Markets: Fixed income
On Tuesday, global core bonds for once had a distinct direction, as risk appetite linked to developments in the euro debt crisis dominated. Global core bonds were down, but first key support (140.71), while tested, didn’t give away. Overnight, the decision of Moody’s to keep the Spanish rating at Baa3 with negative outlook, but off CreditWatch, may affect core bonds negatively at today’s trading. Also in other markets the risk-on sentiment reigned, sending EUR/USD and equities higher. In a daily perspective, the US and German curves bear steepened with yield changes from 2.9 to 6.6 for the German Bunds and between 0.8 and 7.1 bps for the US yields. Eco data (see news section) had no noticeable, sustained impact.
Intraday, the Bund started the session somewhat lower. Website articles in the FT and WSJ signalling that Spain was moving closer to an official request for a precautionary rescue package were the “culprit”, but at first got only a modest positive reaction of investors. Investors clearly hesitated to give it a firmer thumbs up. So, the Bund stabilized for the remainder of the morning session, as did for instance equities. However, short after noon, news agencies reported that two senior members of chancellor Merkel party dropped their objections against a Spanish bailout request. Germany was seen as opposing such a request in past weeks. This time, there was no hesitation. The Bund spiked lower, equities rallied and so did peripheral bonds and the euro. The Bund tested first key support at 140.70, but it held which left the bund hovering just above that support for the remainder of the session. Similarly, also the Dec US Treasury Note future dropped towards first support, but without breaking it.
After trading, Moody’s surprisingly kept Spain’s rating unchanged.
On intra-EMU bond markets, Spanish bonds started strong on the back of the WSJ/FT articles (summary see below). However, the enthusiasm rapidly faded and some return action kicked in. When two German CDU members said an ESM credit line for Spain was possible, Spanish bonds again found support. At the end of the day, spread changes were all in all modest, ranging between -1 bps and -12 bps (Italy) for the 10-yr sector. Overnight, Moody’s removed the negative credit watch from the Spanish Baa3 rating (negative outlook), which it left unchanged one level above junk.
Moody’s said “the combination of euro area and ECB support and the Spanish government’s own efforts should allow the government to maintain capital market access at reasonable rates, providing it with the time it needs to stabilize public debt over the next few years.” The rating agency added that it thought Moody’s would ask for a credit line. The decision of Moody’s should be supportive for Spanish bonds (risk in general) today, as many expected a downgrade into junk territory. On the other hand, it might delay a Spanish bailout request as it might provide Spain with more breathing space on markets. However, this is an important factor of uncertainty which is removed. Next on the calendar are the region elections in Galicia and the Basque country (Oct21).
Whatever the outcome, we still expect a Spanish bailout request, rather sooner than later.
Yesterday, we commented on the articles in the WSJ and FT that quoted an unnamed official who said that Spain is moving towards a bailout. Today, we elaborate further on it. First of all, we continue to rate Spain’s turnaround on a bailout as a positive development that things are moving rapidly in the right direction. The fact that they would be willing to sign a Memorandum of Understanding is a major step forward. Even though, this MoU will likely consist of the measures already announced by Rajoy for the 2013 budget and for the restructuring of the economy (in line with EU recommendations). This is merely to avoid suffering a loss of face from his grassroots support. The articles specifically mentioned that there would be no additional reform measures.
Second, we take a look at the shape of the requested funds. The official said that Spain wants to secure “a credit line” with the ESM, which they would only use if necessary. The ESM has three types of credit lines available: PCCL, ECCL and ECCL+. Only the first one (PCCL; Precautionary conditioned credit line) can be drawn under a loan OR primary market purchases and thus fits with the Spanish desires (having a backstop, but not the loan). Another feature of a PCCL is that is based exclusively on pre-established conditions. In other words, they won’t fall under Troika reviews afterwards once they applied for a programme unless they effectively have to draw funds from the PCCL. The main purpose of the Spanish application would be to initiate ECB bond buying, but that’s where the shoe pinches. When the ECB announced the technical features of its OMT programme, it explicitly mentioned under the “conditionality” paragraph: “A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.”. The ECB thus only wants to commit when there is also conditionality afterwards (ECCL)., not only in advance (PCCL). We’d like to add that German CDU lawmakers Barthle and Meister yesterday said that a PCCL was possible for Spain (although downplayed afterwards). We clearly didn’t reach the end of this debate yet, but we stress once again that things seem to be moving in the direction of an aid request.
Third, the source indicated that the origin why a request is currently delayed, was opposition from other EMU countries. The article mentions the fallout on Italy. This seems to us a rather strange declaration as the establishment of the current firewall (ESM/ECB/EU policy), served to erase all contagion fears.
What is more likely, is that Germany is pushing for a delay so that it can bundle the solutions for Spain, Greece (and Cyprus?) and Chancellor Merkel only has to face the Bundestag once to get approval for all programmes.
After a well-filled eco calendar yesterday, the agenda is lighter today with only the US housing starts and building permits. The German government will release new macro-economic forecasts and the Bank of England will publish the minutes of its latest MPC meeting. Germany (Schatz) and Portugal (T-Bills) will tap the market. Earnings releases include ASML, BoA, PepsiCo and e-Bay.
Although month-on-month volatility in both housing starts and building permits is high, there is a clear uptrend visible in activity. For September, the consensus is looking for an increase in both housing starts and permits. After increasing by 2.3% M/M to 750 000, the consensus is looking for a further increase in housing starts by 2.7% M/M to 770 000. Due to the volatility, we believe that the risks are on the downside of expectations. Building permits on the contrary, are expected to increase to 810 000 in September, after falling slightly in August. For the permits, we are more positive this month and believe that the risks are on the upside of expectations. Multi-family construction has already recovered from its low in 2009, supported by rental activity. Recently however, there are positive signs from single-family construction as low supply combined with some pick-up demand is supporting the sector.
Yesterday, the EFSF issued a new 5-yr bond (€5.9B 1.125% Nov2017). The bond was priced to yield 23 bps over mid swap (67 bps over Bobl), tighter than the initial “MS +25 bps area” guidance. The bond met with good demand (books over €11B) as it offered a good yield pickup compared to the borrowing curve and to semi core paper (Belgium, France). On the other hand, one might raise doubt that they paid so dearly because of waning investor interest. The proceeds will be used for the programs in Greece, Ireland and Portugal. Today, the German Finanzagentur taps the on the run 2-yr Schatz (€5B 0% Sep2014). This year, Schatz auction were the only German auctions which drew more or less stable demand. The average total bid amounted €7.63B and the Bundesbank on average set aside 16.01% of the issued amount for secondary market operations. We expect a risk on climate today, which isn’t supportive for the auction, but overall we think it will pass without many problems.
Regarding trading, the calendar is quite empty today, which means that focus will be on the surprise Moody’s decision overnight (confirmation of the Spanish rating). This should prolong the risk-on climate that dominated also yesterday. The media told us that Obama came out top in the presidential debate overnight, which we think is also at the margin risk-on positive, even if the presidential course has certainly not been run yet. Of course, while the “Spanish” news has been bullish in the past 24 hours, the upcoming EU Summit is still an important source of uncertainty. The risk-on climate is reflected in downward pressure on the Bund in the opening and stronger Spanish bonds (and equities when they open). Technically, the Bund dropped this morning below the first interesting support level of 140.71. If this break would be confirmed in the close (which we expect), the risk is for the Bund to decline further eventually towards the lower boundaries of the still broad sideways range (see graph), with the EU Summit the next big hurdle.
The next major technical support stands at 138.82 (Sept low). The Schatz auction, despite the climate, should go okay.