Core bond yields ended marginally lower on Friday. Leaked ECB bank stress test results put modest upward pressure on yields in the afternoon, but the moves ended up being rather limited. The German 10-year yield ended the day lower by around a bp, while the corresponding US yield fell by less than half a bp. Intra-Euro-area spreads mostly narrowed.
Core bond yields are likely to head a bit higher today on the back of relief after the bank stress test results (see more below).
European equities ended lower on Friday (the Stoxx 600 down by 0.45%), but US equities had a better day: S&P 500 gained by 0.71%. Asian equities are trading mixed to slightly higher this morning, and Europe will open with gains.
Stress tests behind – not the stress
Beyond doubt the latest stress test exercise was a more credible test than similar exercises done before and the remaining capital needs seem manageable. Banks in the stagnating Euro-area economies may now be more willing to lend, but other obstacles like the new regulatory environment and weak demand remain. The macro environment will continue to be challenging.
The exercise revealed capital needs in 25 banks, but taking into account the capital already raised, the amount falls to 13 and the remaining capital need to EUR 9.5bn. Even this number is slightly misleading, as in six of the remaining banks, the capital hole is less than EUR 0.5bn. Only three banks are in need of more than EUR 1bn of capital.
As a notable source of uncertainty has passed, there should be some room for a general relief rally in equities, somewhat higher core yields and a slightly steeper curve today. However, the results are unlikely to change the overall course for the markets: core bonds will remain supported and ECB easing speculation, geopolitical tensions, turns in risk appetite and inflation numbers will continue to be important drivers.
The results should lead to some spread moves in the EUR government bond markets as well. Especially the weakness in Italian banks should incite underperformance of Italian bonds vs Spain. However, Italian banks were expected to be vulnerable in the tests, so the moves are unlikely to be great, while Italian bonds already felt some pressure vs Spain last Friday.
Belgian banks also exhibited clear signs of weakness, and after the strong performance of Belgian bonds vs France lately, the results are likely to lead some underperformance of Belgian vs French government bonds. We would find any such spread widening a buying opportunity in Belgian vs French bonds, as the French outlook is looking increasingly clouded.
A far-left regional government to cause worries in Germany?
The Financial Times writes that Germany’s far-left Die Linke is set to govern in Thuringia, with the support of the SPD and Greens, which would mark the first time after German reunification that the party would take charge of an administration. Merkel’s CDU remains the biggest party in the state, but SPD suffered severe losses after its coalition with CDU, and now seems to have opted to look for another type of government.
SPD’s leader Gabriel has insisted the government in Thuringia would not bring his party closer to Die Linke in the national parliament, but the precedent in Thuringia would no doubt increase speculation about an alternative government also on the national level and thus raise uncertainty about German politics.
ECB’s covered bond purchase announcement not that exciting
The ECB will announce the first details of the covered bonds it has purchased today at 15:30 CET. As the purchases have so far targeted only secondary markets, and no other details than the size is unlikely to be revealed, it will be too early to say that much about the future of the programme. Primary market interventions will give a better picture of the ECB’s resolve, and there the rather low issuance volumes pose a challenge for a central bank aiming for sizable purchase volumes.
An interesting week ahead: Fed, US GDP, Euro-area inflation
After a busy weekend, this week’s calendar has plenty to offer. The Fed will announce the end of QE at its meeting on Wednesday, but more interest will centre on, whether it will change its forward guidance more notably. US Q3 GDP numbers on Thursday are likely to come in at levels suggesting the US economy is not in need of huge monetary stimulus any more.
In the Euro area, the highlight will be the October inflation flash estimate on Friday. A rebound in the headline rate should finally be in the cards, partly due to base effects. The ECB’s tolerance for further downward surprises in inflation should be quite low. In addition, the ECB will release the latest bank lending survey on Wednesday, which will be very interesting especially after the bank stress test results.
Also today’s calendar looks interesting. The German Ifo at 10:00 CET will continue to feel downside pressure. As last week’s improving PMIs raised expectations, there is more room for a disappointment. The September credit numbers for the Euro area will be out at the same time. In the US, the preliminary Markit composite PMI will be released at 15:45 CET and the September pending home sales index at 16:00 CET.
German, Italian and US supply – coupon and redemptions boosting Spain and Italy
This week’s bond supply will start tomorrow, when Italy will sell zero-coupon bonds and linkers. Germany will re-open its 10-year benchmark for EUR 4bn on Wednesday, while Italy will sell benchmark bonds and floaters on Thursday.
In the US, USD 29bn of 2-year notes will be sold tomorrow, USD 15bn of 2-year floaters & USD 35bn of 5-year notes on Wednesday and USD 29bn of 7-year notes on Thursday.
The flow of coupon and redemption payments will continue to support the bond market this week. There will be another EUR 40bn of such payments in store this week. These will stem mainly from Spanish and Italian bonds, giving these markets an additional boost.
Nordea