Fixed Income Update 2012-08-09

A lack of bad news is enough for the Safe Haven markets to lose their appeal.

Little US economic data and a quiet political period in Europe is taking some fear out of the market

Yesterday's auction of new 10yr US Treasuries was a real disappointment to the market and me.

The result at 1.68% was around 3bp above the pre-auction level.

The bid to cover ratio was also weaker than the previous auctions at 2.49 times ( 6mth average has been 3.16 times)

The last new issue auction in May also saw a smaller than anticipated bid to cover of 2.90 times so maybe teh weakness could have been expected.

Indirect bidder participation (Central banks mainly) took a large 40.6% proportion of the auction  although Direct bidders (US Domestic Banks) took only 5.2%, meaning that dealers bought more than 50% of the issue the first time since April that this happened.

All in all it raises concern over today's auction of new 30yr bonds.

That's why Treasuries weakened further after the auction result.  30yr Bonds dropped nearly a point in price and hit a yield of 2.75%.

But other signals continue to point to a recovery soon in Fixed Income markets.

Inflation breakevens- having risen with the general "Risk on" theme, started to turn around yesterday given the lack of a significant rally in the commodity markets.

Oil prices are rising again- as tensions grow again in the Middle East. The spread between Brent and WTI at $18.79/ bbl is the highest in nearly a year. Whilst some of this is due to technical supply issues- the bigger driver is the threat of serious supply disruption in the Middle East. It is not driven by an increase in demand. The rise in oil had led to Inflation expectations rising- but as I have said before, rising fuel costs are a bigger drag on the global economy than an increase in inflation.

And Copper and other base metals are going nowhere. Even Platinum continues to perform badly against Gold with the Platinum/Gold price ratio remaining well below 1 and nearly at modern time historical lows, 0.87.

And Economic news today continues to show that even if the Euro zone crisis was to end tomorrow- a lot of the damage to the global economy has been done. Given that the ECB expects that it will be taking action to stave off the collapse of the Euro, the ECB this morning has still downgraded its growth forecasts for this year and next. And after that it expects a very slow recovery.

The UK Trade Data also shows that the UK exports to the Euro Zone have slowed even more signaling that economic growth in Europe is weaker than many had expected already.

And as I pointed out yesterday- Interest Rate Implied Volatility continues to remain high and has not fallen as much as would have been expected if the sell-off in US Treasuries was a long-term move.

And whilst historical volatility has declined in 10yr Swaps, the front end continues to see increased volatility.  Similar rises have also occurred in Euro Swap Rate Implied Volatilities- and this confirms the perception that risk markets are complacent over the risks remaining in the Eurozone.

So I remain long duration and looking for a return to more normal relationships in the coming week.

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