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from Global Investing:

Three snapshots for Monday

The yield on 10-year  U.S. Treasuries, fell to their lowest levels since early October today, breaking decisively below 1.80 percent. That compares to the dividend yield on the S&P 500 of 2.28%.

The European Central Bank kept its government bond-buy programme in hibernation for the ninth week in a row last week. The ECB may come under pressure to act as  yields on Spanish 10-year government bonds rose further above 6% today.

Output at factories in the euro zone unexpectedly fell in March, the latest in a series of disappointing numbers signalling that the bloc's recession may not be as mild as policymakers hope. On an annual basis, factory output dived 2.2 percent in March, the fourth consecutive monthly slide, Eurostat said, and only Germany, Slovenia and Slovakia were able to post growth in the month.

from Global Investing:

Three snapshots for Monday

Spanish 10-year bond yields hit 6%, around the levels seen in Ireland/Portugal and Italy/Spain at the start and resumption of ECB bond purchases.

U.S. retail sales rose more than expected in March as Americans shrugged off high gasoline prices.

Currency speculators boosted their bets against the euro in the latest week. Figures from the Commodity Futures Trading Commission released on Friday showed a jump in euro net shorts of 101,364 contracts this week from 79,480 previously.

from MacroScope:

The going gets tougher for Italy and Spain

One trillion euros is a lot of money. And as we have previously noted on this blog it did a lot for stock markets early this year but not much for the real economy.

But recent bond auctions in the euro zone suggest the impact of two rounds of cheap 3-year ECB funding on the region's struggling bond market may also be fading.

Italian three-year borrowing costs surged more than a full percentage point at an auction to 3.89 percent – its highest since mid-January.

Nick Stamenkovic, strategist at RIA Capital Markets says:

Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently as the effects of the two LTROs (long-term refinancing operations) from the ECB dissipate.

That was not the only patchy bond sale recently. Italy's one-year borrowing costs doubled at a sale of short-term bills on Wednesday and, just last week, Spain had to pay dearer to borrow through medium-term bonds.

The new jitters in the market have partly been fueled by Spain's fiscal conundrum: austerity aimed at reducing its budget deficit risks choking off the very growth that is needed to repair the country’s fiscal position.

from Breakingviews:

Spain reveals holes in Europe’s crisis plan

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Rising Spanish yields have thrust Europe back into crisis mode. Policymakers thought the European Central Bank’s three-year loans had bought the euro zone some time, but markets are catching up fast.

The flashpoint is Spain. The country’s apparent inability to control its fiscal deficit - which was 2.5 percentage points higher than its target last year - and its decision to raise this year’s target shortfall to 5.3 percent, from 4.4 percent, has spooked investors. Bond-buying by Spanish banks helped to keep yields in check for a while. But the ECB-funded stimulus is wearing off. Yields on the country’s 10-year bonds are back above 5.8 percent.

The government’s decision to relax fiscal targets has placed it at loggerheads with the European Commission. However, the obsession with austerity may be self-defeating. The government is struggling to rein in spending by the autonomous regions, which were largely responsible for the budget spillover. Meanwhile, markets fret about growth; youth unemployment is shockingly high at over 50 percent, and the banking system is still weighed down by real estate exposures. Banks could face losses of 203 billion euros under a stressed scenario, according to Citigroup.

There are few easy solutions. The ECB could throw more money at banks to help them buy government debt. But Spanish lenders are overloaded with government debt having increased holdings by 52 billion euros in the two months to January, according to Citigroup. A full-scale bailout also looks difficult, as it would exhaust the euro zone’s recently-expanded bailout fund.

One option is a targeted bailout for Spanish banks, perhaps in conjunction with an external audit, as has already happened in Ireland. That would at least ease persistent concerns about property exposures, which in turn might lift some of the pressure on the government finances. In the end, however, Spain will have to fix itself. Investors would probably tolerate a loosening of fiscal targets, provided there was evidence that over-spending regions were under control. Spain also needs to press ahead with reforms to boost growth. That means labour reform, and reducing the burden on employers by lowering social security contributions.

from MacroScope:

Spain: ¿Cómo se dice “contagion”?

It was not a good day for Spain.

