• Home ::
• Fundamental ::
• Analysis Reports ::
• Sunrise Market Commentary

• Send
• Print
• Add To
• Rss

Sunrise Market Commentary

0761565f-47cd-40c4-bc61-bb0830ebdbaf

0

0

US Treasuries surge as Argameddon scenario draws closer

Tue, Sep 30 2008, 09:20 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Monday, global bonds rallied exuberantly, as financial stress reached critical levels. At least four European banks and US Wachovia needed a bail-out or were taken over by peers under market pressures, hitting equities and other risky assets and flooding the government bond markets with safe haven money looking for shelter. The rejection of the TARP plan by the House of Congress (228-205) later in the session only exacerbated the fear leading to collapsing US equities that closed down about 9%, the biggest one day decline since the 1987 equity crash.

The Fed already before the rejection took draconic liquidity measures, increasing its dollar swap lines with foreign central banks, that allows the latter to inject dollar illiquidity in their constituency, from 290 billion $ to 620 billion $, while at the same time increasing the size of its 84 day TAP auctions to 75 billion $ from 25 billion $. Also other central banks reacted by injecting liquidity in the system. The ECB allotted a massive 120 billion euro in its special 38 day refinancing operation.

The decline in yields in both US and EMU was massive too and the curve steepened but by far more in the US than in EMU. In the US, 2-year yields fell 44 basis points (1.66%), while the 10-year was down 27 basis points (3.58%). In EMU, German yields dropped by 22.6 basis points at the 2-year and by 19 basis points at the 10- year maturity.

While markets will start looking whether the US Congress will succeed in putting another package together, it should be clear that Central Bankers remain fully involved in the end-game that is currently played in the markets. Liquidity provision remains more than needed of course, but a concerted action on rates looks to have come closer, also in EMU. The timing is however still difficult to pinpoint. Ideally, such action should follow some global plan tackling the underlying problem in the financial sector to give it maximum leverage in markets. However, are central bankers able to wait for that? It is now obvious, even for the ECB, that this financial crisis will push the global economy into a recession, maybe a protracted one. That should ease inflation fears and allow a forward- looking central bank to brush current actual too high inflation off the list of concerns. A further steepening of the EMU curve looks very likely.

US Treasuries surge as Argameddon scenario draws closer

Today, the calendar is well-filled with the S&P Case Shiller home prices (July), the Chicago PMI (Sep) and consumer confidence for September. Last week, the data showed a deterioration of housing market conditions with sales coming out lower than expected and prices falling 0.6% M/M in July according to the OFHEO house price index. S&P Case Shiller home prices are expected to show a drop of -16.0% Y/Y after falling 15.9% Y/Y in June, but a weaker figure should not surprise. In July and August, consumer confidence rebounded on lower energy prices, but is expected to come out slightly lower in September (55.0 from 56.9). The Lehman bankruptcy and bail-out of AIG are expected to have some, but maybe only limited impact on consumer confidence, but we put the risks on the downside of expectations as labour market conditions worsened further. The Chicago Purchasing Manager is expected to come out at 53.0 in September after reaching 57.9 in August. Regional PMI surveys released earlier this month showed a mixed picture with the Richmond and NY Fed surprisingly weak, while the Philadelphia Fed came out very strong. We put the risks on the downside of expectations after turmoil in financial markets increased during the last weeks of September. The August spike also looked unsustainable in the first time as it was so far out of line with all indications about the economy.

Yesterday, markets behaved extreme as the daily changes in equities, bonds and spread products showed. The markets were/are clearly balancing on the edge of the cliff and one cannot exclude a meltdown. Ever more, markets are coming to a standstill. Activity has slowed dramatically in numerous markets and stopped in some others. Authorities should look for solutions. We suppose that Congress will re-start negotiations on a new rescue package, but not today. The market obviously looks to the Fed for relief. Liquidity providing measures have been taken yesterday and will be prolonged as long as needed. However, it is obviously that this isn’t the panacea. So the market starts considering rate cuts. The relevant October FF future stands at an implied 1.61%, suggesting that chances on an inter-meeting 50 basis points rate cut are considered high. A 50 basis points FF rate decline is discounted completely for February 2009. It is difficult to get the timing of such a move correct, but after the rejection of the TARP in the US, the difficulties of several banks in Europe and the standstill in money markets, everything points to the need for a confidence building measure. The extreme values of the VIX in the past always led to a kind of government action (recently Bear/F&F/Paulson plan…). With Congress out of the game and European governments probably not ready to act yet in concert, the burden may lay on Central Bankers once more. In the current environment, price action is violent and event driven. Therefore, it makes little sense to put forward fine strategies.

