Markets: Fixed Income
On Tuesday, global bonds thrived again well, but trading was more orderly than of late. There were noticeable differences between the EMU and the US though. The latter outperformed the former with yields in the US down 2 bps at the shorter end, but 6-7 bps further out, while German yields fell by about 1 bp across the curve.
In EMU, Bunds jumped higher at the onset of trading, with the Bund future testing the contract high, as Asian equities traded sharply down and European equities were expected to do the same. However, equities found their composure at the start of trading and the Bund retreated. The eco data, HICP, unemployment, were ignored. Following the correction, the Bund gradually moved higher again, but failed to re-test the highs and eased somewhat when equities showed some strength on the US data. All in all, it seems investors were in a wait-and-see attitude. Important US data and the presence of the all time low yields explained probably yesterday’s attitude.
In the US, Treasuries were still slightly more away from the recent highs, allowing the bullish sentiment to push bonds moderately higher throughout the session with a temporary correction when equities went up at the onset of trading. Later on, equities stabilized, which was enough for Treasuries to resume their up-move, without however reaching again the session highs, even not when equities fell back. The gains of the Treasuries occurred against the background of month-end extension buying. The eco data were mixed to slightly better than expectations. House prices were stronger, as was consumer confidence, while the Chicago PMI weakened sharply, but near expectations. The FOMC Minutes didn’t reveal much new info, as Bernanke’s speech on Friday had already elaborated on the decisions taken at the FOMC meeting of early August.
In the intra-EMU markets, there was some mild further spread widening versus Bunds across the board. Italian bonds continued to outperform, while also the Irish spread widening was somewhat more pronounced than some of the Irish peers. There remained talk about the losses in the Irish banking sector and its consequences for the Irish deficit and debt. Spanish bonds did quite well as they broadly stabilized versus German ones. The Spanish deficit figures showed good results for the first seven months of 2010, as the deficit shrunk substantially. Overall though there wasn’t a particular strong story behind the moves in the intra-EMU bond markets.
Today, the eco calendar is well-filled with the euro zone (final) manufacturing PMI, US manufacturing ISM and ADP employment report. Fed’s Duke and Evans speak at the Washington Summit and Fed’s Fisher speaks on the US economy in Houston.
According to the first estimate, euro zone manufacturing PMI surprised on the downside of expectations, falling from 56.7 to 55.0, while only a slight decline was expected. The final figure is expected to confirm this outcome. In the US, the manufacturing ISM is expected to decline for a fourth consecutive month in August. The consensus is looking for a drop from 55.5 to 52.8, which would be the lowest level in almost one year and provide further evidence that the US economy is cooling down. We have no reasons to distance ourselves from the consensus, which is in line with regional surveys. Markets will also look at the ADP employment report as it might give us an indication for the payrolls report on Friday. Nevertheless, the ADP report recently lost much of its correlation with the official BLS payrolls report. After a 42 000 increase in July, the consensus is looking for a rise by only 15 000 in ADP employment. We have no reasons to distance ourselves from the (weak) consensus after the elevated claims in the previous weeks.
The FOMC minutes showed that the debate focussed on the weakening economy and possible responses from the Fed. As Bernanke explained in length at the Jackson Hole conference, the Fed decided to re-invest the proceeds of the maturing Agency MBS paper into Treasuries to avoid an unintended and inappropriate tightening of policy in the face of a slowing economy. There were little surprises anymore. Fed governors are closely watching data, looking at the consequences of policy alternatives, avoiding unwarranted tightening and taking the view that the “extended period of very low levels of rates” phrase in the statement has indeed the meaning very long period. Just like Bernanke on Friday, the Minutes revealed that while governors see a slowing of growth, they expect the economic upturn to continue and most also see inflation stabilizing around current levels in coming quarters. Some members nevertheless judged that the risks on further near-term disinflation had increased somewhat. There was a thorough discussion on the reinvestment of maturing MBS paper into Treasuries. This was seen as more preferable than investing back in MBS, but reinvestment into MBS might become desirable if conditions were to change. Some governors were worried about the communication of the decision and also that it might complicate later on the exit policy.
The ECB sterilized €61 of liquidity linked to its purchases of bonds. 71 banks were on the bid side. The average rate was 0.33% and the marginal one 0.35%, which is in line with recent auctions. At its regular weekly tender, the ECB allotted €153.06B of liquidity to 111 banks, adding €2.7452B in 7-day liquidity. We don’t expect it to have a major impact on ST money market rates.
Regarding markets, the next few sessions might be decisive. August has been the best month for Bunds since the Lehman debacle and historical low yields have been reached. However, August is the holiday month and thus trading conditions are a bit special. Therefore, it is interesting to see whether investors after such a stellar performance want to take a somewhat more neutral position. Of course, some main eco releases, notably the US ISM and the payrolls, will play a crucial role in shaping sentiment. In August, disappointment over US growth and more in general fears about a more general pronounced slowing in world growth, some increased deflation fears and signals that central banks might open the spigot further and start more QE operations contributed to the breath-taking rally in bonds. Mid next week, it might be clearer whether bonds steam further ahead or whether consolidation/correction becomes the theme.
Given the recent strength and the levels attained, we have been cautious since early last week. Since, volatility has indeed increased, but as of yet no lasting correction. We won’t consider a change in view unless a clear break above the highs (134.77) has occurred. 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.
The Bund opened lower, as risk appetite returned to the Asian equity markets overnight. However, it will be the reaction after the US eco data that may be decisive.
In the UK, the eco calendar contains the manufacturing PMI. In August, the UK manufacturing PMI is forecasted to drop for the third consecutive month, but only slightly. The consensus is looking for a decline from 57.3 to 57.0, but after the weaker than expected euro zone figure, we believe a downward surprise is not excluded.
