More risk-off pushes German yields to all-time lows

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Yesterday, global core bonds put in another solid performance, despite some mixed economic data (strong US Michigan consumer confidence & weaker EMU production). The equity sell-off and an ongoing sharp fall in oil prices, suggests that the global economy may be in serious trouble, triggering a risk off reaction and a flight into the safe, but very expensive, sovereign bonds. The European bear flattening of the yield curve continued, while in the US Treasury market, the belly of the curve slightly outperformed the wings. German yields dropped by 0.9 bps (2-yr) to 8.2 bps (30-yr) with the 10-yr German yield reaching another new all-time low (0.618%). In the US, yield declines varied between 6 bps (2-yr) and 8.4 bps (5-yr).

On intra-EMU bond markets, Greek bonds continued to underperform ahead of the start of the presidential election process next Wednesday. There are risks for a defeat of the government candidate, new parliamentary elections and ultimately a possible victory of the untested left-wing Syriza party. This shakes investors’ confidence. The 10-yr Greek yield spread added 12 bps (+209 bps this week). The Greek credit curve remains inverted, suggesting increased default risks. Greek 3-yr yields trade north of 11% and 10-yr yields above 9%. Contagion to other EMU peripheral bonds is still limited, also taking into account Friday’s 2.5% crash on equity markets: 10-yr yield spreads widened up to 6 bps for Italy, Spain and Portugal on Friday and are 20 to 25 bps higher in a weekly perspective (Portugal 35 bps). Semi-core spreads were nearly unchanged.

The US eco calendar is quite well-filled at the start of the week with industrial production data, the Empire State index and NAHB housing market sentiment. The euro zone eco calendar is empty today, but later on the Dec PMI business sentiment will get a lot of attention. Nevertheless, the main attention this week might go to other issues: the FOMC meeting on Tuesday/Wednesday, the Greek political situation with the start of the presidential election process on Wednesday and the EU summit at the end of the week. Also the relentless slide of the oil price is source of stress with the situation in Russia becoming precarious following the ongoing crash of the Rubble on Friday despite the rate hike (Thursday) and presumed FX interventions. Venezuela is another market eye-catcher as the country may in time face insolvency, as FX reserves are rapidly depleting and are currently only matching the amount of bonds redeeming the next two years. The unexpected fast crash of oil could have nasty effects on other markets too via financial linkages.

Regarding the eco data, after a significant throwback in October, the Empire State index barely recovered in November. Also for December, a quite limited increase is expected, from 10.16 to 12. We believe however that the risks are for an upward surprise. Industrial production, on the contrary, is forecast to show a substantial rebound in November, by 0.7% M/M following a 0.1% M/M decline in October. The headline reading will be supported by strong output of utilities, while also production of motor vehicles and parts should be robust. Although the bar is quite high, we continue to see upside risks. Finally, also the NAHB housing market indicator is forecast to extend its rebound, rising from 58 to 59 in December. Also here, a stronger outcome is likely.

Overnight, most Asian equity markets trade with moderate losses. The Tankan report was a mixed bag and Abe secured a solid two third majority in the lower house (see FX). Japanese equities trade modestly negative and USD/JPY is little changed following a dip lower. The dollar is a tad stronger against the euro. US Treasuries are off early session highs.

Later today, the US eco data are expected strong, ,which is a negative for corer bonds. However, it might not be the main focus of the markets. Risk sentiment on equity markets will be key and driven by oil, Greece, Russia/Ukraine and who knows Spain. Indeed, over the weekend, Vanguardia reported that Spain opened the debate over haircuts on regional debt (details are missing). The search of the Greek PM Samaras to find 17 missing votes to get his presidential candidate elected continues.

Last week, deteriorating equity market sentiment/slide in oil price took the upper hand resulting in safe haven flows. US Treasuries profited as well, despite continued eco data strength and the upcoming FOMC. We think the Fed can drop the “considerable time” phrase (keeping the door for a Summer rate hike open), while leaving the “dots” roughly unchanged.
That combination is a negative for US treasuries. In EMU, the TLTRO outcome was low and together with a weaker growth and the inflation outlook cements chances on more ECB easing. We believe that German yields will stay low at least until the ECB effectively walks the QE talk in January or March.