Global bond sell-off continued : Strong US data prolonged the sell-off in US bonds and ended the minor consolidation in German bonds

  • US Equities sharply reversed gains in the final hours of trading, but managed to recoup part of the losses just before closing. The S&P ended marginally up led by an increase in telecom and health care shares. This morning, Asian shares trade mixed, while Chinese stocks trade 0.5% lower.
  • The US Federal Reserve stuck to its policy of buying $600 billion in US Treasury bonds and keeping short-term interest rates near zero amid signs that the recovery is gathering steam. 
  • Yesterday Standard & Poor’s cut its outlook for Belgian debt to negative saying the country’s inability to form a government threatened deficit- and debt reduction goals and indicates Belgium’s AA+  rating could be downgraded within six months. 
  • Italian Prime Minister Berlusconi narrowly survived a no-confidence motion that left his struggling centre-right government clinging to power by just a handful of votes. 
  • This morning,  Moody’s placed Spain’s Aa1 rating on review for a possible downgrade, citing concerns over the country’s mounting debt and its funding needs next year. Moody’s believed however that Spain’s solvency is not under threat and will not ask for AFSF support. 
  • Japanese manufacturers’ business sentiment worsened for the first time in nearly two years this quarter, according to the Tankan survey, but the gloom was not as severe as expected.  
  • Today, the eco calendar contains the euro zone and UK employment data, US CPI inflation, the Empire State manufacturing index and US industrial production data. The Swedish Riksbank and Norwegian central bank will decide on rates.  

On Tuesday, global bonds tanked as stronger US data convinced kicked in. It  ended the consolidation period of recent in the Bund market, while it was simply a prolongation of the downtrend in US Treasuries. The FOMC statement brought no new info and didn’t impact the market, but it couldn’t stop the selling either. German yields ended 2.2 to 7.5 bps higher, but part of the carnage occurred after the official European closure, US yields increased by 7.2 to 19.8 bps with the wings outperforming the belly. The US 10-year yield stayed above the key 3.37% level and officially ended at 3.49%., which is a bearish signal that, as such,

would point to the risks the 10-year yield will make a full retracement of the April-toOctober rally that started with yields at 4%.

Yesterday, peripheral yield spreads versus the German bonds widened marginally. German/Belgian spread went out 2 bps after S&P rating agency announced that is revised the outlook of Belgium from stable to negative on the ground of increasing political uncertainty.  If Belgium fails to form a government soon, a downgrade by 1 notch could occur within 6 months. “We believe that Belgium’s prolonged domestic political uncertainty poses risks to its government’s credit standing, especially given the difficult market conditions
many governments are facing.” S&P also stressed out that the economic recovery in Belgium is well on track.

However, to meet next year’s targets a stable government is necessary. German/Irish yield spread increased by 8 bps. In Ireland a new law was published yesterday giving the government the power to impose losses on subordinated bondholders. The bill, in order to restructure the banking sector, will apply to banks that have received state support, building societies and credit unions. German/Spanish yield spread went out 3 bps. Bank of Spain reported that Spanish banks ECB borrowing in November decreased a 4th consecutive month. The amount dropped from €140B in July to 64.46B in November. This morning, Moody’s rating agency put Spain’s Aa1 debt rating on review for possible downgrade. In Italy, PM Berlusconi managed to survive a vote of no-confidence in his government, winning in the Senate and lower house. In the lower house it was a close call for Berlusconi, defeating the motion by 314 votes to 311.  

Intra-day,  the Bund traded in a narrow sideways range in very thin markets.  US bonds came under pressure after the release of the retail sales for the month November. These were better than expected and suggest the US economy is proceeding at a much higher growth pace than most observers thought. Indeed, Q4 growth
may be as high as or higher than 3.5%. This is key information that also may alter at some point and if confirmed the outlook for Fed policy. There was some calmness after the FOMC meeting (see below) that didn’t bring new info, but the selling resumed later on. The Bund declined in sympathy with US Treasuries, closing at a new low of 124.12 (after-closure low even 123.76).

