Core bonds rallied on Friday, as there were no real signs of wage pressures in the US (see more below), while curves mostly bull-flattened. The German 10-year yield retreated by 2.5bp, while the US 10-year yield tumbled by almost 7bp. US yields dropped along the curve, and the 5-year yield plunged as much as 9bp.
Core yields are likely to correct a bit higher today, but in general bonds are set to remain supported for now.
Intra-Euro-zone spreads widened, led by Portugal, which saw its 10-year spread to Germany widen by more than 10bp. Spanish and Italian 10-year spreads widened by 8-9bp as well. The general spread move should be seen as illustrating profit taking, which may continue for a while longer, but should not illustrate a trend reversal.
Especially European equities continued to take a beating on Friday, with the main indices losing more than 1% (the Portuguese market lost almost 3% again). In the US, the losses were more moderate, with the S&P 500 down by 0.29%, but this still made it the worst week for the index in more than two years. Asian equities are trading mostly with modest gains this morning, while Europe is set to open slightly higher, but in general, there should be more room for equity prices to fall in the near term.
Another bank rescue – central bank credibility hurt
The troubled Portuguese bank, Banco Espírito Santo, will be split into a good bank and a bad bank. The part dubbed good will consist of all the bank’s branches, workers, deposits, healthy credit portfolios and senior debt, and will receive a EUR 4.9bn capital injection, mostly from the money left over from the EU/IMF bailout. The good part will be offered to sale later. The more risky assets, shareholders and junior debt will be left in the bad bank, which is set to be wound down.
The rescue should resolve most of the doubts around Banco Espírito Santo, but the damage to the credibility of the Bank of Portugal, among others, has been done. The details of the rescue also serve as a reminder of how sensitive the topic of imposing losses to senior creditors remains. In general, the episode is a fresh reminder that not all the banking sector worries have been resolved, and even after the initial problems are revealed, the severity of the problems can still be hidden for quite some time. As the ECB’s stress tests loom, this is unlikely to have been the last negative surprise coming from the banking sector.
Still no signs of wage pressures picking up in the US
US payrolls came in at 209k in July, slightly less than expected, while the June gain was revised 10k higher to 298k. More importantly, there were no signs of wage growth picking up, as average hourly earnings were flat in July, which meant a modest 2.0% growth rate in y/y terms. The unemployment rate edged higher from 6.1% to 6.2%, as the labour force jumped by 329k.
The continued brisk pace of job growth still points to an improving labour market, but until wage growth shows more signs of picking up, the Fed will not be in any hurry to start tightening policy.
Later in the US, the manufacturing ISM index jumped from 55.3 to 57.1, the highest in more than three years, while new orders surged to 63.4. The US economy thus continues to perform strongly, which should gradually also start to generate more inflation pressures.
ECB and BoE meetings but no policy changes
More central bank meetings will be in store this week, with both the Bank of England and the ECB set to decide on monetary policy on Thursday. No new measures or monetary policy signals are likely to be in store, though.
On the economic data front, the highlights include the US non-manufacturing ISM index tomorrow, German June factory orders on Wednesday & industrial production on Thursday, and Chinese July trade data as well as US Q2 productivity and unit labour cost data on Friday.
In today’s calendar, the Euro-zone June PPI will be released at 11:00 CET.
German, Spanish and Austrian supply ahead
Austria will set this week’s EUR government auctions in motion tomorrow, when it will re-open bonds maturing in 2019 and 2024 for a combined EUR 1.1bn. German auctions, in turn, will resume on Wednesday with a EUR 3bn re-opening on the 5-year benchmark. Finally, Spain will sell bonds maturing in 2020 and 2024 on Thursday.
Nordea