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Sunrise Market Commentary

US Treasury sell−off slows

Thu, Jul 24 2008, 07:04 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Wednesday, global bonds traded weak in the European and early US sessions, but found their composure later on and closed the session with small, insignificant losses and the shape of the curve little changed.

The European data were uneventful and the US eco calendar even empty. In the morning, trading was dominated by the presence of the key support level (109.65) in the Bund that was nearly tested in early session, after which the market stabilized at slightly higher levels. In the US session, President Bush dropping its threat to veto the housing bill temporary boosted equities, pushing bonds lower. Also the up-coming 2-year T-Note auction weighed. However that auction went well and when a temporary dip on the Beige Book describing activity as moderating, but price pressures as elevated or increasing, was reversed some short-covering intervened, pushing bonds higher and erasing most of the intra-day losses.

Interestingly, oil prices fell another 4 $/barrel yesterday, but the fall did occur more than one hour after US inventories were reported higher than expected. Still more important, when oil prices plunged, equities didn’t move much. Does this mean that its impact on equities and thus Treasuries is loosening?

US Treasury sell-off slows

The eco calendar heats up today, as it contains the weekly initial claims and the June Existing Home sales. NY Fed Geithner and SEC Cox testify before the House Committee, while the Treasury will hold a 21 Bn. $ 5-year Note auction.

Yesterday, President Bush dropped it threat to veto the housing bill that is now approved in the House and goes to the Senate. This is a positive for both the GSE’s and for the housing market. Fannie Mae’s bill auctions were mixed, the spread to the 3-month T-Bill tightened by 13 basis points to 101 basis points, but still sharply wider than in the July 2 auction when it was 51 basis points. However, the spread to Libor continued to cheapen from -29 basis points to -16 basis points, which is cheap compared to the pre credit crisis periods. However, the auction suggests that the overall situation is improving or at least not alarming anymore.

Regarding the initial claims, these fell sharply two weeks ago and edged only modestly higher last week (366 000). Analysts are questioning whether the labour market is improving. We suspect it isn’t as other anecdotal evidence points to a worsening of conditions. Special factors are probably at play: the model changeover at some plants (cars/textile) or problems in implementing the extension of the period claimants get an allocation. Some normalization could take place over the next weeks, if we are right. Existing Home sales are expected to have declined by 1% M/M in June, following a 2% M/M jump in May. Existing Home sales seems to be in a bottoming out process since the start of the year. However, the pending home sales that lead Existing Home sales fell in May which would indeed point to a decline in the June Existing Home sales. The latter were in the past no market mover, because it wasn’t the timeliest indicator for the housing market. However, in the current circumstances, we admit its importance has increased and markets regularly react in case of surprises.

The 31 Bn. $ 2-year Note auction went well. The stop at 2.82% was near the bid in the WI at the stop. The bid/cover of 2.42 was below June’s 2.64 and an average 2.60, but given the upped size it was not bad. The Indirect bid and takedown were very large for the second consecutive month. The result bodes well for today’s 21 Bn. $ 5-year Note auction, which size has also been upped sharply in recent months. It will raise all new cash upon settlement, which is a negative. Last month’s auction went very well. The run-up in yield in recent sessions, which brings it again near the cycle high, makes us think that the auction will go well.

Regarding trading, Treasuries had a fairly quiet session yesterday, closing with some modest losses. The sell-off in recent sessions had left the market oversold and when equities’ rally slowed, there was room for some short covering, especially as the Sep Note future arrived at a support area. Also the strong demand at the 2-year auction should be considered as a positive. Treasuries aren’t out of the woods yet and it is too early to call off the alert, as a re-run to the cycle highs in yields cannot be excluded, but cautiously we think that Treasuries are in the process of bottoming short term ahead of the new key July eco data to be released from the end of next week onward. For today, the June Existing Home sales may still be a hurdle. We expect them weaker, as does the consensus, but unexpected strength could hit Treasuries, as it would suggest the worst is over for the housing sector, especially in connection with the housing bill, a housing market supportive factor. A strong 5-year Note auction would be a positive suggesting that investors start to see value at current yields. So, we continue to opt for sideways price action in Treasuries near term. For the Sep Note future the boundaries of this ST sideways range may still be 116-02 to 113-02. Equities should start a congestion process, relieving pressure from Treasuries that might start looking more to eco data.

Bund does not fall below key support, but can it move higher too?

