Morning Bond Update: US debt woes see risk-off trading emerge
The continued US government shutdown and concerns about the debt ceiling deadline on October 17 are beginning to make more market participants nervous as they look for risk-off trades, with the most classic response being to go long bunds from the present level of 140.20. On the other hand, other investors see this as an opportunity to add on risk at current levels in higher yielding corporate bonds and emerging markets bonds, as an expected equity rally on a solution will drive yields on riskier asset classes down.
The market will probably trade like a dutch auction/uniform price auction with the clock ticking towards the October 17 deadline. As long as nothing happens, downside pressure will continue to build on equities and higher yielding bonds.
The trigger points will be if market thinness can handle larger position unwinding in the next week or so and how many investors will join the risk-off ship. At the moment the fear of missing out on a potential rally is greater than the need to play it safe. Investors are convinced there are better times ahead as economic indicators continue to improve (PMI data yesterday) and regardless of the impasse in the US.
Be aware that Spanish, Portuguese and Italian bonds are performing remarkably well at the moment. This is mainly because of excessive cashflows into the euro, more than anything else. The Spanish bond auction went well and the focus right now is not on the problems of these 'Club Med' countries.