The eco calendar remains well-filled today with the US CPI inflation data, the Empire State manufacturing index, US industrial production and euro zone (quarterly) and UK employment data. EU’s Van Rompuy & Barroso speak to the EU Parliament ahead of the Summit, while Spain and the UK will tap the market.
In the US, consumer inflation is expected to fall back to 1.1% Y/Y in November, while monthly figure is expected to show a 0.2% M/M gain. The core reading is forecasted to stay unchanged at  the lowest level since core  inflation data started to be published in 1958, keeping the fears for deflation alive. We have no reasons to distance ourselves from the consensus. After a surprisingly pessimistic NY Fed manufacturing index in November, we hope to see a significant rebound this month. The consensus is looking for an improvement from -11.14 to 5.00 as the NY Fed index clearly was an outlier last month. Also industrial production is forecasted to show a (slight) rebound in November (0.3% M/M), but the utility component might be a swing factor in November. In the UK, jobless claims are forecasted to decline again after
an unexpected drop in October.

A German government official said that Germany would support a possible capital increase by the ECB to hold off the euro zone sovereign debt crisis from further contagion. “The government supports the ECB in all that it deems important… If such a request comes, we will judge it positively.” Yesterday the FT reported
some rumours that this idea was playing inside the ECB and this might be brought up at the Head of States meeting tomorrow. This capital increase might be due to worries over potential losses on the peripheral bonds the ECB has been buying with its bond buying programme. For the moment, markets didn’t really took notice of the news but if it were true that the ECB recognizes the losses on its peripheral bonds, the periphery might come under huge pressure again causing yield spreads to skyrocket again.

The German main opposition party,  Social Democrats, presented a three-point plan that mostly goes against Chancellor Merkel’s stances on the solution for the euro zone sovereign debt crisis. The Social Democrats call for Germany to take the lead in pressing for closer integration to underpin the euro. The plan presents a rather radical solution based on three pillars. First of all, haircuts should be imposed on bond holders by restructuring  the debt of Greece, Ireland and Portugal.

Secondly, debt guarantees should be given for all other, “stable”, euro zone debt to prevent further contagion; possibly by enhancing the rescue funds. Last but not least, the plan proposes the use of E-bonds to  cover a limited share of public debt. The plan could only work if all three elements are implemented.  

The ECB allotted €187.8B of liquidity at its one-week MRO tender versus a maturing €197.3B or a net amount of €9.5B drained. The number of bidding banks increased slightly to 159 from 155 at the previous tender.  The December FOMC meeting, indeed, passed without much fuss. The Fed refrained from altering its policy and changed its assessment of the economy only slightly and in line with the already published eco data. Indeed, the FOMC confirmed its $600B Treasury Securities purchasing programme and its re-investment of previous asset purchases that mature. It explained in similar wordings than before why it
entered the programme, notably to fulfil its mandatory mandate of maximum employment and price stability. The Fed will regular review the pace of purchasing securities in the light of incoming information and eventually adjust the programme. All the paragraphs, expect for the description of the economic situation was unchanged.

Regarding the economic situation, the statement said that the recovery is continuing, though at a pace that is insufficient to bring down unemployment. This assessment is a slight improvement from the November statement that said “the pace of recovery in output and employment continues to be slow.” This December assessment is somewhat better than the November one, but has no impact on policy. There was a slight
changing in the wording on inflation, but it didn’t  change the underlying message.

Kansas Fed Hoenig once more dissented showing  its resistance against the high level of monetary accommodation.  Concluding, the FOMC as expected didn’t want to affect markets in  the thin end-of-year markets. The Minutes, published on January 4 may give us a flavour of the debate inside the FOMC. It is only at the next FOMC meeting, but probably only at the March meeting; we might get an eventual re-assessment of the QE-2 programme, if eco and inflation data would suggest a change is needed. Neither the equity market, nor the bond or dollar market reacted on the announcement of the FOMC statement.  .  

Regarding bond market trading, the minor consolidation in the German bund that we are counting on since mid last week came to an end as the sell off continued on better than expected data in the US (improvement in retail sales).

The March Note Future suffered a lot and comes close to the important support level of 119-02+ (62% retracement) while the 10-year yield stays above the key 3.75% level. Flows have thinned and will do so further out, making it very difficult to see which market moves are due to “fundamentals” and which to
year-end positioning. The latter may easily be reversed early 2011. In this context, we feel uneasy to give short term guidance that might be nothing more than guessing. Our medium term stance  is still that one  shouldn’t fight the bear run that is ongoing, while short term we thought/think that some consolidation was/is likely.
Full report : Global bond sell-off continued : Strong US data prolonged the sell-off in US bonds and ended the minor consolidation in German bonds