The euro zone calendar is well-filled today with the PMI surveys, the German IFO indicator and business confidence figures in Belgium, France and Italy, all for July. These data should give us a clear indication of the growth outlook in the euro zone. Last month, the PMI figures fell unexpectedly below 50, to 49.3, indicating a contraction in economic activity. In July, the index is expected to stay below the benchmark of 50 and forecasted to come out even slightly lower (consensus 49). The IFO business climate indicator is forecasted to stay above the LT average of 96.6, at 100.1, down from 101.6 in June. However, the trend is down.

The series of weak bond auctions continued on Wednesday, as demand for the new 30-year Bund (3.94 Bn. Euro) didn’t cover the offer (4 Bn. Euro). Without the Bundesbank retention of 0.79 Bn. Euro, the auction would even have been undersubscribed despite the small size. Also the other details of the auction pointed to weakness. The small size was not only an advantage, but also a disadvantage as it is too small to be included in the CTD in the 30-year future contract and maybe is a hurdle for benchmark status. The auction occurred at an average yield of 4.91%.

Regarding trading, the Bund sell off stopped yesterday as a very key support level (109.65) barred the road down. As indicated yesterday, a break lower (which corresponds with 10-year yields above 4.70%) would have meant a meaningful further deterioration of the technical picture, also with longer term consequences. The market opened modestly higher this morning on the overnight movement of Treasuries. However, that was a short covering issue and thus not quite representative for what has to come. Nevertheless, we expect buyers to come in soon, also as today’s PMI’s and business confidence will confirm that growth is slowing rapidly in the euro area. Lower oil prices are helping to moderate (financial markets) inflation expectations and thus it isn’t excluded that some ECB members start to talk a bit softer too. That complex of factors should give the European bonds some upside.

In the UK, the calendar is thin with only the key retail sales released today. In May, they came out surprisingly strong at the fastest monthly rate since series began in 1986. The details showed that food and clothing sales were boosted by the warmest May ever. In June, the retail sales are expected to fall again as the May figure was considered as an outlier. In May, the market reacted quite sharply. In the evening BoE’s Bean speaks at the CBI.

Currencies: dollar extends (mostly oil-driven) rebound

On Wednesday, the dollar extended its rebound against the euro (and against most other majors). On Tuesday, oil was the dominant factor to support the US currency and also yesterday, the intraday correlation between oil and EUR/USD was again very high. Markets are turning somewhat less focused on the theme of the credit crisis and the improvement in the global stock market sentiment also might have been supportive for the US currency. Later in the session the Beige Book painted a slightly less bright picture of the US economy, but continued to register elevated or even increasing price pressures. The report pushed US yields slightly higher and also helped the dollar to reach intraday highs against the single currency with EUR/USD testing bids in the 1.5670 area. EUR/USD closed the session at 1.5698, still a decent gain of the dollar compared to the 1.5786 close on Tuesday.

Today, the calendar in Europe contains the Advance PMI releases for the month of July, the German IFO indicator and business confidence indicators in some other European member states. In the US, the initial claims (were surprisingly low over the previous weeks) and the existing home sales are scheduled for release. The US data probably will only have intraday impact on trading. However, this time also the European side of the equation deserves some attention. In this respect it will be interesting to see whether a negative surprise in the European data, if it occurs, does change the market expectations for ECB monetary policy action and/or for the single currency. At the moment of writing, the headlines of an interview with EU’s Alumina hit the screens. The Commissioner considers calls exchange rates a real problem, sees the euro overvalued but recognizes the risk for a further fall in the US dollar.

Last week, EUR/USD tested the top of the MT term sideways trading range as resurfacing credit concerns (GSE’s) weighed on the US currency and EUR/USD briefly traded above the previous highs at 1.6020. However, there was no follow-through price action to confirm this break. An easing of the credit concerns after the results from (some) US financial majors and even more a sharp decline in oil prices eased the pressure on the dollar. Recently, we advocated that there is not a compelling reason for EUR/USD to engage in a new strong up-leg beyond the 1.6020/40 range tops as we expect European data to show ever growing signs of weakness in the European economy, too. Today’s confidence data in this respect could be an interesting test case. On the other side of the Atlantic, the feeling is that the Fed has the intention to raise rates as soon as possible. However, until now, currency markets react in the first place to the oil price rather than to eco data (or central bank guidance). Will this pattern be amended by today’s (European) data?

