Markets: Rates


On Monday, many European markets closed for Whit Monday holiday, keeping trading flows in the Bund very low. In the US, the market calendar was devoid of market moving releases or events. Besides some intraday volatility, US Treasuries ended the opening session of the week nearly unchanged , even if volumes traded were not bad. Intraday, US Treasuries moved higher at the onset of US trading, but when equities staged an albeit short-lived rally (M&A news: Yahoo bought Tumblr for $1.1B), US Treasuries erased earlier gains, after which both markets traded sideways towards the close (see graph). US yields were up 0.5 to 1.4 bps in the 5-to-30-yr sector, while the 2-yr yield dropped 0.4 bps. The German Bund closed near opening levels, but the official opening was considerable lower than Friday’s close, as the Bund caught up with the losses that Treasuries registered in late US trading Friday eve.


Bund


Today, the market calendar remains thin. There are no releases in the US and no market moving ones in EMU. In the UK, various price indicators will be released, but these should be only of local interest. Events are few too, with ECB Liikanen and Fed governors Bullard and Dudley speaking. Regarding the latter, Dudley is an outspoken dove. Should he start favouring a fast start of asset purchase reduction, it would convince markets such a decision is coming closer.
Later this week, the agenda becomes really interesting with the EMU and Chinese PMI reports for May and Bernanke’s testimony, as well as the release of the Fed minutes.


Chicago Fed Evans, an outspoken dove and one of the architects of the current Fed communication policy, elaborated on the outlook for the QE programme. He said that there has been good progress in the labour market outlook. He looked open to the possibility to start taking the foot from the gas pedal. However, while some other governors want to taper the programme gradually, he supported the view to continue buying $85B of assets each month until “we decide that absolutely we’ve seen enough improvement, and then bring it to a quick conclusion at that time. That would be a programme going into fall, I would think, because you can’t really have that much confidence to bring it to an end before that.”. Last week, another dove, San Francisco Williams suggested the Fed may be ready to start cutting back on asset purchases this summer and (conditional on eco developments) end it late this year. Dallas Fed Fisher, a renowned hawk and opponent of bond purchases hasn’t changed its mind, but interestingly thinks that a sudden stop in the programme would be too violent.
So he favours gradual reduction of purchases. We still favour the September meeting as the one at which the Fed announces a tapering of its bond buying programme. Current eco outlook is still a bit too uncertain to take such a decision now.


On Friday, Fitch downgraded Slovenia’s A-rating by one notch to BBB+ (negative outlook). Fitch said the macroeconomic and fiscal outlook deteriorated significantly. The rating agency estimates that the banking sector will need further capital of €2.8B, more than twice the official government estimate. Between rating agencies, there is still a big gap between Moody’s Ba1, junk, rating and BBB+ at Fitch/A- at S&P. On secondary markets, there was no negative impact on Slovenian bonds.


Regarding trading today, Asian equities trade slightly negative, the euro is marginally higher versus dollar and the Bund trades little changed from yesterday’s closure.


Last week, it seemed that the sharp down-run which started after the (encouraging) May payrolls had run its course. Wednesday/Thursday, bonds went higher, in an even technical significant way. However, renewed weakness pushed both the US Note future and the Bund future towards the recent (sell-off) lows. This means that the sell-off lows may be retested again (144.22 for the Bund and 131-16 for the US Note future). We had a negative bias on bonds and were lukewarm to embrace last week’s two day rally. However, we also think that it is too early to see the great turnaround of the Fed, which if it comes would be problematic for core bonds. A big sell-off would in that case be likely. Of course, tomorrow’s publication of the Fed Minutes (of the April 30 meeting) and the testimony of Bernanke potentially are key events, but we don’t expect Bernanke to settle the issue of the starting tapering off the purchases. He probably wants to discuss the issue first inside the FOMC, that will meet June 18-19. If we are correct, bonds shouldn’t decline too much this week or even stage some recovery. For today, we expect a more sideways oriented session in the absence of market movers. Only NY Fed Dudley’s speech, after European closure, is a wild card.