eur-usd 1month at the money vdax

Fixed Income Outlook

EU Finance ministers failed to agree the implementation of the Basel III rules on all EU banks last night with the British claiming that the EU commission was watering down the rules for the "specific" benefit of French and German banks over the UK Banks. The EU Commission's proposal comes against advice from the ECB and yet again suggests that the EU is not willing to take the necessary decisions to strengthen the capital controls of the financial system. It's refusal to allow both the UK and Swedish to implement stricter controls if they so deemed necessary is a ridiculous attempt at hiding the weak position of the Euro-zone banks, and in particular the French banks.   But the lack of an EU wide bank capital regulation agreement means that the strength and credibility of the whole of the EU's banking system becomes questionable again.

The market reaction is for Bank equities to rally first thing today- French Banks +2%, Italian +1.5%, UK +1.2% but Financial credit Spreads are wider, showing that the non-decision weakens the banks credit positions.

Over the coming days this failure to agree the implementation fully of Basle III will put more pressure on the financial spreads.

German 10yr Bund yields hit an all time low yesterday of 1.599%. The flight to safety has put a huge premium on the Bund market. A weakening financial credit market will only lead to an even bigger premium for the Bund market over the other Euro-zone sovereign credits. It has increased the Swap markets implied volatility, although still only modestly. And Implied volatility in the currency market has also increased, although again, the level is still way below the levels seen during the Euro-zone crisis of Q4 last year. Of course the reason why the levels of implied volatilities is so low is that the markets are convinced that any crisis will be met with Central Bank intervention. This blind faith in Central Banks, either the ECB restarting its sovereign debt purchases  or the Fed buying Mortgage Backed Securities in QE3, cannot make for rational investment strategies. At some stage the market will re-price the risk, and that has to mean weaker equity markets and weaker credit markets.

In the US- there has been a small decline in Inflation breakevens over the past week, as commodity markets continue to price in a slowdown in the global economy. Yesterday's US Factory Orders for March is now confirming the weaker picture seen in Q1 GDP, and if anything led to economists revising down the Q1 GDP from 2.2% to 2%. This is quite a change as the calls last week were for the initial Q1 to be revised higher as it did not tie up with the PMI surveys from Q1. So now the economists are starting to perhaps realise that the survey data could well have been wrong. It casts doubt on the ISM data from this week which was used by Risk markets as a reason to rally.

Tomorrow's US Employment report is becoming more and more important for market sentiment. The consensus call is for a rise in Non-Farm Payrolls of 160k, which is up on the 120k seen last month. To me this seems illogical given the data that we are starting to see come from the end of Q1. The ADP report yesterday seemed to signal that indeed the payroll data would be weaker than the consensus estimate, but was explained away by some as an aberration. Recent Initial Jobless claims data has also been weaker than expected but again shrugged off as  weather and holiday distorted.

I would not be surprised if the NFP for tomorrow was below 100k. And following that I would not be surprised to see equity markets price in QE3 more and therefore rally after an initial sharp sell-off. Longer term though I would not be taking investment decisions on the hope for a Central Bank bailout. 

But that will mean 10yr US Treasury yields will fall below 1.90%, and given that I am sure the number of short positions has grown this week, a significant break of the recent range maybe on the cards.

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