On Friday, global bonds were on the defensive following strong German orders intake for January

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Mon, Mar 8 2010, 08:14 GMT
by KBC Market Research Desk

KBC Bank | View company’s profile

Markets: Fixed Income

On Friday, global bonds were on the defensive following strong German orders intake for January and encouraging US payrolls that pushed equities sharply up. US traders took the opportunity to prepare for this week’s slew of new government (and corporate) supply. Therefore, US bond losses were substantial, but German bonds lost only moderate ground, which didn’t affect the bullish technical picture. In a daily perspective, US bond yields rose by 4 to 8.6 basis points, steepening the curve. In Germany, the belly of the curve underperformed, with yield rises limited to between 2.3 and 3 basis points.

The February payrolls fell by 36 000 (below the expectations for a decline by 68 000), but given the impact of the snowstorms that were according to the BLS unquantifiable, but nevertheless real, payrolls probably would have been well positive. The details were strong. Temporary Help Agency payrolls, a leader for overall payrolls, once again grew sharply. Private payrolls fell only 16 000, with hints that the construction, manufacturing and retail payrolls may have been affected by the snowstorms. The series not at work due to weather showed one of the highest numbers ever. The diffusion indices, measuring the breadth of the market, improved noticeable and the unemployment rate stabilized at 9.7%, after having dropped 0.3%-points in the previous month. The markets embraced the report with equities sharply rallying and commodities doing well. On the equity markets, the cyclical sectors outperformed the non-cyclical ones. The dollar did well against the yen, but lost versus the euro after an initial hesitation, as the reversal of risk aversion primed the cyclical argument.

In the intra-EMU government bond market, the Greek 10-year yield spread to Germany widened marginal, but other credits saw their spread narrowing, partly also driven by a general narrowing of credit spreads after the encouraging US payrolls report. Especially Italy, Spain and Ireland profited from the better climate for peripherals. Over the weekend, the Greek PM Papandreou met French President Sarkozy, who gave the PM strong support and promised Europe will help Greece, even if there was again no concrete financial support. However, he said that his Finance Minister in tandem with her colleagues in the euro zone and Europe is working on a certain number of precise measures if Greece needs them. Sarkozy vowed a European crackdown on financial speculators that are often blamed for the Greek woes. Also IMF Chief Strauss Kahn in an interview overnight supported the Greek case, praising its very strong policy program and its solid debt sale. He also repeated that the EU wants to manage the fiscal crisis alone and the IMF has only been asked for technical support. The meeting with chancellor Merkel on Friday ended with less fanfare, even if Merkel did applaud the Greek efforts. However, she said that direct aid to Greece was not necessary, as the stability in the euro area was not at risk. Interestingly, it seems Germany (and others) are looking whether an IMF-style European fund can be launched to deal with Greek-style fiscal/debt problems in the euro area Papandreou seems to belief that speculators are responsible and ups his attacks. He got a willing ear on it in Frankfurt and Paris and will look for more support from Obama, which he meets today. Overall, we think that the news flow points to some easing of tensions at the start of the new week and thus further spread narrowing.

Today, the eco calendar is thin as it only contains the German industrial production data (January). After disappointing in December (-2.6% M/M), German industrial production is forecasted to increase by 1.0% M/M in January. If confirmed, it will be an encouraging sign for German Q1 growth after a disappointing GDP figure in the fourth quarter of 2009. Last Friday, the factory orders came out significantly better than expected, which is already an hopeful sign. Later this week, also the euro zone industrial production data are scheduled for release. Also in the euro zone, industrial production is forecasted to have increased in January after falling by 1.6% M/M in December. Additionally, attention may go out today to the bi-monthly BIS meeting and to the meeting of the Greek PM Papandreou and US President Obama. Also the speech of ECB member Stark, after market closure on: “The New Normal? Policy choices after the great recession” might be interesting, but probably only from a longer term perspective, less likely from a day-to-day market perspective.

