Markets: Fixed income
On Wednesday, in another low volume summer trading session, global core bonds part ways, as German bonds ended the day with modest gains and US Treasuries closed mostly marginal lower. However, the price action didn’t contain much info for the broader picture. In other markets, the peripheral EMU bonds gained more ground (see below) on new Spanish austerity measures. The euro showed more volatility, but in the end was only slightly weaker. Similarly US equities traded intra-day weaker, but ended flat to modestly lower. So, this snapshot shows that the price action yesterday will be rapidly forgotten. In yield terms, US yields ended mixed with the 2- and 30-year yield marginally down and the yields at the belly marginally higher. In Germany, yields were down 1.8 to 2.5 bps, but the 10-year outperformed sending its yield 4.9 bps lower.
Intra-day, the Bund auction was well received, but had little overall impact. It helped the 10-year Bund outperformed on a daily basis though. The US 10-year Note auction was outstanding (see below), triggered a spike higher, but the move couldn’t be sustained. The FOMC Minutes were, we think, more dovish in nature. It temporarily pushed Treasuries down (as well as EUR/USD and equities), suggesting the market had expected still more dovish minutes, but the moves were undone by the end of the day. The US eco data were in line with expectations and thus ignored. The only noticeable price action in the Bund came in early afternoon and was technical in nature. The Bund broke through the recovery high which was tested already a few times in past sessions, attracting some technical-oriented buying. There was indeed no similar movement in other markets and no headline news message coincided with the jump higher, which was sustained further out.
On intra-EMU bond markets, Spanish/Italian spreads narrowed by respectively 18 and 9 bps. On all other non-PIG markets, spreads changes were limited to -2 bps to +1 bps. The Spanish government announced €65B worth of additional austerity measures (VAT rise, cuts to local governments, rolling back unemployment benefits,…) as part of a deal to secure European aid and extending its deficit target deadline by one year. PM Rajoy’s PP party has a large majority in parliament, which minimizes implementation risks. The declining spreads indicate markets attach credibility to the plans. However it is still early days as the potential negative impact on growth, can rapidly dampen investors’ enthusiasm.
According to a draft memorandum seen by the FT, another part of the bank recapitalization would be via fully writing off preferred shares and subordinated bonds for any lender accepting financial aid. Spanish banks have €67B of subordinated and hybrid debt, much of which was sold to retail investors. The agreement will be formalized at the July 20 Eurogroup meeting.
Today, the eco calendar remains thin. The release of the US initial claims and the import prices will get some attention and the claims may even affect intraday trading, while in EMU only the (outdated) industrial production figures for May are worth looking at (but is no market mover). The event calendar isn’t interesting either. Mr. Draghi speaks in Casablanca, not exactly a place you expect him to elaborate on new thoughts and Fed Williams already spoke (very dovish) some days ago. The ECB monthly report usually re-iterates the message Mr. Draghi brought to the markets at the ECB press conference following their monthly meeting. We nevertheless look what special items are treated in the bulletin. That leaves the 30-year US bond auction the main item for today, but it proceeds only after the European closure.
Import prices (Thursday) should have fallen sharply in June (consensus: -1.8% M/M, -1.5% Y/Y), following an already sharp decline in May. The main factor will be lower oil prices, but also food prices might have declined. Initial jobless claims (Thursday) are expected to have fallen by 4 000 to 370 000 in the first week of July. Early July, many carmakers close their plants for retooling. So the non seasonally adjusted number goes higher. However, this year less than usual plants will be closed, which might via the seasonal adjustment factor have a dampening effect on the published claims figure. Some offset may come from the storms that caused power stoppages in parts of the US and increased the number of initial claims in some States.
Yesterday, the German Finanzagentur tapped the 10-yr Bund (€5B 1.75% Jul2022) a final time. The auction met with good demand (total bids €6.39B; highest since last August) despite the record low yield (1.31%), reflecting investors’ fears about the future of the EMU. The Bundesbank set 16.94% of the issued amount aside for secondary market operations, the lowest this year.
In the US, the $21B 10-yr Note auction results were spectacular. The auction stopped massively through the 1:00 P.M. bid side (4.4 bps), with the second largest bid cover ratio on record (3.61 versus 3.09 average past year). The Direct bidder takedown was a record by far, helping to drive the auction. The indirect bid, reflecting foreign investor demand, was also very strong. As with the German Bund auction, the US Note auction was sold with a record low yield (1.459%). Today, the treasury concludes its mid-month refinancing operation with a $13B 30-yr bond auction. Currently, the WI is trading around 2.625%.
The stellar results of the 10-year Note auction and the ongoing operation twist suggest that the bond auction will go smoothly, but this isn’t also the case.
The FOMC minutes were dovish. It mentioned that “a few” members thought more stimulus would probably be needed to meet the mandate, while “several” thought more action would be appropriate under certain conditions. Three such conditions were put forward: if growth slowed, if risks to the growth outlook increased or if inflation were at risk of falling below target persistently. “A few members” worried that accommodation posed inflation risks. On the growth outlook, “most members” expected a slower rate of growth over coming quarters, while a few thought the slowdown was transitory. The risk list contained, fiscal policy, higher financial risk, the economic performance outside the US and slow household income. Overall though, the Minutes conveyed the message that the Fed is ready for more action if one of the three above mentioned conditions are materializing. Apparently, there was some initial disappointment, which we don’t understand fully. As the Fed didn’t start QE3 at the last meeting, one reasonably couldn’t expect a still more dovish statement. Otherwise they would have started QE-3 at that meeting. If data remain weak, especially if the July payrolls disappoint again, we think they’ll start QE-3.
Regarding trading, overnight Asian equities trade very mixed. Japanese, Korean and Indian equities showed heavy losses, but China is gaining. Overall though it seems that the Korean rate cut and weak Australian data are scaring investors about a sharper growth slowdown. That might mean that European equities start somewhat weaker too, but we wouldn’t put too much money on such expectation. The Bund opened nearly unchanged, showing also traders are cautious about the message from Asia. As stated above, the market calendar is unexciting. We retain from yesterday’s trading that US investors booked profits when the T-Note future spiked towards the 134-30+ contract high. The chart shows a near perfect doji (trend reversal signal) that need of course confirmation in today’s trading. This suggests that traders need a more powerful event/eco data to try to push the Note future above that hurdle. To complicate things, the Bund took out a (minor) resistance yesterday and might start to get attracted by the contract high (at 145.97). In this context, we retain our technical-inspired strategy: the picture is bullish for the Bund, but given recent strong gains (and the question mark for the T-Note future), we would only buy on dips, preferably closer to 142.26, while longs should consider at least partial profit taking closer to the contract high. For the T-Note future similarly with the contract high a place to take partial profit and levels around 133/132-18 entry levels.