Markets: Fixed Income
On Thursday, global bonds consolidated and booked some modest gains. The German yield curve flattened with the longer end decreasing 7 to 10 bps. The German bund rally took off in the opening and basically continued until the close. In the US, the 10-year note future showed a sideways trading pattern intraday, but eventually gained some at the buzzer, supported by the strong 30- year bond auction.
In the periphery, yield spreads increased by about 6-7 bps versus the German bund. German/Spanish yield spread underperformed and widened 12 bps. German/ Belgian spread kept flat and was once again outperforming against other peripherals. Investor’s confidence that the contagion risk for the country is minimal and that it doesn’t belong in the same category as Spain and Italy is definitely returning. Fitch Ratings has downgraded the Republic of Ireland’s long-term foreign and local currency ratings by 3 notches from A+ to BBB+. “The downgrade reflects the additional fiscal costs of restructuring and supporting the banking system,” the agency said. “Ireland’s sovereign credit profile is no longer consistent with a high investment grade trading.” The rating agency also published a report on the implications of contagion external support and the ESM for euro zone sovereign ratings. A spokesman for the smallest Irish opposition Labour party said that the party will vote against an €85B EU/IMF bailout package when it is put before parliament for approval next week.
Today, the US eco calendar heats up with the trade balance and University of Michigan consumer confidence, while in the euro zone, only the Italian industrial production data are scheduled for release. ECB’s Trichet, Ordonez and EU’s Van Rompuy will speak in Madrid. Other ECB appearances concern Mersch on the Luxemburg Q3 bulletin, Nowotny at a briefing and Constancio on financial regulation.
In October, the US trade balance is forecasted to show a marginal contraction in the deficit from -$44.0B to -$43.9B. Both imports and exports are forecasted to show a slight increase. If confirmed, this will be good news for fourth quarter GDP as the drag from net-exports seems to be declining. After already a significant improvement in Michigan consumer confidence in November, the consensus is looking for a further increase in December (from 72.5 from 71.6). We believe however that the risks might be on the downside of expectations as last week’s payrolls report might have depressed consumers’ sentiment. In the euro zone, Italian industrial production is forecasted to show a 0.7% M/M rebound in October, after sharp decline (-2.1% M/M) in September. After the strong German data, we believe that also for Italy, the risks might be on the upside of expectations.
EU commissioner Rehn complimented Greece on the efforts made in its economic reforms. “By succeeding in its program, Greece is regaining the trust of its partners in Europe and beyond.” “One sign of this is that the council of EU finance ministers is ready to look positively into the extension of the repayment period of the loan for Greece.” Such a loan extension would be good news for investors as some still fear that the country will default on its debt. On the euro zone crisis, Rehn insisted on a coordinated action to tackle the problems. Fundamental reform is needed at both national and EU levels.
In an article with the FT, ECB Draghi warned on the ECB’s bond purchases: “I’m only too aware that we could easily cross the line and lose everything we have, lose independence and basically violate the (EU) treaty.” Before last week’s ECB meeting there had been rumours that the ECB should start a US-style QE-programme and spend around €1000B on asset purchase, but Draghi repeated that the programme is not about providing cheap credit to governments but about ensuring the proper functioning of bond markets. ECB vice-president Constancio expressed the same opinion. He said that the bank’s bond purchases had led to “further normalisation” of risk spreads. The main source of concern for now is the interplay between the sovereign debt crisis and vulnerable parts of the euro zone banking system: “What is important is that countries continue to implement fiscal policies that they have committed to… that will be an essential answer to the existing pressures regarding sovereign debt.”
A spokesman of French President Sarkozy’s office indicated that France is backing the German stance that there is no need to enlarge the current stability fund and that E-bonds are not an option.
The ECB’s monthly bulletin was virtually the same as last month. There is positive underlying momentum in the euro zone economy but inflationary pressures remain contained. The report warns about the rise long-term employment and confirmed that almost all euro zone countries are about to meet or beat deficit forecasts partly due to the better macroeconomic environment.
The US treasury’s 30-year bond auction yesterday went very well. The auction stopped far below where the WI was trading around the 1:00 P.M. (4.41% vs. 4.463%) auction bidding deadline, with a strong bid/cover of 2.74 (vs. this year’s average of 2.67). The buyside demand was also quite strong; Indirect bidders took down a hefty 49.5% of the auction, the third largest since the return of the bond in Feb2006, and Direct bidders took down 8.1% of the auction.
Regarding trading, the sell-off in global bonds on Tuesday, eased on Wednesday, setting the stage for some modest bond buying on Thursday, especially at the longer end. The short end of the German market was still reeling from the “failed” Schatz auction on Wednesday. We think that the consolidation/correction may go somewhat further. The market needs to digest previous losses. The longer end attracted some bargain hunters both in Germany, where the Bund yield surpassed the 3% and in the US where investors bid strongly in the 30-year bond auction. The US eco data might be mixed today, trade balance bond-unfriendly, but compensated for by weaker consumer sentiment, while the most important ECB speeches are scheduled after European closing. The situation in the peripheral European bond markets seemed to have calmed down for now and thus should go for a few days to the background. In this respect, the sentiment and market technicals might be again the key drivers in bond markets today. Oversold conditions and maybe some preweekend profit taking on shorts suggest that the consolidation may continue.
US: Continuing claims drop to 2-year low
In the week ended December the 4th, US initial claims dropped by 27 000, from an upwardly revised 438 000 to 421 000, slightly below the expected 425 000. The fourweek moving average extended its downtrend, falling from 431 500 to 427 500, which is the lowest level since August 2008 and confirms that the trend in claims remains downward. Nevertheless, the figures might still feel the impact from Thanksgiving and Black Friday in the week before as non-adjusted claims rose sharply, but claims always tend to rise sharply in the week after Thanksgiving. Continuing claims, which are reported with an extra week lag, surprised on the downside of expectations, showing a 191 000 decline to 4 086 000, which is the lowest level in two years. Concluding, this report eases somewhat the concerns after the weak payrolls report last week.
Other: UK trade deficit widened as imports rose to record high
In October, the UK visible trade balance showed a bigger deficit than expected. The visible trade deficit widened from an upwardly revised -£8392 to -£8529, while the consensus was looking for a contraction in the deficit to -£8100. Both exports and imports rose significantly, but the increase in imports was bigger than the rise in exports. Although the headline figure is significantly weaker and might weigh on growth in the fourth quarter, the details show that the weakness of sterling is finally boosting exports, while the strength in the manufacturing sector might have increased imports.
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