Markets: Rates


On Wednesday, markets easily digested the Cypriot parliament’s rejection of the bailout plan. They are confident that a solution will be found to cover the final €5.8B, a mere trifle compared to previous rescue packages. Moreover, there are no real signs of contagion towards other troubled peripheral countries. Yesterday, EMU bonds already reversed half of Monday and Tuesday’s modest widening. Furthermore, global core bonds slid lower, EUR/USD recovered and equities eked out gains . During the US session, the FOMC kept policy unchanged. It thus remains very accommodative and further backed yesterday’s market moves.


Intraday, the German Bund future opened near the contract high but gradually slid from the start of the session. Investors closely monitored incoming headlines on Cyprus. Cypriot President Anastadiases negotiated with the Troika in Cyprus, whereas Cypriot FM Sarris was in Moscow to broker a deal. Options on the table include tapping the Cypriot pension fund, restructuring and selling the two biggest banks, involving the Cypriot natural-gas reserves (either sell them directly or attach future revenues to a new bond), … As the options were rumoured (and some later denied), they sparked volatility. The eco calendar was of no importance, neither was a German Bund auction. In the US session, attention went to Fed chairman Bernanke. The FOMC didn’t change policy or policy guidance. The Committee clearly wanted to give the message that they are on the right track and see no need for change. It succeeded gloriously, as markets barely moved. The FOMC still sees downside eco risks and subdued inflation. The timing of the first rate tightening, as communicated via individual Fed governors estimates, was virtually unchanged (2015). For a more thorough analysis see our flash report. At the end of the session, both the German and US yield curves bear steepened. In Germany, yield changes ranged between 1.9 bps (2-yr) and 5.1 bps (30-yr). In the US, they varied between 0.8 bps (2-yr) and 7 bps (30-yr).


On intra-EMU bond markets, 10-yr yield spreads versus Germany narrowed up to 2 bps in the (semi-)core. The drop was larger for Spain (-11 bps) and Italy (-13 bps). In Slovenia, lawmakers approved a new government (52-35 vote) led by PM Bratusek. Her coalition holds 47 seats in the 90-member parliament. It’s positive for Slovenia that early elections were avoided. Now the country can continue implementing structural reforms (including setting up a bad bank).
Especially ailing up the banking sector is important to avoid becoming the next Cyprus. Yesterday, the IMF warned that Slovenian banks were under stress. In Italy, President Napolitano continues consultations with party officers. After these talks (which last until tonight), Napolitano will give a mandate to form the new government. An announcement is only expected late tonight or tomorrow.
Fitch said in a special report on Belgium that the Belgian government made significant progress in reducing the budget deficit and it expects the public debt to peak this year, before gradually sliding to 80% in 2021. Recently, Fitch changed the outlook on Belgian’s AA rating from negative to stable.


Today, the eco calendar heats up with the PMI’s in the euro zone and Philadelphia Fed, claims and existing home sales in the US. Ireland will release the first estimate of fourth quarter GDP and Spain (Bono & Obl.), France (OAT) and the US (10 yr TIPS) will tap the market. Cyprus remains a key item with the presentation of plan B by the president at 7h30 GMT. Cypriot banks remain closed till next Tuesday. The ECB non-monetary meeting will discuss doubtless Cyprus, but decisions on the Emergency Liquidity Assistance (ELA) are not expected as long as there is no clarity on an Cypriot rescue deal.


Last month, the euro zone PMI’s disappointed as the composite PMI fell back slightly, while most other confidence indicators extended their rebound. Now for March, it will be interesting to see whether the PMI’s will be able to resume their recovery. The consensus is looking for a slight increase in both the manufacturing and services PMI. Both indices are at the same level (47.9) and are expected to show a similar increase to 48.2 in March. While the consensus is looking for an increase in both the manufacturing and services PMI, our expectations are more mixed. We believe that weakness will persist in the services sector, due to poor sentiment domestically. For the manufacturing sector, we are more optimist and believe that the risks are for an upward surprise, supported by orders from abroad. In the US, the Philadelphia Fed index is forecast to show a rebound in March, after the index weakened significantly in February. The consensus is looking for a pick up from -12.5 to – 2.5. As the index is usually volatile and shows regularly big leaps, we believe that the risks are for an upward surprise as almost all business confidence indicators surprised on the upside recently. Jobless claims are forecast to have picked up slightly in the week ending the 16th of March. Initial claims are expected to have risen to 340 000, from 332 000. In the previous two weeks, initial claims surprised on the downside of expectations, providing further evidence that the US labour market is improving. For this week’s data, we continue to believe that the risks are for a lower outcome. Finally, US existing home sales are forecast to have increased for a second straight month. In February, existing home sales are expected to have risen by 1.6% M/M, after only a marginal 0.4% M/M in January.


Yesterday, the German Finanzagentur tapped the on the run 10-yr Bund (€4B 1.5% Feb2023). The auction went ok, despite that the yield on offer (1.36%) was the second lowest on record. Total bids amounted to €5.44B, more than the previous tap (€5.03B) and above the 2012 average (€5.17B). The Bundesbank set €0.64B of the issued amount aside for secondary market operations, resulting in an official bid cover of 1.62.


Today, Spain and France conclude this week’s supply. The Spanish Tesoro taps the on the run 2-yr Bono (2.75% Mar2015), 5-yr Bono (4.5% Jan2018) and the 10-yr Obligacion (5.4% Jan2023) for a combined €3-4B. The amount on offer is relatively low compared to the latest auctions (€3.5-4.5B & €4-5B). After reaching cycle low ASW-spreads (and against Italy) on March 11, Spanish bonds underperformed versus swap (and Italy). The bonds on offer cheapened respectively by 11 bps, 22 bps and 27 bps since, the curve thus steepening. We think this should be supportive for the auction as it is our view that the Cypriot hick-up won’t infect other EMU countries. Relatively to surrounding bonds, the Mar2015 trades normal, whereas the Jan2018 & Jan2023 trade slightly cheaper. So far, Spain managed to raise 28% of this year’s expected funding need. The French debt agency launches a new 2-yr BTAN (0.25% Nov2015) and taps the on the run 5-yr BTAN (1% May2018) for a total amount of €7-8B. On the grey market, the new BTAN trades at a 4 bps discount in ASW-terms compared to the Oct2015 OAT. This translates into a 3.5 bps yield pick-up. The May2018 BTAN cheapened around 3 bps going into this auction and trades relatively normal on the French curve. Additionally, they’ll raise €1-1.5B via inflation-linked bonds.


Regarding trading today, Asian equities trade volatile and are modestly higher, which is a bit disappointing given the FOMC decision to keep the liquidity flowing and stronger Japanese and Chinese business confidence data. The S&P eked out modest gains yesterday, but couldn’t really accelerate following the FOMC decisions. Of course major resistances (1565, all time closing high and 1576 all-time high are looming). For today’s data, we see more risks for upward surprises than for downward ones (see higher). The Spanish auction may get cross market attention and should go well. Cyprus is the main wild card, which might after all keep investors cautious, even if it had not much impact until now on riskier assets. Based on the above considerations and setting aside the binary impact of Cyprus events, it should be a moderate positive session for riskier assets, while global core bonds who did well in past days might lose some more ground.
However, given the pending Cyprus issue and the absence of important technical signals, we prefer to stay on the sidelines short term, while we keep a core bond negative bias for the longer term.