Last week and early this week, we argued that EUR/USD had to move away from the EUR/USD 1.60 area soon and in a convincing way to avoid the risk of an additional USD stop-loss selling move. The sharp decline in the oil price helped this scenario to come true this week. On Tuesday, the pair fell below the ST uptrend line/channel bottom (today at 1.5845) and this is a ST USD positive. So, we hold on to our view that the topside in this pair should hold and maintain our cautious sell-on-upticks approach. The target of the channel break comes in at 1.5488.

Except for the sharp spike higher at the start of European trading yesterday morning, oil was also the most important factor for USD/JPY trading yesterday. The pair tried (and still tries) to regain the previous highs in the 107.75 area in a sustainable way. Equity markets apparently were less decisive than the oil prices. The pair closed the session at 107.90, compared to 107.32 on Tuesday.

As was already the case over the previous the moves in EUR/USD and USD/JPY obviously were dollar moves. EUR/JPY still holds a very tight range in the 169-area. So, the highs and the psychological level of 170 remains within striking distance.

This morning, Japanese trade balance data came out weaker than expected. Asian (and in particular Japanese) stocks continue to perform well, but for now this has no big impact on yen-trading this morning.

Looking at the charts, the turmoil on global markets caused USD/JPY (and EUR/JPY) to temporary drop below first important support levels (USD/JPY 104.99; EUR/JPY 166.09) last week. However, this signal was soon reversed. USD/JPY is now again in the previous sideways trading range (cf. graph). Oil, (the easing of?) credit concerns and the global stock market performance remain the key drivers for this pair. We had/have a neutral view on USD/JPY. Recently, the 200-day moving average (today at 106.99) proved to be a strong resistance. A sustained break above this level (and above the 107.75 reaction high= neckline double bottom) materially improves the technical picture in this pair. However, we are still a bit reluctant to jump on a move that is so highly depended on the oil price. On top of that, key technical resistance levels are lining up 107.75 (still under test, and 108.58; cf. graph). We take a tactical approach and look how the range top behaves. A correction in EUR/JPY (if it occurs) also might make further gains in USD/JPY less easy. For investors who want to go dollar long we prefer USD/EUR rather than USD/JPY, for now.

It hasn’t been the case for long, but on Wednesday, EUR/GBP showed quite some impressive price action. The pair opened the session in the 0.7920 area, but declined throughout the whole session, with the BOE minutes the catalyst for this move. Those minutes showed a surprise 7-1-1 vote to leave rates unchanged and especially the one vote in favour of a rate hike (from Besley) apparently was a surprise to the market. The global framework for the BOE policy going forward was not that different from recent BOE guidance, but the BOE making its next decision more dependent on the new inflation rapport available next meeting might have been a factor that tilts slightly more to a rate hike and that supported the sterling. Rumours on possible take-over targets in the UK banking sector could have been a sterling supportive factor, too. EUR/GBP closed the session at 0.7850, a decent gain for sterling compared to the 0.7925 close on Tuesday.

Today, the UK retail sales are on the agenda. Markets will look out to what extent the May figures was an outliner.

Since mid April, EUR/GBP developed a very uninspiring consolidation pattern (0.7766/0.8098). We turned neutral as the pair shows no trading momentum at all. Several attempts to move higher ran into resistance. Early last week a test of the key 0.8033/34 area was again rejected and yesterday’s sharp move brings the pair close to important support levels. We are a bid surprised by yesterday’s sharp reaction to the Minutes and in a longer-term perspective we hold on to our sterling skeptic attitude. However, after trading in a very narrow range for such a long time, a break of key support levels could trigger an additional repositioning short-term. The pair dropping below 0.7831 would be an important warning signal. A break below 0.7766 would raise a red alert to our sterling negative view (Stop-loss protection).

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Published on  Thu, Jul 24 2008, 07:17 GMT

Archive

• US Treasuries profit from plunging equities
  Published On Fri, Sep 5 2008, 07:17 GMT
• US Treasuries eke out more gains on technical grounds
  Published On Thu, Sep 4 2008, 07:12 GMT
• US Treasuries rally higher, as equities cannot hold on to their early gains
  Published On Wed, Sep 3 2008, 07:10 GMT
• US Treasury trading resumes
  Published On Tue, Sep 2 2008, 07:09 GMT
• Inflation decline supports short end European yield curve
  Published On Mon, Sep 1 2008, 07:16 GMT

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