Markets: Fixed income
On Monday, global core bonds eked out further gains. Due to hurricane Sandy and an early close of the US bond markets, volumes were even thinner than usual at the start of the week which might have caused exaggerated moves. Cross-market, day-to-day differences were proportionally the biggest on bond markets. European equities closed nearly unchanged, whereas the losses in EUR/USD were fairly limited. On a daily basis, the German yield curve bull flattened with yield 2.1 bps (2-yr) to 8.2 bps (30-yr) lower. Changes in the US were modest and ranged between -0.8 bps (2-yr) and -2.7 bps (10-yr).
Intraday, the German Bund found support from the start of trading. Over the weekend, the Greek debt debate remained in deadlock and the early Monday data release, weak Spanish retail sales, added to the positive sentiment for Bunds. From then on, the Bund marched higher and approached a key resistance level (141.95) going into the close. In the US, also for the Dec Note Future the only way was up until the early close. Eco data, personal income and spending, had no impact on markets.
On intra-EMU bond markets, spreads widened in the risk averse climate.
Italian bonds underperformed (10-yr spread 19 bps higher). Three factors were at play. First of all, weekend headlines by former Italian PM Berlusconi, who said his People of Liberty party is considering withdrawing support for the Monti government. Second, the “Five Star Movement” party, a protest party led by comedian, Beppe Grillo won Sicily’s regional elections. With about 15%, it’s the single biggest party on the island. In the direct vote for the governor, a centre-left candidate won. The regional elections in Sicily are seen as a bellwether for the upcoming national elections (Spring next year), and signal that the Italian people are tired with Italian politics and the government’s austerity. The low turnout at the ballot (47% compared with 67% in 2008) is another sign of discontent. This makes it harder to extrapolate the election result to a national level. Nevertheless, a negative political development. A third and final factor, which had a minor influence was last-minute positioning ahead of today’s auction. In the semi-core spectre, Belgian bonds outperformed French and Austrian bonds following a strong Belgian auction (see below).
Greek politicians remain in deadlock over the labour reform measures demanded by the Troika. Head of the Eurogroup, Juncker, said that a “physical” meeting will probably be held on November 8 to discuss Greece, following Wednesday’s scheduled Eurogroup by teleconference, and ahead of a regularly scheduled November 12 meeting. Decisions are only expected at that final meeting. In Spain, the government announced the details of the bad bank (SAREB). SAREB was set up as a condition for the bailout of the Spanish banking sector. Operations are set to begin Dec 01. SAREB will likely buy around €60B of toxic assets using Spanish resources and some of the funds allocated under the bailout agreement. It will apply an average discount of 45.6% on loans and 63.1% on foreclosed assets. These large discounts are used as SAREB hopes to lure investors to become shareholders in the bad bank. Today, all eyes in Spain will be on the Q3 GDP data. Markets expected a 0.4% Q/Q GDP decline.
Today, the eco calendar heats up with the European Commission confidence indicators, Belgian and Spanish CPI, the Spanish Q3 GDP data, German unemployment figures, US Conference Board’s consumer confidence and US S&P CS home prices. Italy will tap the market, ECB’s Draghi is scheduled to speak and Merkel hosts, IMF, OECD, WTO and Word Bank chiefs in Berlin. In the US, equity markets will be closed a second day running and after yesterday’s early close, the US bond market will also close today. The SIFMA also recommended full closes of $-denominated government securities in Tokyo and London.
