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Sunrise Market Commentary

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ECB heads for gradual exit from liquidity measures

Fri, Nov 6 2009, 08:10 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Thursday, the yield curves in the US, euro zone and UK steepened further amid rising concerns that central bankers are keeping their policy too loose for too long and that sooner rather than later inflationary pressures may emerge. This was especially the case in the US and the UK, where the Fed had reaffirmed its commitment to keep the Fed funds rate at exceptionally low levels for an extended period and in the UK where the Bank of England yesterday decided to expand its QE policy by another £25B to £200B. In both the US and the UK, the 10-year break even inflation rates reached new recent highs after the decision. In the euro zone, a significant different message was heard, as the ECB moved closer to a gradual exit from its emergency liquidity measures after ECB president Trichet strongly hinted that the December 12-month tender will be the last. The less expan-sive policy of the ECB is also reflected in the break even inflation rates in the euro zone, which are still some way off the recent highs. Overall, the eco data didn’t play a major role neither did the strong rebound on the equity markets, as markets are now awaiting the key US Payrolls report.

In a daily perspective, US 2- and 5-year yields fell by respectively 2.4 and 4 basis points, while 10- and 30-year yields were unchanged. In the euro zone, German 2-year yields moved higher in a first reaction on Trichet’s liquidity comments, but fell back afterwards and closed 0.5 basis points lower. German 10-year yields however rose by 3 basis points. In the UK, the steepening was the most visible, as UK 2-year yields fell by 1.3 basis points, while 10-year yields rose by 6.2 basis points.

ECB heads for gradual exit from liquidity measures

Today, all eyes will be on the US payrolls report (October), but also the German fac-tory orders (September) are scheduled for release. Last month, the payrolls report disappointed as it fell short of expectations. Employment dropped by 263 000, while the consensus was looking decline by 175 000. For October, the consensus is again looking for a drop by 175 000 in the official report. We have no reasons to distance ourselves from the consensus as we don’t believe that last month’s weakness puts the improving trend in the payrolls into doubt. However, if the payrolls would again come out weaker than expected, markets might react disappointed. In Germany, the factory orders are forecasted to rise for the seventh consecutive month in Septem-ber.

With regard to monetary policy, ECB’s Gonzalez-Paramo will speak today in London, while Fed’s Evans and Duke will speak to the Community Bankers conference in Chicago. We don’t expect them to break new ground after this week’s central bank meetings. At the ECB press conference, Trichet sounded more optimis-tic on the economic outlook yesterday, as he said that the ‘available data and survey-based indicators continue to signal an improvement in economic activity in the sec-ond half of the year’. Trichet also strongly hinted that the ECB would start withdraw-ing its emergency liquidity measures from next year onwards. ‘Looking ahead, and taking into account the improved conditions in financial markets, not all our liquidity measures will be needed to the same extent as in the past’. During the Q&A, Trichet said that he would say nothing to dispel the market view that the ECB won’t offer 12-month loans next year and left open the possibility to charge a higher interest rate at the December 1-year tender. In Sweden, the Riksbank yesterday announced that it would start to charge a supplement on top of the longer-term three, six and twelve months repo loans, as the situation in financial markets has improved. The supple-ment will be set at 0.25 percentage points for loans with three-month and six-month maturities and at 0.30 percentage points for loans with twelve-month maturities. The Bank said that ‘by gradually raising the price in line with the further improvement in market conditions, the facility will be phased out naturally and the banks will be en-couraged to gradually reduce their dependence on Riksbank loans’. A similar ap-proach could also be followed by the ECB for their supplementary tenders, as the 6- and 12-month Euribor rates are now at or even higher than the 1% level at which the ECB provides the funding. For a complete review of the ECB meet-ing, we refer to our Flash.

Regarding bond trading today, the US Payrolls report will be the key driver. Follow-ing the Fed’s commitment to keep rates low for an extended period a better than ex-pected report may result in a further steepening of the US yield curve, as it may raise concerns that the Fed is keeping rates too low for too long. In the euro zone, the steepening should be less outspoken after the ECB moved closer to a gradual exit from its emergency liquidity measures. On the other hand, a weaker than expected report may support bonds, but after the recent deterioration in sentiment, we feel the upside is rather limited, unless equities would fall below key support at 1019 in the S&P.

Regarding the European bond market, the longer-term bullish technical picture of the Bund started to deteriorate after the Bund fell off the highs at around 123.00 and broke below its long-standing uptrend channel. It didn’t however come to a real test of the September lows at 119.85 and the Bund tried to recoup its lost uptrend channel, which failed for now. This suggests that the upside is limited and a new test of the lows may be looming, in case the report comes out stronger than expected.

Regarding the US Treasury market, the technical picture of the US T-Note future is very similar to the Bund future, as the T-Note future has also fallen off the highs (119-729) since early October and rebounded before a test of the September lows (116-18) occurred. On Tuesday, the US T-Note tested but failed to break above the neck-line of a potential double top formation at 118-27, which is a bearish signal.

In the UK, the calendar contains the PPI inflation data.

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Published on  Fri, Nov 6 2009, 08:10 GMT