Markets: Rates

On Friday, global core bonds traded mostly range-bound, digesting Thursday’s gains and awaiting the outcome of the Italian elections. The short end of the curve profited fully from the ECB announcement that banks will repay only €61.1B 3-year 2nd LTRO loans this week combined with a very low €1.7B 1st LTRO loans. This was much less than expected. As a result the curve (bull) steepened handsomely. Equities eked out strong gains as bargain hunters showed up after the recent sell-off, but the upcoming Italian elections offset the negative impact of equities on core bonds and these remained well bid into the close. In a daily perspective, US yields were flat (2-year) to 1.7 basis points lower (10-year). German 2-year yield fell 4.2 bps, while 5- and 10-year yields were respectively 2.1 and 0.5 bps lower. The 30-year yield added 0.2 bps.

Intraday, the Bund opened constructive on hopes the risk-off sentiment would persist. Equities performed better though and together with a surprisingly strong IFO, they pushed the Bund temporary lower. However, without follow through action, the Bund remained just below opening levels. The EU winter forecast revised EMU growth down to -0.3% (from +0.1% in autumn), but it had no big impact. At noon, the ECB announcement that banks would repay a smaller amount of LTRO loans than expected pushed both equities and Bunds higher and especially favoured the short end of the European curve. During the US session, the US Treasuries and Bunds remained well bid, despite a nice rally of equities later on.

On intra-EMU bond markets, 10-yr yield spread changes were limited between +2 bps (Ireland) and -5 bps (Spain). The EC published its winter economic forecast, but this couldn’t move markets ahead of the Italian elections. The Spanish 2012 deficit was forecast at 10.2% of GDP. Excluding bank bailout costs, the deficit was estimated at 7% of GDP, in line with recent comments from Spanish government officials. The Spanish debt ratio increased from 69.3% in 2011 to 88.4% in 2012. EC Rehn said the EC will decide in the coming weeks or months whether to adjust the Spanish deficit reduction path. Similar announcements are expected for France and Portugal.

Cypriot centre-right opposition leader Anastasiades won the second-round of the presidential elections against Communist Party Malas. The victory is seen as positive to resume and conclude bailout talks.

Today, the eco calendar is extremely thin with only the Chicago Fed national activity index, which is less followed by markets. Fed’s Rosengren and ECB’s Asmussen en Weidmann are scheduled to speak and Italy, Germany (Bubills) and the US will tap the market. Rosengren’s speech in Seoul overnight concerned bank regulation and didn’t contain comments of immediate importance for bond markets. The first exit polls of the Italian elections are expected at 15h CET.

ECB data showed that 356 banks will repay this week €61.1B of 3-year LTRO loans of the second LTRO operation, which is considerably below the €137B banks repaid at the first option date for the first LTRO. It fell also short of the consensus estimate of a €130B repayment. 9 banks will repay this week together 1.7B of LTRO loans from the first operation. The slow repayment of ECB loans suggest that the healing of the banking sector takes more time than expected. It eases fears of a fast evaporation of excess liquidity, which would have already in the next months pushed eonia higher, effectively tightening monetary policy by stealth. The announcement pushed money market rates lower and weighed somewhat on the euro. Equities climbed, probably due to expectations rates will stay lower for longer and liquidity will remain abundant.

Besides the Italian election, trading will be dominated this week by the semiannual testimony of Mr. Bernanke and the nomination of the next BOJ governor and his deputies. The press suggest that Mr. Kuroda, the head of the Asian Investment Bank, will be nominated very soon. He is a savvy communicator. This is needed especially towards his foreign counterparts, which are looking suspicious towards the weakening impact of the Japanese policy on the yen. He is also seen as a loyal executor of PM Abe’s plan to finally end deflation. In a first reaction, USD/JPY jumped higher, set a new recovery high, but eased somewhat afterwards. Should the yen weaken substantially further, it would be positive for the German bonds, via pressure on the ECB to keep policy accommodative for longer. In our weekly, to be published later today, we elaborate on the semi-annual testimony of Mr. Bernanke before Congress (tomorrow/Wednesday). It might be more interesting than previous testimonies of Bernanke, coming on the heels of the FOMC Minutes that showed widespread unease about the costs and risks of further asset purchases. Some governors thought the programme should taper at some point, even if no substantial improvement on unemployment has been registered. This goes against the FOMC statement. Bernanke is of course one of the architects of the asset purchase programme. Will he downplay the “opposition” inside his Committee? Or is he happy that riskier assets markets took a breather following the strong rally? In any case, he may impact markets this week.

Today, the US treasury starts its end-of-month refinancing operation with a $35B 2-yr Note auction. Currently, the WI is trading around 0.26%. The auction is followed by a $35B 5-yr Note tomorrow and a $29B 7-yr Note auction on Thursday. The Italian debt agency raised between €2.5B and €4.25B via zero coupon and inflation-linked bond auction. More attention goes to Wednesday’s BTP auctions.

Yesterday, it was the 1st election day in Italy. Voting runs until 3 pm CET today, with early exit polls coming out soon after. The centre-left party of Bersani is still expected to win a majority in the lower house. In a worst case scenario, the centre right gets control over the upper house and Italy ends up with a hung parliament. The latter would be a huge impediment for further implementation of structural reform measures.

Overall, we believe the chances on a doom scenario arenot fully priced in. If results show a hung parliament, there is room for more spread widening. In the other case, we think it remains difficult to form a strong government, and any spread narrowing should be more modest.

Regarding trading today, Asian equities trade cautiously optimistic with Japanese equities outperforming after Mr. Kuroda is whispered as the next BOJ governor. Chinese PMI fell a bit short of expectations, but has no big impact. In other news Moody’s downgraded UK to Aa1 from Aaa, but outlook is stable. It is no complete surprise and the immediate impact (weaker pound, higher gilt yields) should be small. As such it should benefit the ever fewer AAA credits, but also here no abrupt impact is likely. The calendar is thin, but the exit polls of the Italian elections may be the defining factor in afternoon trading. A hung parliament, the worst case scenario, would be Bund friendly and might push the Bund above the key resistance area of 143.75/144.07, a level approached on Friday.
A Bersani-Monty “victory” would still pose questions about stability and the implementation of reforms, but should prevent a break higher of the Bund. Overall though, it seems that the risk-on sentiment is still showing signs of fatigue and as the fiscal negotiations in the US will get again more attention (sequestration on March 1 and continuation resolution on March 27) the outlook for the Bund may improve. However, we want to get more information about the market via the outcome of the test of the resistance area that now looms before changing our view. .

Looking at the MT technical picture, the Bund has dropped below the previous low, keeping the lower high, lower low configuration intact, the definition of a bear trend. It has also taken out the 62% retracement level, suggesting that a complete retracement to 139.73, the September low, is likely. Intermediate support stands at 140.95 (October low). Only sustained trading above 143.75/144.07 would change the MT picture for the better, with a test more likely after a stronger run on Thursday (and Friday).