The Bundesbank with a warning to carry-chasers
It turns out that everything is not hunky dory, certainly not according to Bundesbank board member Andreas Dombret who sees new risks to financial stability as a product of easy monetary policy in a global scope, especially when combined with investors hunt for pick-up in a low interest rate environment. This risk is hardly news, but the fact that the Bundesbank publicly comments on it is.
Mr. Dombret: “We do see risks, despite the fact that the markets are calm. Real-estate markets in some European countries are pretty high, corporate bond valuations seem stretched and high. The low volatility leads to market participants thinking that they don’t need to hedge”.
Indeed, the combination of carry chasing driven to extremes which includes eliminating that annoying carry-reducing hedge is almost always a recipe for trouble: It goes well until it goes terribly wrong. Also true, (realized) volatility has been low and options are still cheap (e.g. € swaption vol continues to trade very low, though the latest movement is upwards). We only need to look towards the recent days pricing on e.g. Italian bonds to see that historical measures of volatility need not be suitable for much.
We find it likely that the markets indeed are fragile and that the lack of hedges/chase for carry very well can exacerbate market movements on e.g. spread-overs.
Spread widening continues for e.g. Italien govies
Indeed, taking stock of the recent pricing on government bonds from Southern Europe, the last week looks like a rude wake-up call. For Italy for example, the 10Y spread to Germany now lies in 191bps, up 45bps in less than two weeks. The yield itself is up 35bps. For Spain the movements are similar though a bit less, and in Portugal, yesterday’s +10bp move leaves us very close to 4%. The current trajectory is likely to continue in the short term.
Wait-and-see on the EURUSD
High stability in the EURUSD FX cross after the big drops after the last ECB meeting. From the US side today’s release of Aprils FOMC minutes can have an impact though Yellen is extremely likely to carefully comment on QE3-dismantling in measured steps and with rates low for a significant period after the full stop to QE. A potential wildcard sits with details about medium-term policy issues which potentially could offer details on how the Fed sees their exit strategy and also a time-frame on it.
Also, we may need to like the Fed’s way of doing things, practically that is in terms of scheduling, as the ECB reportedly is considering mimicking a setup with 8 annual meetings and minutes with a 3 week lag.
Bank of Japan refrains from adding more stimulus
This morning the Bank of Japan did not deviate from the plan and will continue to expand the monetary base at an annual pace of 60-70 trillion yen per year. Though this was quite widely expected, the yen has strengthened on the news. BoJ is clearly more confident in the economic effects of their monetary policy.
The big bond supply today comes from the Bundebank with 5bn to be sold in the May-24 bond.
Nordea