The euro zone's fourth largest economy had to pay dearer to borrow through medium-term bonds, a sign that concerns over the country´s fiscal problems was curbing appetite for its debt. It sold 2.6 billion euros of 2015, 2016 and 2020 paper - at the low end of the target range.

In contrast, Portugal's 1 billion euros sale of 18-month treasury bills was a successful test of market appetite for the longest-dated debt since it took an international bailout. Appetite for short-dated paper has been especially supported by the one trillion euros of cheap three-year European Central Bank funding injected into the financial system since December.

The problem is that Spain is the latest country to come into the firing line of the euro zone debt crisis. This week's tough budget was not enough to calm investor nerves and many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 – the highest in the European Union. Meanwhile, the government expects Spain’s public debt to jump in 2012 to its highest since at least 1990.

And although Spain has already sold around 46 percent of this year's planned issuance of long-term debt and therefore is in a favourable funding position compared to its peers, analysts worry it could become the next source of euro zone contagion. In the secondary market, yields on 10-year Spanish government bonds rose to their highest since January at 5.72 percent after the auction.

DZ Bank rate strategist Michael Leister says:

It was only a lukewarm auction. This shows that the LTRO (ECB's long-term refinancing operation) effect is losing momentum and that Spain is having a much more difficult time.

from Global Investing:

Asian bonds may suffer most if QE on ice

Bonds issued in emerging market currencies have been red-hot favourites with investors this year, garnering returns of 8.3 percent so far in 2012. But for some the happy days are drawing to a close -- U.S. Treasury yields are nudging higher as the U.S. recovery gains a foothold and the Fed holds back from more money printing for now at least. That could spell trouble for emerging markets across the board (here's something I wrote on this subject recently) but, according to JP Morgan, it is Asian bond markets that may bear the brunt.

Their graphic details weekly flows to local bond funds as measured by EPFR Global (in million US$). As on cue, these flows have tended to spike whenever central banks have pumped in cash. (Click the graphic to enlarge.)

Over the past several years,  inflows have driven local curves to very flat levels, but current levels of flatness are not sustainable if/when inflows begin to slow, let alone reverse.As there is a clear correlation between the Fed's "QE periods” and large inflows into Asian markets, we think the next few months will be difficult for Asian bonds markets (JPM writes)

JP Morgan says risks are greatest for Malaysia, Indonesia and Thailand because that's where foreign ownership ratios are largest -- in Indonesia for instance foreigners hold a third of local debt. Deficits in these three countries are also rising meaning debt issuance is rising faster than elsewhere, the bank warned. It advises clients to be underweight Asian local debt (countered by overweights in Latin  America and emerging Europe)

Asian currencies face risks too --from China. The yuan is up 30 percent since mid-2005 but ended March with its first quarterly loss since 2009 and many reckon China, fearful of an exports slowdown will not permit any more big rises for now. Asian governments will have to fall into step if they want their own exports to compete. And that, JPM says, is robbing the region's currencies of a major support anchor.

from Global Investing:

Yield-hungry tilt to equity from credit

For income-focused investors, the choice between stocks and corporate bonds has been a no-brainer in recent years. In a volatile world, corporate debt tends to be less sensitive to market gyrations and also has offered better yields -- last year non-financial European corporate bonds provided a yield pickup of  73 basis points above stocks, Morgan Stanley calculates.

But, long a fan of credit over equity, MS reckons the picture may now be changing and points out that European equities are offering better yields than credit for the first time in over a decade. (The graphic below compares dividend yields on non-financial euro STOXX index with the IBOXX European non-financial corporate bond index. The former narrowly wins.)

The extra yield available on equities, coupled with perceptions of a more stable macro backdrop, may encourage income-oriented investors back into stocks.

The bank has put together a 10-stock basket with an average 2012 yield of 5.1 pct (vs MSCI Europe's 3.9 pct). That is around 250 bps higher than corresponding bonds. Check out Britain's Vodafone -- its shares offer a whopping 8.3 percent yield. That's 600 bps above its 5-year implied credit yield.

That sounds tempting. But there are caveats. The best yield pickup is available in sectors where investors remain underweight -- utilities and telecoms. And a positive yield gap is not always a bullish signal for stocks, Morgan Stanley warns.  Japanese dividend yields have been above bond yields since 2008.

from Breakingviews:

ECB short of firepower as Europe gets worse again

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Smoke is again visible in the euro zone. The economy contracted in the fourth quarter of 2011 and looks like doing so again in the first quarter of this year. Sovereign yields have risen again. The European Central Bank put out the fires before by spraying one trillion euros on the banks. But its now greatly expanded balance sheet, and stubborn inflation, are big obstacles to a credible policy response.

