Markets: Fixed Income
On Monday, in a session devoid of eco releases, markets continued to be driven by developments surrounding the euro debt crisis. So, equities traded sharply lower at Europe’s open, as concerns about potential Greece default hit the banking sector. Especially French banks were in the focus as a (negative) rating action of Moody’s looms. However, there was very little new info, which stabilized equities. The Bund mirrored developments in equity markets and profited from widening spreads with non-core bonds (see lower), but after a strong opening, the Bund traded sideways. Global bonds lost some of their shine later on in the US session, first on some likely prepositioning on the US 3-year Note auction, that passed without fuss (see lower) and in late session by a short covering spurt in equities attributed to some reports that Italy was in talks with China on the possibility of an investment in the country and its bonds. We wouldn’t draw too many conclusions from the market moves. Two technicals elements probably played a role too. The US T-Note future set a new high intra-day, but couldn’t sustain, which might have convinced some short term players to cut longs, while the curve movement (a bear flattening in the US, a flattening in Germany) suggests that some investors are betting the FOMC might decide next week to implement an operation twist (extending the maturity of their portfolio). In a daily perspective, US yields were up between 0.4 bps and 6.1 bps, the curve bear flattening with the 5-year underperforming. German yields dropped 3 and 6 basis points in the 10-to-30-year sector, but were up 4.4 to 1.4 bps in the 2-to-5-year sector. Also here there were new historical low yields in most maturities.
Yesterday, EMU yield spreads versus Germany all widened. The Greek spreads added an astonishing 1253 bps at the 2-year tenor and 302 bps at the 10-year tenor on all sorts of Greek default talk. Italian, Spanish and Portuguese 10-year spreads widened 20 bps, the Belgian spread 10 bps. In the core countries, France underperformed, widening 7 bps on increased fears of a rating downgrade for French banks due to the high exposure on Greece. French banks (BNP, Soc Gen and Credit Agricole) are on creditwatch negative since June 14 at Moody’s and CWN is normally solved within a 3-month timeframe. Yesterday evening, the FT ran an article that Italy turned to China for help in the debt crisis. FM Tremonti welcomed a Chinese delegation recently and head of treasury Grilli visited Chinese investors in Beijing in the hope the Chinese will make significant purchases of Italian bonds and investments in strategic companies. Equity markets and the euro reacted positive when the article was published but we are very sceptical. In a recent past, we’ve seen similar desperate hopes from Portugal and Greece and we all now how that ended.
Today, the eco calendar remains thin with only the US NFIB Small Business indicator, the UK CPI inflation data and trade balance for release. Holland, Italy and the US will tap the market and the ECB announces allotment in its 7-day and 1-month tender, that will mark the beginning of a new reserve period.
In August, US NFIB small business optimism is forecast to drop from 89.9 to 88.4, which will be the sixth consecutive decline. We believe however that the consensus is still too optimistic and see the risks on the downside of expectations as also most other business confidence indicators weakened significantly in August. In the UK, CPI inflation is forecasted to pick up again after two consecutive declines. The headline figure is expected to increase from 4.4% Y/Y to 4.5% Y/Y, but we believe that an upward surprise is still not excluded. Core CPI, on the contrary, is expected to drop from 3.1% Y/Y to 3.0% Y/Y.
Today, the Dutch treasury taps the on the run 10-year DSL (€2-3B 3.25% Jul2021). The German/Dutch spread is the lowest in the EMU spectre and the AAA-rated bonds should enjoy support from this quality status in the current turmoil. The Italian debt agency issues a new 5-year BTP (€3-4B 4.75% Sep2016) and taps the three off the run BTP’s for a combined €2-3B (4.25% Aug2018, 4.25% Feb2020 and 4.00% Sep2020). Two weeks ago, Italy sold €7.75B in the first auctions after the ECB interventions, but that auction was rather poor and ECB support before and after the auctions was needed to prevent Italian yields from further increasing. Yesterday’s T-bill auction didn’t bode well neither. The yield on 12-month bills hit a threeyear high at yesterday’s auction (above 4%) pointing to increased stress. Today, the offered amount (€5B-€7B) is relatively low with the bulk to be allotted to the new 5- year BTP. As a fortnight ago we fear the Italian bonds will meet with little demand, despite this weeks €44.32B EMU bonds redeeming and the so-called Chinese demand (see above). The ECB will probably need to stand ready to intervene.
Yesterday, the US treasury’s $32.0B 3-year note auction was dull. The auction stopped through the 1:00 P.M. bid side, but the bid cover was a shade below average and the buy side takedown was close to average. Today, the Treasury will hold a $21.0 billion reopening of the 2.375% 10-year note. The auction will raise all new cash. Last month's original issue 10-year note auction went especially well. The auction stopped 3.9 basis points below the 1:00 P.M. bid side with a strong bid/cover. Currently the WI is trading around 1.955%.
The ECB bought €14B bonds during the most recent 7-day period in the framework of its controversial SMP programme, slightly up from the €13.3B it bought in the previous period, but well above the €6B it bought in the week before. The ECB now bought in total €143B, almost half of it in the last 5 weeks when it started to buy Italian and Spanish bonds. The latter remain under pressure, forcing the ECB to keep up the strong pace of purchases. The SMP programme is heavily contested in especially Germany, as the resignation of ECB Stark on Friday illustrated. If market tensions don’t abate soon, the ECB will have a considerable amount of bonds on its books, upping the anger in Germany. So, the question is whether the ECB will become a more reluctant buyer in the next weeks, to sooth fears in Germany or whether it will decide it has no other choice than showing markets it is firmly standing behind the objectives of the SMP. Once the EFSF is operational, it should be the latter that intervenes on the markets, but that will still take a precious amount of time during which the national parliamentary votes might still lead to surprises.
Regarding trading, event news may still be the most important impetus for (bond) markets today. The Italian bond auction is of course a key feature today, but the Dutch parliamentary vote on EFSF/ESM might also give us some news headlines. Chancellor Merkel tries to ease fears about a default of Greece and also some voices from the IMF suggest that the next tranche of support will be released by the end of September. The Bund opened lower this morning, reacting on the rise in US equities. Asian equities trade more mixed, but following the advances of recent days, we think that profit taking in the Bund shouldn’t surprise on signs of an eventual easing in tension. The market is indeed overextended. However, as evidenced for some time, it is impossible to build a ST strategy on the ebb and flow of risk aversion. The underlying situation in the debt crisis remains precarious and no fundamental solution lurks around the corner. In that environment, Bunds might continue to do well. In case of substantial corrections, one could still consider to add to long positions.