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Sunrise Market Commentary

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We mention only a speech of ECB Weber on "after the crisis"

Fri, Nov 20 2009, 08:12 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Friday, Global bonds profited from a correction in equity markets, but only cautiously though. Gains were indeed modest, as yield changes illustrate. US yields fell by 2-to-4 basis points, the short end favoured because of the equity losses. In EMU, German yields were down around 1.5-to-2 basis points. Indeed, technicals (resistances 119-29 T-Note future and 122.44 Bund future), stronger data and the fact that equities plunged sharply after the US opening, but steadied afterwards explains why bonds couldn’t gain more. Intra-EMU spreads versus Germany widened as is usually the case when equities correct. However, the widening of the weakest credits like Greek (+13bps.) and Ireland (+7 bps) caught the eye.

Intra-day, the Bund started the session little changed, but vey gradually dwindled lower till noon, despite equities trading a bit heavy. However, losses never amounted to more than 15 ticks and were erased at the start of US trading. The Spanish and French auctions went well, without being spectacular. There were no eco data releases in the euro area and no other events that could inspire investors to take positions. It all changed during the US session. The bid picked up from the start of US trading as equities continued to struggle. Initial claims confirmed the stabilization in the labour market, but as they were in line with expectations, they failed to impact trading. Following the opening of cash equity trading, the correction intensified and equities plunged lower. Other riskier assets like commodities were hit too, but in a more moderate way. We didn’t see any robust trigger to explain the weakness and look at it as a not totally unexpected technical correction for now. The 3-month T-bill fell to 1 basis point and also further out the bill sector, issues fell to extremely low levels. Some observers link it to end-of-year positioning. So it shouldn’t surprise the short end of the coupon curve outperformed. The Philly Fed survey on manufacturing was stronger than expected, but Treasuries continued to move higher after publication. However, when the T-Note future touched 119-29 (contract high) the tide turned and Treasuries erased good chunk of the earlier gains. Around that time equities had hit the bottom and started to move sideways, which continued into the close.

Intra-day, the Bund started the session little changed, but vey gradually dwindled lower till noon, despite equities trading a bit heavy. However, losses never amounted to more than 15 ticks and were erased at the start of US trading. The Spanish and French auctions went well, without being spectacular. There were no eco data releases in the euro area and no other events that could inspire investors to take positions. It all changed during the US session. The bid picked up from the start of US trading as equities continued to struggle. Initial claims confirmed the stabilization in the labour market, but as they were in line with expectations, they failed to impact trading. Following the opening of cash equity trading, the correction intensified and equities plunged lower. Other riskier assets like commodities were hit too, but in a more moderate way. We didn’t see any robust trigger to explain the weakness and look at it as a not totally unexpected technical correction for now. The 3-month T-bill fell to 1 basis point and also further out the bill sector, issues fell to extremely low levels. Some observers link it to end-of-year positioning. So it shouldn’t surprise the short end of the coupon curve outperformed. The Philly Fed survey on manufacturing was stronger than expected, but Treasuries continued to move higher after publication. However, when the T-Note future touched 119-29 (contract high) the tide turned and Treasuries erased good chunk of the earlier gains. Around that time equities had hit the bottom and started to move sideways, which continued into the close.

Today, the US eco calendar is empty. In the euro zone, only some second-tier data are scheduled for release. The Italian industrial production data (September) are outdated and therefore won’t have any impact on markets. In Belgium, we will receive the November consumer confidence data. After a slight worsening in October, it will be interesting to see whether consumer sentiment improved again in November. Not only the eco calendar is empty, the event calendar is razor thin too. We mention only a speech of ECB Weber on “after the crisis”.

Following the non-monetary policy ECB meeting and given the title of the speech, Weber might dwell on the exit strategy. He was the first ECB governor who suggested the ECB would discontinue its 1-year LTRO tender in 2010, an idea later underscribed by ECB president Trichet. However, yesterday evening Mr. Trichet, Bini Smaghi and Wellink already spoke and didn’t unveil much new, specific info on the exit policy, suggesting that the discussions will continue and be finalized at the December meeting. We retain from Trichet’s comments that the exit will occur naturally and gradually. He also said that the ECB had avoided deflation because inflation expectations were well anchored. The speech of Bini Smaghi was more interesting. He said markets may be too optimistic on growth, but underlined that the economic outlook had improved significantly in the last six months. He also repeated that the exit would be timely and gradually, but sounded nevertheless a bit concerned about the loose policy and its effects, even if he called the policy currently appropriate. Bini Smaghi urged national authorities to address the overreliance on cheap, unlimited ECB funds by some banks. Other slight hawkish comments include that keeping rates unchanged when the economic outlook is revised up is a loosening of policy. He also said it is riskier to exit too low than too early. We will during the day verify whether these headlines represent the tone of his speech. Bini Smaghi is wellknown for his excellent speeches and analysis, but he not always is a good pointer for the next ECB decisions. Anyway, we don’t consider his comments as a clear indicator about when and how the ECB should start his exit policy. We probably only know for sure after the December meeting.

