Markets: Fixed income
On Thursday, global core bond trading was dominated by the ECB meeting and a profit taking move at the end of the US session, that was mostly technical in nature. As the ECB meeting didn’t bring any fireworks (as expected), German bonds ended virtually unchanged, even if there was intra-day volatility. In late US trading, US investors started to take profits in a move that would last until the close. The Minutes couldn’t turn the selling tide. There might have been some pre-positioning on today’s payrolls release. Equities were stronger and the dollar under pressure, but it was disappointing that US Treasuries didn’t break through resistance which kept the market at bay thid week. In a daily perspective, German bonds were virtually unchanged, while the US curve shifted higher and steepened (yield changes between 1.2 and 7.1 bps.
Intraday, the Bund opened little changed and traded sideways in the morning as a shy attempt to rally faltered at first resistance (near term high 141.95).
Nervousness ahead of the ECB pushed the Bund lower. At the start of the press conference, the Bund jumped higher, only to fall back somewhat lower and setting an intra-day low during further comments of Draghi. However return action higher had started before the end of the press conference; It erased all intra-day losses. US eco data had no noticeable impact: claims were near expectations, factory orders were marginal better than expected. After European closure, US Treasuries came under pressure (albeit once more in thin trading conditions) for technical reasons in a context of positioning ahead of the payrolls release. The Minutes of the FOMC were interesting (more on it in the Weekly Pulse), but were, we think, no driver behind the selling.
The ECB meeting didn’t bring fireworks, even if it was as usual interesting. For a full review, see our flash report . Summarizing, there were no new policy signals from the ECB, Interest rates were not discussed at the meeting, suggesting that the ECB is satisfied by the current stance and only material weaker activity may force rate cut. There was no significant new info on the bond buying scheme, but there are indications that the OMTs may be less widely and less forcefully used that markets seem to expect.
The two final sentences of the introductory statement highlight the role the ECB sees being played by the new OMTs; 'Our decisions as regards Outright Monetary Transactions (OMTs) have helped to alleviate such tensions over the past few weeks, thereby reducing concerns about the materialisation of destructive scenarios. It is now essential that governments continue to implement the necessary steps to reduce both fiscal and structural imbalances and proceed with financial sector restructuring measures.'
These two sentences seem to capture the essence of ECB thinking at present.
The ECB see that (i) tensions have eased, (ii) extreme tail risks appear to have reduced significantly and, given this breathing space, (iii) it is now up to Eurozone governments to take the necessary measures to address the many current shortcomings of the Euro area. To reassure markets further the press statement went on to say ‘The Governing Council remains firmly committed to preserving the singleness of its monetary policy and to ensuring the proper transmission of the policy stance to the real economy throughout the euro area.’ and added that, ‘We are ready to undertake OMTs, once all the prerequisites are in place.’ Though these comments may appear very strong, they are notably more limited than Mr Draghi’s previous assertion that the ECB would do ‘whatever it takes’. Instead the OMTs might be seen as an insurance policy against the possibility of extreme and awful outcomes in the months ahead: ‘OMTs will enable us to provide, under appropriate conditions, a fully effective backstop to avoid destructive scenarios with potentially sever challenges for price stability in the euro area.’
On intra-EMU bond markets, Spanish and Italian bonds underperformed and their spreads widened 9 bps. Portuguese bonds kept outperforming after Wednesday’s successful return to the bond market. A Spanish bond auction (see below) went well but didn’t provoke reaction on secondary markets.
Spanish Central Bank governor Luis Maria Linde cast doubt on the government’s 2013 budget and deficit cutting plans , saying they were based on too optimistic growth forecasts. He pointed out that independent forecasts projected a 1.5% economic contraction, compared with the government’s forecast of only -0.5% GDP growth. This has been the general critic after the 2013 budget was released. After market closure, Spanish FM de Guindos said Spain doesn’t need a bailout. Moreover, he described the ECB’s plan to buy bonds of nations that agree to a rescue program a proposal tied to conditions that “aren’t very far from the situation we have now in Spain”. In a more or less similar vein: ECB president Draghi sounded very positive towards Spain at yesterday’s press conference. An indication that the conditionality hurdle towards ECB buying will be low? Tonight, Spanish PM Rajoy, Italian PM Monti and French President Hollande meet on the sidelines of a Mediterranean Summit. The future path of Spain will likely be part of the agenda, as well as aligning views ahead of the upcoming official meetings.
