate of euro zone CPI inflation and the unemployment rate. Besides the eco data, attention will also go out to the Minutes of the latest FOMC meeting. As Bernanke though spoke in length on the Fed policy, we suspect that the Minutes won’t reveal many surprises anymore. We might get more details on the discussions surrounding the decision to re-invest maturing Agency MBS paper in the Fed’s portfolio in longer-dated Treasuries.
After two consecutive declines, Conference Board’s consumer confidence is expected to show a slight uptick in August (50.9 from 50.4), which would be in line with the recent developments in the ABC and Michigan consumer confidence indicators. Nevertheless, consumer sentiment remains very fragile due to high unemployment, low wages and the weak economic outlook. In August, the Chicago PMI is expected to fall back to 57.0 after an improvement in July. We have no reasons to distance ourselves from the consensus, but are aware that the Chicago PMI may sometimes show very large monthly changes. So, a 57 reading would still keep it at better levels than most other regional surveys suggest. S&P Case Shiller house price rises are forecasted to slow from 4.61% Y/Y to 3.60% Y/Y in June. House prices are important for the eco outlook and given the steep decline in house sales after the end of the tax incentives, question is whether house prices will start declining again. After a significant increase in July, euro zone CPI inflation is forecasted drop back in August. The consensus is looking for a decline from 1.7% Y/Y to 1.6% Y/Y, but after the German inflation data last Friday, a downward surprise is not excluded, which might spark increase doubts about the low level of inflation. The unemployment rate is forecasted to stay unchanged at 10.0%, for the fifth consecutive month.
The ECB bought only €142M of bonds in the past week, following purchases worth €338M in the week before. This compares to purchases of at least €4B/week in the first two months of its Securities Markets Program. Various ECB members including Trichet suggested some time ago that their program had largely run its course, but no formal end has been agreed to or announced. However, in recent weeks, Portuguese and Irish bond markets were again under sharp pressure, as yield spreads widening to historical very high levels and trading conditions deteriorated. Apparently, the ECB, which was subject of harsh critique on its Securities Program, feels it is inappropriate to up its presence or at least it feels so until now. The issue may eventually be debated at Thursday’s regular meeting and the press will certainly question Trichet on the subject. As before, the ECB will sterilize the total amount of the bond purchases (€60.5B) via a reverse auction.
Italy’s debt sale drew good demand, as it sold €10.3B of BTP and CCT paper, near the top end of the targeted range. Especially the new 10-year BTP3.75% Mar 2021 went well of which it sold €5B for a bid/cover of 1.34 at an average yield of 3.81%. It sold also €2.861B of its 2% June 2013 BTP (bid/cover 1.45) at an average yield of 2.07% and €2.464B of its 2015 CCT (floaters) at an average yield of 1.74%
Regarding bond markets, investors took Friday’s correction as a good opportunity to buy again bonds. Interestingly, the charts shows how big moves were both on Friday and Monday. This is remarkable, especially for Monday as the price action occurred despite some breaking news. We even didn’t detect minor news of some importance (except the month-end extension buying). However, it didn’t come as a total surprise either. We still think that after the breath-taking bull-run of the past few weeks and the increased volatility since a number of sessions (see graph) the market may be in a topping out phase in which a re-test of the highs is quite often a part of the scenario.
when the summer holidays end (US Labour day holiday on Monday) whether our feeling is correct. Of course, a confirmed break above the highs would negate the hypothesis of a topping out. The eco data and more particular the reaction on them will be decisive in the judgement. In such a context, we prefer a sell-on-upticks tactics for shorter term players, while longer term players may prefer to wait for a clear technical signal that the uptrend is broken.
Asian stocks are mostly losing more ground during the session overnight and also US equity futures are down. This should lead to a weak opening of EMU equities and more Bund strength. A retest of the contract high in the Bund is occurring. The US eco data are interesting and might influence sentiment, but the key data are only tomorrow (ISM) and Friday (Payrolls). For the US equities the 1030-10 level in the S&P is crucial and a break is probably needed to push bonds sustainably above previous highs.
In the UK, the mortgage approvals and consumer credit data are on the agenda. Last month, UK banks approved fewer mortgages than forecasted due to tight lending conditions and weak housing demand. For August, a further decline to 46.5K is expected.
