Over recent weeks Government Bond markets have staged a strong rally, at a time when traders and investors have become increasingly concerned about the Euro zone Sovereign debt crisis and the US budget deficit. Why is that? And will it continue?
TECHNICALS
MONTHLY BUND CHART
The market’s fall from the All Time Highs of 2010 has been brisk.
More than that, it has smashed multiple supports that have destroyed hopes of the rally continuing: for example, the breakdowns through 126.53, 124.60 and the steep rising diagonal trendline support.
So medium-term bulls are dashed, but are the bears in charge?
WEEKLY BUND CHART
The rally from mid April broke the sharp downtrend, but has paused beneath the band of broken supports, which (classically) now becomes resistance.
And note too that the market has failed there before…
Look closer still.
Daily Jun 11 Bund CHART
The pause in the very short-term is interesting and though not a reversal, merits close attention.
A push up through 124.60 would be convincing strength; equally, a pull-back through the rising diagonal would be telling weakness…
FUNDAMENTALS
Over recent weeks Government Bond markets have staged a strong rally, at a time when traders and investors have become increasingly concerned about the Euro zone Sovereign debt crisis and the US budget deficit.
Given that government bonds are no more than IOU’s, one could be forgiven for expecting US and Euro zone bond markets to sell off on these anxieties. But there have been several factors at work that have driven bond markets higher, which are:
1.Fear of resurgent inflation driven by lose monetary policy,
2.Fear rising oil prices would pose a downside risk to the global economic recovery,
3.Correcting equity markets driven by risk aversion derived from the above, and
4.And general safe haven buying driven paradoxically by the Sovereign debt crisis.
But since the Sovereign debt crisis has been a Euro zone phenomenon, why has the Bund performed so well?
A significant part of the answer is to do with traders fearing that one or more of the peripheral economies in difficulty with debt and receiving financial support, might yet default on their debt.
Although the EU/EZ/IMF rescue fund was set up to prevent such an occurrence, the terms imposed on states taking the help are so draconian that they have retarded economic recovery and in some cases deepened recession making it even more difficult to meet credit obligations.
Rumours have been circulating in both the press and the markets recently that Greece is on the verge of rescheduling her debts, and while these have been denied they have persisted and contributed to the Bund rally. Investors have sought to hedge against default of a Euro zone country by buying what is essentially Blue chip German debt.
In fact, some finance ministers have publicly begun to entertain the thought of a Greek debt restructure. This has helped ease the current wave of risk aversion and the Bund has eased lower.
The ECB has today let it be known it is against a debt restructure and said it would no longer accept Greek bonds if a restructuring went ahead.
While those remarks are unhelpful, it does indicate the level of discussion concerning debt restructuring. In the end the politicians, not the ECB, will decide whether or not a Greek or indeed Irish or even Portuguese debt restructure is acceptable.
The markets seem to take the idea positively: stocks have begun to recover, and the Bund has eased lower. While a debt restructure could be viewed as a soft default, since bond holders would have to accept longer repayment periods etc. it would create them breathing space the Euro zone needs.
Simply put, one year after the Sovereign debt crisis broke, the problem remains unresolved. The effect of massive rescue fund which was meant to reassure has been neutralized because of the strict conditions insisted upon by Germany. A debt restructure would allow individual states greater room to manoeuvre.
If such a solution were to be adopted, the Bund could begin a long correction lower.
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