In the US, the calendar heats up only during the second part of the week with the trade balance, weekly claims, retail sales and Michigan consumer confidence. In February, US retail sales are expected to show a slight decline after rising by 0.5% M/M in January, as bad weather kept many households from visiting the malls. But weakness is forecasted to be based especially in autos and gas as core retail sales (ex gas and autos) are forecasted to have risen by 0.3% M/M. Michigan consumer confidence is expected to show a marginal improvement in March after declining in December. Concerns about the labour market and income prospects might keep consumer sentiment at relatively low levels. Last week both initial and continuing claims dropped which might indicate that they are moving back to normal levels after being distorted by the backlog problems in California and the snowstorms. For this week, a further decline is expected. The trade deficit is expected to expand further in January after a big jump in oil imports swelled the deficit in December.

Regarding supply, the US Treasury holds its mid-monthly financing operation, besides various T-bill auctions. On Tuesday, the Treasury will hold a $40B 3-year Note auction, while on Wednesday the 3.625% 2020 Note will be reopened for an amount of $21B and on Thursday the financing is closed with the reopening of the 4.625% 30-year bond for an amount of $13B. The auctions will raise all new cash upon settlement. In EMU, the cash flows surrounding this week auctions will be balanced, as redemptions mount to about EUR15B and coupon interest payments about EUR1B, while issuance totals about EUR18B leading to net issuance of about EUR2B, comparable to last week. This favourable environment will change from next week onwards when issuance will be much larger than redemptions. The Netherlands and Austria will tap the market on Tuesday with the 3-year DSL and the 10-year RAGB. Wednesday, Germany will issue EUR6B of its on-the-run Schatz and tap the 10-year indexlinked Bund for EUR1B, while Portugal taps its 2021 bond. Italy closes the issuance on Friday with its BTP auction covering 5-year and 15-year BTPs. There are still some potential new issues in the pipeline including a 10-year Slovakian and Finnish 10- year bond, a 5-year Belgian bond and a Greek bond.

There will be no Fed speakers beyond Tuesday when Chicago Fed Governor Evans speaks at an economic conference, as the black-out period preceding the March 16 FOMC will kick in. Governor Evans spoke as recent as last week and thus his views should not have changed. Last week, Evans did say that the “extended period” wording of the FOMC statement would be on the discussion table and this discussion will probably indeed be the main point at the March 16 FOMC. Two FOMC voters, Hoenig and Bullard, have shown their wish to change the wording, as to give the Fed more flexibility in monetary policymaking now the economy is on the mend. Other governor expressed still confidence in the wording of the previous FOMC statement. We think a change may indeed be decided, but a compromise between doves and hawks may be to postpone the change to the April meeting. In EMU, various ECB members may take the floor, but recently we saw very little dissenting voices of ECB members, especially not immediately after the ECB meeting and the press conference of Trichet. So, it would surprise us should ECB talk move the markets this week. The SNB meeting on Thursday may be interesting, even if no rate change is expected. Also on Thursday, the ECB publishes its monthly bulletin.

Regarding bond trading, we are surprised how well bonds have traded recently, including on Friday when an encouraging payrolls report boosted equities, especially the cyclicals, commodities and corporate spreads. In such an environment, one should expect bonds to be under more severe pressure. Bonds did decline on Friday, but very little, especially German ones. EMU and US bonds remain close to recent highs and the bullish pictures are of yet intact. US equities are again eyeing the cycle highs and a test might occur soon. There aren’t too much key eco reports or events on the calendar this week, meaning that sentiment and technicals may drive the markets, especially ahead of the US retail sales, scheduled for release on Friday. For various reasons, central banks shouldn’t be a meaningful factor in trading either, leaving it to supply, especially in the US and developments in Greece to guide markets. Regarding Greece, there may be some easing of tensions while supply is a negative, especially in the US. In this context, we remain sceptical about German bonds over the whole curve, but as no technical signal is available, we shy from taking long positions. However, we still feel that profit taking on the rally might be rewarding. A sustained break of the Bund below 121.67 (uptrendline) is needed to fragilize the picture with 121.10 (previous low) next key support. On the topside, the contract high on 123.05 is the eye-catching resistance. In yield terms, the 3.09% low tested three times remain a formidable hurdle, while a break above 3.30% is needed to open the road towards a test of the broad range top at 3.43%. This broad range that is intact for many months now looks set to continue to play its role for some more months.

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Published on Mon, Mar 8 2010, 12:02 GMT