Yesterday, France and Spain sold a total of €10.6B euros of bonds. Demand was strong. France sold 7.336B of 2-to-5-year bonds, near the top of the €6.5-to-7.5B range, while Spain re-opened its 15-year bond and sold €3.3B of paper. The US Treasury announced it will sell $118B of notes next week, including $44B of 2-year notes, $42B of 5-year notes and $32B of 7-year notes. The size of the 5- and 7-year note auction was upped by $1B each compared to the previous one, while the size of the 2-year note was unchanged. The auctions take place from Monday to Wednesday. The 5- and 7-year note will raise all new cash, while the 2-year will raise approx. $23B new cash.

Regarding trading, Asian equities limit the losses, dissociating from Wall Street’s steep losses. Given the dearth of today’s calendar, equities might be the driver. The big question is whether there will be follow through selling. This is far from certain. The correction yesterday didn’t continue into the close and the S&P tested nicely the uptrendline, but failed to break through. We don’t want to sound too optimistic as we are looking for more sideways trading in the next weeks and some more correction, but the market may find yesterday’s price action encouraging and want to retest recent highs. For bonds, we think that technical resistance at the longer end (122.44 for the Bund and 119-29 for the US Treasury Note future) will block the upside, unless equities plunge again, while yields at the short end have dropped probably far enough to have fully discounted recent Central Bank softness. Upcoming US supply at the 2-to-7-year sector next week and some good, albeit no exceptional gains for bonds may lead to pre-weekend profit taking, once more unless equities plunge.

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 (which if broken would violate the higher low higher high configuration). The Bund managed to move away from these lows and a few constructive sessions lifted it to 122.50 yesterday. The Nov 3 high at 122.44 and the broken uptrend at around 122.50, under test now, are still the first point of reference. The longer end of the bond market seems to be in a wait-and-see period from which we don’t see it exit in the near future. Sideways trading in the 120.51/119.85 to 122.44 range is still favoured, but if the 122.44 resistance is broken, it would open the road for a retest of the 123.04 contract high, where profit taking should be considered.

Regarding the US Treasury market, the technical picture of the US T-Note future improved on Monday as Bernanke’s comments pushed the contract up to a 119-29 high on Thursday, matching contract high. A bullish inverted head and shoulder formation with neckline at 118-28+ is now reigning and has final targets around 120-30. The short term picture is bullish, but we have still some second thoughts about the upside. We wouldn’t jump on the bandwagon, but use eventual retests of the contract highs to offload long positions.

Also in the UK, the calendar is empty today. BoE Executive Director for Markets, Paul Fisher, said yesterday that all options regarding the extension of QE remain open when the MPC will decide at the February meeting. The quarterly inflation report meetings of the MPC provide a much better background to make decisions on QE than the monthly meetings. Interestingly, Fisher spoke very frankly about the effect of QE on asset prices, besides the desired effect of narrowing spreads between e.g. Libor and OIS. "All of these (QE) operations are designed in various ways to increase asset prices; it is an intentional, deliberate act to carry out policies which would increase asset prices". He also joined the choir of central bankers that stated in recent days that there are no signs of “bubble” behaviour in the markets. "You would normally (in case of bubbles) expect to see leveraged money coming into markets, you expect to see people trying to do all sorts of ways to push yields up, expect to see in property markets valuations going over 100%.All those sorts of behaviours you are not seeing yet". Regarding the timing of the unwinding of QE, he said it should be done when the MPC thinks inflation is going to be above target over the forecast horizon. Of course, Central banks want by their actions influence the economy, not only via the credit transmission, but also via higher asset prices, but saying it all so brutal and overtly is to our knowledge a novelty. Isn’t it an open invitation to put the cash to work in the riskier markets?

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Published on  Fri, Nov 20 2009, 08:12 GMT