In the euro zone, the European Commission confidence indicators are forecast to extend their downtrend in October. For an eighth consecutive month, economic confidence is forecast to have worsened during the month. The consensus is looking for a decline from 85.0 to 84.4 due to a weakening in both the services and industrial sector. Consumer confidence, on the contrary, improved marginally in October. We believe however that the risks are on the downside of expectations, especially after the deterioration in both the PMI’s and German IFO’s. In Spain, GDP is forecast to have contracted by 0.4% Q/Q in the July-September period, the same pace of contraction as in Q2. While exports probably continued to support growth, weakness was most likely domestically based. We have no reasons to distance ourselves from the consensus, as the Bank of Spain already reported that it expected growth to have contracted by 0.4% Q/Q. In Germany, unemployment is forecast to have increased further at the start of the fourth quarter. The consensus is looking for an increase by 10 000, broadly the average of Q3, we believe that the risks are for a bigger jump as activity probably slowed further at the start of Q4. Turning to the US, the Conference Board’s consumer confidence index is forecast to jump to the highest level since early 2008. The consensus is looking for an increase from 70.3 to 73.0 after already a sharp increase in September. Also the U. Of Michigan consumer confidence indicator jumped sharply higher in October, together with the weekly Bloomberg indicator. The sharp drop in the unemployment rate should have supported Conference Board’s consumer confidence, which is traditionally more responsive to labour market developments. Therefore, we believe that the risks are for a stronger outcome.
Yesterday, the Belgian treasury tapped the on the run 5-yr OLO 63 (€0.87B 3.5% Jun2017), the on the run 10-yr OLO 65 (€1.26B 4.25% Sep2022), the on the run 20-yr OLO 66 (€0.67B 4% Mar2032) and the off the run 30-yr OLO 44 (€0.78B 5% Mar2035) for a combined €3.58B, slightly exceeding the maximum of the intended range. The overall bid cover was 1.86 and especially 10-yr OLO 65 drew very strong demand (2.24 bid cover). Selling the most of the bonds at the longer end of the curve is also positive as it helps lengthening the average maturity of Belgian debt. On secondary bond market, Belgian bonds outperformed their peers, another sign of the strong auction. The Belgian treasury paid a record low yield, but despite the lofty levels these bonds trade at, there was still strong demand because of the yield pick up over other (semi-)core debt. Belgium now completed 98% of this year’s issuance target. That target was earlier this year increased from €31.5B to €38.25B to prefund for next year. The Belgian treasury has one big OLO auction scheduled remaining (Nov 26), which we think it will use to further prefund for next year.
Today, the Italian debt agency issues a new 5-yr BTP (€3-4B 3.5% Nov2017) and taps the on the run 10-yr BTP (€2-3B 5.5% Nov2022). The 10-yr BTP cheapened around 30 bps in ASW terms since last Wednesday, more than the surrounding bonds. Relatively to the curve, the bond trades cheap. As it is our view that Spanish PM Rajoy will ask for an official bailout, which will initiate ECB bond buying, we think Italian bonds can rally further, resulting in declining ASW spreads. Therefore, we believe the auction will go well.
Yesterday’s developments in Europe show unease on different fronts. At the top level, policy makers and Greek politicians can’t come to an agreement. The former on filling the €30B budget gap if they grant Greece a 2-yr extension (3 Eurogroup meetings are scheduled the following two weeks!). The latter on structural reform measures which are a quid pro quo for more money. In Italy, the Sicilian vote shows the unease of the Italian people with current politics and the austerity policies. While it is still early days, it casts concerns over the Spring national elections. Finally, in Spain, PM Rajoy repeated his mantra that now it is not in the interest of Spain to ask for a bailout. These three factors can cause a lot of uncertainty and volatility on markets the following weeks.
Regarding trading today, overnight the BoJ eased policy further which in se is positive for risks. However, when we look at the reaction in USD/JPY and Japanese equities, the BoJ couldn’t redeem market expectations. Other Asian equities trade rather neutral. This morning, the Bund immediately tested the 141.95 resistance level, but a test so far failed. Later today, Spanish GDP data and European/US eco data will be released. Risks for the latter are skewed to the downside and might initiate a new test. Moves might, as was the case yesterday, be exaggerated due the low trading volumes. US bond markets stay closed because of hurricane Sandy.
Technically, the German Bund future broke above the 140.71 resistance on Friday, which makes the technical picture neutral again and opened the road for a test of 141.95 (first one failed this morning). While we didn’t expect the break above 140.71, we hold on to our longer term somewhat negative view towards the Bund. The Dec US Note future took our the 132-26 first resistance level this morning, similar to the 140.71 for the Bund. However, we repeat that this happened this morning in very, very thin trading.