Various factors supported global bonds
International Trading
Markets: Fixed Income
THE TECHNIQUE OF GIVING A GOOD MASSAGE
14 years ago
Tuesday, September 28, 2010
, Posted by Usman Ali Minhas at 12:42 AM
Following a downward profit-taking correction on Friday, global bonds were again well bid on Monday, reversing all of Friday’s losses and closing the session with juicy gains. US yields dropped between 2.4 and 8 bps and the German yields by 1 to 7.7 bps, in both cases flattening the curve. While there was maybe some risk aversion trade behind the gains, we shouldn’t overemphasize these as equities didn’t do too bad, sliding only moderately and keeping a large chunk of Friday’s big gains.
Various factors supported global bonds. Firstly, the correction on Friday was apparently seen as indeed an end-of-week phenomenon and thus considered as a buying opportunity by some. Later on, risk aversion played a role, as Irish and Portuguese bonds came under further pressure. Moody’s downgraded the Anglo Irish rating by 3 notches to Baa3 and kept a possible downgrade assessment. The health of the Irish banking sector and its impact on the Irish debt situation is a big concern. Markets are also extra nervous as the cost of the Anglo Irish bail out should be made public in the next few days. ECB’s Trichet said that Ireland proved in the past that it could face sizeable fiscal challenges, but added there was a big issue with the “very big financial sector”. Handelsblatt reported that in view of the crisis in Ireland, the ECB debated a plan for activating the EFSF rescue fund, but it was rejected. This seems a bit odd as it looks an issue for the EU political leaders. Regarding Portugal, there are fears that the minority government won’t get support for additional measures to keep finances on track for a deficit reduction to 6% of GDP. In the next days, it should become clearer whether the talks between government and opposition may succeed. As a result Irish and Portuguese 10 year yield spreads widened by 17 and 10 bps to new post EMU highs of 414 and 429 bps respectively.
There was also a lot of talk in the press about the weakness of the German Landesbanken, which might also have favoured core global bonds. The M3 money supply data were intrinsically bond-unfriendly as they suggest lending growth is accelerating, but markets ignored it.
In the US, a similar rebound in Treasuries took place. The global bond positive climate should also here be the main factor, additionally helped by some weaker second tiers eco reports (Chicago Fed National Indicator and Dallas Fed manufacturing survey) and a strong 2-year Note auction.
In the intra-EMU bond market, beside the Irish and Portuguese case (see higher), Spanish and Italian bonds lost ground too and registered a spread widening of 5, 6 bps. In Italy, concerns about early elections are rising. The Belgian debt outperformed the whole sovereign bond universe after a strong OLO auction, allowing the German-Belgian 10-year yield spread to narrow 5 bps. Also in other maturities Belgian debt outperformed German one.
The US eco calendar heats up today with the Conference Board’s consumer confidence indicator, Richmond Fed manufacturing index and S&P CS house prices. In the euro zone, the focus is on inflation with the first estimate of German CPI inflation and the Belgian inflation data. The ECB remains very active with Tumpell- Gugerell, Stark and Liikanen scheduled to speak, while Italy and the US will tap the bond market.
US conference board’s consumer confidence is expected to show a worsening of sentiment in September, after a bigger than expected improvement in August. The consensus is looking for a decline from 53.5 to 52.3, but we believe an downward surprise is not excluded after the recent decline in the Michigan and ABC indicators. The Richmond Fed manufacturing index is forecasted to show a further decline in September. The headline figure is forecasted to decline from 11 to 6, raising expectations that overall manufacturing ISM will fall back in September after an unexpected improvement in August. In July, the S&P Case Shiller house prices are expected to show the first month-on-month decline in four months as the effect from the government’s incentives are forecasted to fade. On a yearly basis, the increase in house prices is forecasted to have slowed from 4.23% Y/Y to 3.10% Y/Y. In Germany, CPI inflation is forecasted to have risen from 1.0% Y/Y to 1.3% Y/Y as last year’s 0.5% M/M decline falls out of the calculation. On a monthly basis however, inflation is expected to have dropped by 0.2% M/M, confirming that inflationary pressures remain extremely low.
The Belgian OLO auction went very well. The Debt Agency sold €2.292B OLOs (March 2016, September 2020 and March 2041), which was above the middle of the targeted range. The bid/covers showed good demand, but partially due to the smaller amounts allotted than in previous auctions. The Belgian OLOs that had cheapened in the run-up to the auction, outperformed other Credits in secondary markets. The US $36B 2-year T-Note auction went very well despite rock bottom low yields. Indeed the auction stopped at 0.441%, below the 0.446% bid in the WI at the stop. The bid/cover of 3.78 was the largest in more than 2-years. The Indirect, Direct and dealers’ bid all improved and the combined buy-side takedown improved to 49.3% from 41.3% in August.
Today, the Dutch Debt Agency will tap its 3.25% July 2015 DSL and 4% July 2018 DSL for an amount up to €2B, while Italy taps its 2.1% September 2021 for an amount of €1-to-1.5B. The US Treasury holds a $35B 5-year T-Note auction that will raise all new cash upon settlement. The success of the 2-year Note auction yesterday is a good omen for the 5-year today. Some commentators refer to the Japanese interventions as a factor underpinning the auction. The flattening of the curve might be a positive for the 5-year, as investors are reaching out for more yield. At least, last month buy-side demand was very strong.
Regarding other news, the ECB bought last week only €134M in bonds, showing that despite the rising tensions in the peripheral bond markets, the ECB doesn’t want to play a big role anymore in stabilizing the market. The WSJ writes that the Fed is weighing a more open-ended, smaller-scale bond buying program compared with 2009. More in particular, the Fed would announce purchases of a smaller amount for some brief period and leave open the question of whether it would do more. The latter would be answered by how the economy is doing. If this would indeed be the solution the Fed chooses, it would mean that the impact on the Treasury curve is less beneficial (smaller decline yields) and especially for the longer end of the curve that was expected to be targeted. The overnight reaction, sharp underperformance 30-year, points indeed to such an effect. However, we would be cautious to read too much in it. We aren’t sure that indeed the debate is involved in that direction. It might be an attempt to test the market reaction.
Regarding bond market trading, we were a bit too cautious yesterday by suggesting a buy-on-dips tactics. The rebound clearly showed that Friday’s correction was nothing more than a healthy profit taking correction. So, our basic bullish view remains on track. However, while we were too cautious yesterday, there is some technical reason to remain cautious today. Both the Bund and the T-Note future are testing the reaction- and contract high respectively. As the market has entered overbought territory, it is not the right time to take additional long positions at current levels. So, while existing longs may be kept, initiating new longs should be done in case of dips or in case these resistances are taken out. From a fundamental point of view, the eco data may be supportive today, month end extension buying may kick in and the US 5-year Note auction may go well. The situation in peripheral Europe is a wild card, but even should the peripherals rebound, we suspect that the negative impact on core bonds would be modest. The WSJ article on QE (see higher) is a potential negative, but might be offset should equities correct lower. So, it will be interesting how the bond market will cope with these factors at a critical juncture technically. It will tell us more on the underlying sentiment and on the possibility that US and German bonds might revisit the historic highs.
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