At yesterday’s press conference following the ECB meeting, president Draghi confirmed that OMT purchases would not be undertaken until full market access has been completed. This remains a negative for Portugal and Ireland, though it didn’t reflect in spread widening yesterday. If the intention of the OMTs is to reduce market fragmentation, it seems to make little sense for the ECB to only contemplate bond purchases when market rates for a country’s bonds have fallen to levels that make possible its return to market funding.
More generally, it seems unusual to hold out OMTs as a support mechanism designed to encourage countries such as Spain to seek formal EU/IMF assistance when current programme countries can only access such support when exiting their programmes.
Reuters published an article saying that the euro zone is considering aiding Spain by using the “insurance-option” of the ESM, ie that the ESM would guarantee the first 20-30% of each new bond issued by Spain. It would be the first time this is used, but we think the ESM will rather use another option if Spain formally asked for a bailout, namely buying Spanish bonds in the primary market. The insurance scheme can become an optional feature to the bailout.
Today, all eyes will be on the US payrolls report. Besides the payrolls, also the German factory orders are on the agenda and Italian PM Monti, Spanish PM Rajoy and French President Hollande will meet after the European close.
Last month, the US payrolls report brought a major disappointment. After an unexpectedly strong report for July, the August report came out significantly weaker than expected. Non-farm payrolls rose only by 96 000, while an increase by 130 000 was forecast and also the previous two figures were significantly downwardly revised. Weakness was broad-based and also the temporary help payrolls dropped. For September, the consensus is looking for a slightly stronger outcome. Non-farm payrolls are expected to have risen by 115 000, which is broadly the average of the previous two months (141 000 in July and 96 000 in August). Last year, the September payrolls marked the start of a series of strong payrolls reports. As some believe that this was due to distortions in the seasonals, which boosted payrolls at the end of 2011 and early 2012 and depressed the payrolls in the second quarter, there might be risk for an upward surprise. Nevertheless, based on the fundamentals, we see little reasons for an upward surprise. Temporary help payrolls disappointed last month and also manufacturing activity probably remained sluggish. An increase is expected in educational payrolls, but will probably be insufficient to really boost the headline figure. This week’s data surprised on the upside of expectations. Both the manufacturing ISM and non-manufacturing one surprised on the upside, but the labour market indices showed a mixed picture. Finally, also the ADP report surprised on the upside, but we are cautious to draw strong conclusions from it as the correlation between the ADP and BLS report was weak of late.
Yesterday, Spain and France supplied the EMU bond market. The Spanish treasury tapped the off the run 5-yr Bono (€1.28B 3.3% Oct2014), the on the run 3-yr Bono (€2B 3.75% Oct2015) and the off the run 15-yr Obligacion (€1.71B 5.5% Jul2017) for a total amount of €3.99B, ie the upper end of the intended €3-4B range. The total amount on offer was relatively large and the auctions had strong bid covers, two good signs. Spanish bonds didn’t underperform after the auction results. So far, Spain completed 87% of this year’s expected issuance. The French debt agency tapped the off the run 10-yr OAT (€1.38B 4.25% Oct2018), the on the run 30-yr OAT (€1.79BB 4.25% Apr2041) and launched a new 10-yr OAT (€4.81B 2.25% Oct2022) for a combined amount of €7.91B, near the maximum of the €7-8B range. The French auctions went fine as usual. So far, France completed 92% of this year’s issuance programme, thereby leading the EMU bunch.
Regarding trading today, attention will go to the US payrolls release.
Market expectations are modest and our in-house economic analyst sees some downside risks. Our rule of thumb is that the deviation from consensus should be about 50 000 to get a technically significant move, which would mean gains of either less than 65 000 or more than 165 000.
The unemployment rate has gained importance since the FOMC promoted it to the main objective (for now). The market sees an increase to 8.2% from 8.1%. Should the payrolls be strong but the unemployment rate rises, or vice versa, market reaction should be affected. Following yesterday’s strong move of equities and the profit taking in Treasuries, we think the market is more prone to take the figures on the positive side than on the negative side. This suggests that bonds are more likely to drop than to rise, unless of course the report would be very bad. However also in this case, it remains to be seen whether the resistance level (133-26+) that held this week will be broken.
For the Bund, the impact of the payrolls reaction will be determined by potential events in the euro crisis. In case of a sell-off of US Treasuries, the reaction of the Bund may be more muted as investors will be cautious ahead of the meeting of the President of France and the Spanish and Italian PM’s and Monday’s euro group. Of course in case Treasuries break above key resistance, the Bund should rally too. However key resistance at 142.62 might act as a stop.