The euro zone’s problems begin with growth. Output in manufacturing and services dropped further into contraction territory in March. Employment declined at the fastest pace for a year. That makes it harder for governments to cut fiscal deficits.

The market is having second thoughts again about Spain, whose 10-year bond yield has shot up to 5.5 percent - close to 1 percentage point above its lows in February. Last year the government targeted a deficit of 6 percent of GDP. It came in at 8.5 percent. The target is 5.3 percent this year. There must be large question marks over Spain’s ability to hit that goal. The country’s debt rose to 68.5 percent of GDP in 2011. The chances of containing it to the currently projected 80 percent of GDP in 2014/15 look poor.

For euro zone policymakers the challenges are big. To help growth the ECB ought to cut its interest rate. The problem is that German feathers might be ruffled: inflation, at 2.7 percent, is already above target. But a rate cut wouldn’t do much to ease debt strains.

Spraying out more money around the banking system would work better temporarily but any such move is hard to justify. The ECB’s balance sheet is larger now as a share of GDP than the U.S. Federal Reserve’s. It may be swollen - as ECB President Mario Draghi is keen to stress - by substantial gold holdings not present on the leaner books of the Fed or Bank of England. But a liquidity response to further sovereign strains won’t be what Germany and possibly other countries want to see.

from Breakingviews:

Safe haven tremors signal big investment shift

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Suddenly markets are shifting. The dollar is at an 11-month high against the Japanese yen. Gold has fallen by 8 percent since Feb. 28 and yields on UK gilts, German bunds and U.S Treasuries have risen sharply as expensive safe havens wobble. Global equities are up, but pensive.

All this is driven by something fundamentally good. The world economy, and the U.S. one, is improving. A third round of U.S. quantitative easing looks less likely. But a touch of normality threatens to shake the soaring edifice of safe haven bonds, scattering fallout across global forex, commodity and equity markets.

A semblance of normality is threatening because it breaks trends sustained over years and stretched to extremes: UK gilts are paying the least in three centuries, Treasuries have advanced for three decades.

Policy for exceptional crisis has brought something for everyone. QE pushed safe haven yields low in order to make money cheap for investment in riskier things – like equities and foreign currency assets. The dollar thereby became a funding currency for much else. The index of the dollar’s value against a basket of currencies peaked at about 120 in 2001 and has recorded lows in the 70s since 2008. This favoured gold, the alternative metal currency. And as commodities are priced in dollars, they too were favoured by dollar weakness.

But the dollar is rallying as Treasury yields push up. The dollar index has gone up, although it is still only at 80. The threat for inflated global commodity markets is that it keeps going higher. Commodities and gold could react very negatively. That would be a good thing. If global economic recovery is to continue – justifying the fall in safe haven bonds – oil needs to get cheaper.

from MacroScope:

Bonds take a dive

U.S. Treasuries have taken quite a battering this week, and there has been no shortage of explanations from market pundits. For some, the downturn reflects an improving economy and the pricing out of expectations for further monetary easing from the Federal Reserve. For others, the market is playing catch up after eyeing firmer inflation numbers and a better if still anemic employment backdrop.

The Fed’s statement this week lent itself to a hawkish interpretation since what few changes were made appeared positive. The bond market responded in kind, adding to a selloff that has seen ten-year note yields rise nearly 40 basis points in just over a week. George Goncalves at Nomura describes the price action:

U.S. Treasury yields had a seismic break and have finally moved this week, and boy did they move. The market blew through the range it had held for the past four months, our near-term targets and through several important technical levels, all in the space of two trading sessions.

Consumer price data on Friday have the potential to exacerbate the sell-off, says Stephen Stanley at Pierpont Securities. Analysts polled by Reuters are forecasting a 0.2 percent gain in the core measure of prices that excludes food and energy.

In the context of a Treasury market that has melted down this week, the difference between a high 0.1% rise (optically benign) and a low 0.2% advance (a little too high for comfort and not quite consistent with the Fed’s wishful thinking on inflation) could be meaningful.