Global bonds experienced a calm trading session

On Thursday, global bonds experienced a calm sideways trading session ahead of the Head of States meeting with the Philly Fed and technical reasons responsible for the only movements of the day. German bonds were traded very thinly and officially closed slightly below opening levels. German yields increased 1.2 to 3.6 bps. The manufacturing PMI in the euro zone was significantly stronger than expected whereas the services PMI was significantly weaker.  Investors decided to leave it an open question and ignored (or added up) both indicators. At the end of the session, lows were tested but the Bund rebounded after the official European
closure erasing all intraday losses. We saw a similar pattern in US bonds, at first calm sideways trading pattern but eventually bonds came under pressure, supported by a better than expected Philly fed. The March Note future set new lows but also rebounded and eventually gained some. US yields were down 3.2 to 10.9 bps with the belly outperforming the wings. So, in both the Bund and the US T-Note future, the test of the lows failed.

In the periphery, yield spreads versus the German bonds widened marginally. The decision by the ECB to double its subscribed capital (see lower) didn’t heat up peripheral tensions and was classified as a technical adjustment. The German/Belgian yield spread  outperformed, narrowing by 9 bps as heavy buying was
reported. On Tuesday, Moody’s changed the outlook of Belgium’s sovereign debt rating from stable to negative on lingering political concerns. This week, political parties showed willingness to get back to the table to work on a constructive solution to end the political impasse. Hope springs eternal. This morning, Moody’s rating agency downgraded Irelands foreign- and local-currency government bond rating by 5 notches from Aa2 to Baa1 with outlook negative. The key drivers behind the downgrade are: the crystallization of bank related contingent liabilities, the increased uncertainty regarding the country’s economic outlook and the decline in the Irish government’s financial strength. The negative outlook is based on Moody’s forward looking view that the risk that the Irish government’s financial strength could decline further  if economic growth were to be weaker than currently projected or the costs of stabilizing the banking system turns out to be higher than currently forecasted.

After the approval in the Irish parliament to accept an €85B EU/IMF bail-out loan on Wednesday, the IMF approved on its €22.5B  tranche yesterday. IMF chief StraussKahn expressed himself positive on Spain. He said that the country will ward off the sovereign debt crisis without needing external aid and that there is no threat to the euro currency. “I don’t see that the risks for Spain will be that big in 2011. It doesn’t mean there is no risk… but  I’m not that pessimistic  about the Spanish economy.”

Moody’s rating agency put Greece’s sovereign debt rating on review for a possible downgrade by multiple notches. Currently the Greece’s rating is at Ba1, the highest junk status and equal to S&P’s BB+ rating. Moody’s acknowledged Greece has already made significant efforts by implementing several austerity measures but has its doubts about the future as uncertainty over the country’s ability to cut its debt ratios to sustainable levels still prevails.  “Therefore, Moody’s review will focus on the factors, namely nominal growth and fiscal consolidation that will drive the country’s debt dynamics over the next few years.

Today, the eco calendar contains the euro zone trade balance, German Ifo and US leading indicators. But attention will probably remain focussed on the EU Summit. In September, the euro zone seasonally adjusted trade balance showed a surplus for the first time in five months as imports dropped significantly, while exports rose slightly. In October, the trade balance will probably remain in surplus, but the surplus might have narrowed. The German IFO jumped last month to its highest level on record, although the consensus was looking for a slight decline. After the record level reached last month, the consensus is looking for a slight decline (from 109.3 to 109.0) on the back of a decline in expectations. After yesterday’s strong (German)
manufacturing PMI, we believe however that an upward surprise is not excluded. In the US,  leading indicators are forecasted to have risen by 1.1% in November, which would be the largest increase in eight months. An upward surprise is not excluded due to the contribution of the ISM’s supplier deliveries index.

The EU Heads of State and government leaders agreed to create a permanent financial safety net from 2013. They will insert two extra lines to the EU Treaty that apparently don’t need to be approved in referenda.  The member states of the euro area may erect a stability mechanism that is activated if it is indispensable to guarantee the stability of the euro area. The decision need to be taken by unanimity. Both the condition of “indispensable” and unanimity seemed to be inserted on demand of Germany that wants to avoid countries asking for help too fast and have a final say on every decision. So, in fact it is only a broad agreement and now the hard work of agreeing a detailed European Stability Mechanism will be started, even if the Finance Minister already painted the broad outline.

The ECB indeed decided to increase its subscribed capital by €5B, from €5.76B to €10.76B. The ECB noted that the decision resulted from an assessment of the adequacy of statutory capital conducted in 2009. It was deemed appropriate in view of increased volatility in FX rates, interest rates and gold prices as well as credit risk.

The maximum size of the ECB’s provisions and reserves is equal to the level of its paid-up capital. So, the decision allows the Governing Council to increase the provision by an amount equal to the capital increase, starting with the allocation of part of this year’s profits. It is the first capital increase and according to the ECB it is also motivated by the need to provide an adequate capital base in a financial system that has grown considerably. We had some fear that such a decision might have caused nervousness in the peripheral bond markets, as it could have been seen as a precursor of some losses (defaults?) on the bond portfolio.

However, markets barely reacted, probably considering the decision a merely technical in nature. Over night, the US Congress gave final approval for the extension of the expiring Bush-era tax cuts, a deal reached by president Obama and the Republicans. The budgetary stimulus to boost job creation at the cost of deepening US debt might be able to add up to 1 percentage point to economic growth next year, due partly to a
one-year cut in the payroll tax and removal of uncertainty about taxes in general.

Peter Diamond, a 2010 Nobel Laureate in economics and possibly future member of the US Fed board said that the US can bring down high unemployment by using every available tool.  “My reading is that right now  I don’t see any signs that we should be worrying about inflation as a reason to limit our reaction to high unemployment.” So, if he is effectively nominated, it seems the dovish aisle inside the Fed will have an extra member.

The Spanish treasury sold €1.78B of the on the run 10-year Obligacion (4.85% Oct2020) and €0.62B of the on the run 15-year Obligacion (4.65% Jul2025). The total amount of €2.4B was in the intended €2-3B range. Bid cover ratios were 1.67 and 2.52 respectively but given the small auction size this doesn’t really mean something. Overall Spain’s last auction for  the year met with decent demand. Given the very high yields the country had to pay, it’s clear that the pressure on the peripheral countries still prevails.

Regarding bond market trading, the calendar is thin with the IFO the only potential market mover. It might be stronger-than-expected, but after the PMI releases, it is unlikely it will have a big influence. The “results” of the EU Summit and the passing of Obama’s tax deal are two factors on which markets may react. On the former, we are not disappointed that the leaders didn’t take additional measures, but in the markets there maybe be some disappointment that may result in some spread widening (also due to rating action overnight) and may have the hugely oversold German bonds moving higher.  The tax deal on the contrary should be bond negative, as it suggests higher growth and further worsening fiscal position. However, bonds have
been heavily sold and both items evolved as one could reasonably have expected. In this context, we think that global bonds might be in for consolidation/correction, but given the thinness of the markets and the possibility of erratic price moves, we wouldn’t get too much engaged in trading anymore.
Full report: Global bonds experienced a calm trading session