Markets: Fixed Income
On Wednesday, global bonds fell off a cliff, as markets had to upgrade their expectations for the world economy or at least the US economy. Indeed, mar-kets were clearly positioning for the risk of a double dip, or at least upped the risks for such a scenario dramatically in August. The manufacturing surveys for August showed a moderation in the activity of this cyclical sector, but after the publication of the August surveys, there seems to be small risks on an outright relapse in recession. We would see the softening in the data more as part of a soft patch in which the economy is currently. Given the extreme posi-tioning in the global bond markets, a correction was long overdone and these manufacturing surveys were just the excuse investors needed to trim long po-sitions across the board. US and German yields registered nearly similar changes that were understandably much bigger at the longer than at the shorter end of the curve: about 3 bps higher at the 2-year sector, but 11 and 14 bps increases at the 10 and 30-year sectors, which steepened the curve.
Markets will now wait eagerly on the US payrolls to be published on Friday. A weak report is expected and based on some leading indicators like the initial claims & ADP that is the most likely outcome, even if the ISM employment sub-index rose to a high level, suggesting that at least manufacturing employment may have done well. We should be mindful that last Friday’s steep correction was completely reversed on Monday. So, cautiousness remains warranted, even if we feel more comfortable with our view that the August bull run has run its course. However, given the power of the run, the bond bulls may not yet be disarmed and weakness in the payrolls report might give them the renewed conviction to push bonds once more higher. However, we would consider this as opportunities to sell-into-strength, as investors who didn’t sell yesterday might look at an opportunity to do it into the next few rallies. We con-sider yesterday’s price action as part of a topping out pattern that has further to go.
In the intra-EMU bond market, the sharp correction in the German market lessened pressures on the other core and peripheral bonds resulting in a spread narrowing across the board. The sharpest decline in yield spreads was logically in the peripheral bond markets. The 10-year yield spread dropped by 14, 13, 9 and 6 bps in respectively Italy, Spain/Greece, Ireland and Portugal. Better growth pros-pects in the global economy would be highly favourable for these countries that face very austere fiscal policies in 2011 and beyond.
Today, the eco calendar contains the preliminary estimate of euro zone Q2 GDP, the euro zone PPI data, US weekly claims, factory orders and pending home sales. However, most attention will go out to the ECB meeting, while also the Swedish Riksbank will decide on rates. On the supply front, Spain, France and the UK will tap the bond market, while the US Treasury will announce the details of next week’s auctions.
In the euro zone, the preliminary figure of second quarter GDP is forecasted to confirm the first estimate, which showed GDP grew by 1.0% Q/Q. But more inter-esting will be the first release of the breakdown. In the US, attention will go out to the weekly claims, one day before the important payrolls report. After an (encouraging) downward surprise last week, initial claims are forecasted to have risen by 2 000 to a total number of 475 000 in the week ended August the 28th. Continuing claims, are expected to show a slight decline (by 6 000) in the week ended August the 21st. In July, Any surprise, especially should it be on the downside of expectations may af-fect the markets, one day before the payrolls (and even as the claims date from after the payrolls survey week). US factory orders are expected to show a slight rebound after falling significantly in the previous two month. Although an increase by 0.2% M/M is expected, the details might be weak as was also the case for the durables. We believe a downward surprise is not excluded after the disappointment in the du-rable goods orders. However, as the durables, the most cyclical part of the factory orders have already been published, its impact on the market should be limited. US pending home sales are expected to decline for the third consecutive month, al-though at a slow pace. The consensus is looking for a decline by 1.0% M/M, which confirms that housing market activity remains very sluggish after the government’s tax credit expired.
Regarding the ECB meeting, the markets expect that 2010 staff growth projections will be substantially revised higher, but more uncertainty reigns about the 2011 projection. The inflation forecasts should be little changed from June. The ECB will highly likely extent its Full allotment/Fixed rate liquidity tenders of all maturities (1 week, 1 & 3 months) into 2011. So, the ECB will postpone the exit of its emergency liquidity measures. We expect Trichet to face a number of questions on the Securities Markets Program. Overall though it is likely that Trichet will do little to unsettle markets. Paraphrasing from his speech at Jack-son Hole, we expect Trichet to sound humble, alert and ready for swift action as poli-cymakers face an environment of unprecedented uncertainty. We suspect markets have a similar view on the ECB decisions and Trichet’s comments. Of course, this also means that the risks might be one-sided. Indeed, Trichet might sound more optimistic on the economy and they may already take one more mice step in their exit policy. Following yesterday’s carnage in the bond market, this might lead to more bond sales. Investors might however in any case be cautious as tomorrow’s US payrolls report might view us another surprise.
Regarding markets, Asian equities initially reacted only lukewarm on the steep gains of the US equities yesterday, but they are gathering strength as the session advances. French and Spanish bond auctions will keep traders busy with especially the Spanish auction worth keeping a close eye on. Spanish bonds were on the de-fensive in recent weeks, but outperformed German yesterday. EMU eco data won’t stir the pot, but the ECB meeting is also a potential source of market movements. Above we explained that while the ECB might pass without too much fuss, the risks are one-sides in a bond unfriendly way (see higher). US eco data might affect the sentiment later on, but more in the sense that they may convince some traders to al-ter the positioning ahead of the key US payrolls release tomorrow. As we wrote higher, the bulls may not have disarmed and if data suit their case they may try to push Treasuries once more higher. However, we should still consider it as part of the topping out process.
The technical picture of the Bund shows some cracks, but hasn’t yet lost its bullish character. Following the correction, the uptrendline seems to have been lost, but the contract is now testing the neckline of a potential ST double top and the MTMA (133.25 & 133.29) A sustained drop below these would prolong the correction and confirm that the bull campaign is over, at least for the next weeks to months.