From a technical point of view, the S&P shows again a Marubozu (exhaustion signal): A very large daily move opening at the highs, closing at the lows with the index hitting an extreme (low). We saw recently (cf. graph) more of these signals that indeed were followed by a rebound, albeit only (very) temporarily. Do we get a similar reaction today? On which government measure?

European yields fall dramatically

Today, sentiment on the equity markets will again dominate trading. Yesterday’s crash of the European and US equity markets heavily supported the bond markets with the short end outperforming. As a result, there was a massive steepening of the European yield curve. Investors are now increasingly looking to the central bankers to restore confidence in the markets. In their battle to keep the financial system turning, the ECB yesterday injected EUR 120 B via its new 38-day refinancing operation and doubled the swap lines for USD liquidity from USD 120 to 240 B. However, more will be needed and in this context the rejection of the US bailout plan by the House is a major disappointment for the markets.

The heavy declines of the stock and commodity markets illustrate the deflationary impact of the current financial turmoil. Yesterday, the CRB commodity index and in particular oil prices plunged lower, while the rapid deterioration of the growth outlook should prevent second round effects from materializing. As such, the decline in the euro zone headline inflation rate will continue over the coming months. Today, the CPI estimate for September will be released and is expected to decline from 3.8% Y/Y in August to 3.6% Y/Y in September, after reaching its peak (4.0% Y/Y) in July. Looking at the national data, we put the risks however slightly on the upside of expectations with German CPI falling from 3.3% Y/Y to 3.0% Y/Y, which was a bit disappointing as the consensus was looking for an outcome of 2.9% Y/Y. Also Belgian inflation disappointed, rising from 5.39% Y/Y to 5.46% Y/Y, while in Spain, CPI came out lower than expected at 4.6% Y/Y (from 4.9% Y/Y). The current developments have the potential to soften the ECB stance on inflation and bring rate cuts on the table sooner rather than later. In this context, Thursday’s ECB press conference will be very interesting. In the current environment, we remain bullish on the short end of the curve and support a further steepening of the European yield curve. Today, ECB’s Trichet and Gonzalez-Paramo are scheduled to speak.

On the money market, the ECB will hold its 7-day refinancing auction today. Last week, banks bid very aggressively with the marginal and weighted average rate rising to new highs at respectively 4.73% and 4.78%. Regarding the intra-EMU government bond spreads, the safe haven flows heavily favoured German government bonds and lead to a massive widening of the spreads. Yesterday, Belgium sold only EUR 1.4 B of its 3 and 6-year OLO’s and even accepted no bids for its 10-year benchmark. In response to the weak demand, the spread widened dramatically from around 50 bps to more than 60 bps currently. Italian government bonds performed even worse following very weak demand for its BTP and CCT auctions. The numerous bailouts across the European banking landscape does point to a further widening of the government bond spreads.

In the UK, the calendar contains some second tier data. Yesterday, the Bank of England injected GBP 40 B via an emergency three month operation to ease the liquidity strains in the UK banking system, where the liquidity spread has exploded to 155 bps.

Currencies: US dollar holds up well despite rejection of bailout plan

On Monday, the credit crisis flooding the European bank universe hammered the euro against the dollar. Early in Asia, EUR/USD was still traded in the 1.4550 area, but in the run-up the European trading session the euro came under heavy pressure as traders found the European financial sector in disarray at the start the new trading week. A series of stop-loss selling waves sent the pair to the 1.4305 area early in European trading. EUR/USD then held a rather sideways trading pattern, looking out for the fate of the US bail-out plan. Rising uncertainty on the whether or not the plan would be approved gradually caused the dollar to give back some of the early gains against the single currency and the poor stock market opening in the US temporary weighed on the US currency, too. US lawmakers rejecting the bailout plan caused some violent spikes higher in EUR/USD, but after all the dollar losses on this high profile (USD negative) event were still not excessive. So the market apparently still sees a chance for some kind of US plan passing in the days to come. Whatever the explanation, EUR/USD closed the session at 1.4434, still a decent gain for the dollar compared to the 1.4614 close on Friday. The sharp deterioration in the global growth expectations (and deflation fears) also hammered the oil price, but the intraday correlation between oil and EUR/USD was not as close as it was often the case recently.

Today, the calendar contains again a series of releases that under normal circumstances would get ample market attention. In Europe the CPI estimate for September is scheduled for release. In the US the Chicago PMI and the consumer confidence are on the agenda. However, the developments on global (credit) markets probably will continue the set the tone for trading on all markets.

In previous days, we advocated that US bail-out plan as such, even if the details and the specific impact for markets and the economy remain subject to a high degree of uncertainty. Of course after yesterday’s events, this factor is not that valuable anymore. However on this side of the Atlantic, the authorities still (have to) address the rout in the financial sector by ad hoc measures as is extensively illustrated over the last 48 hours. It’s hard to asses which region will come out best (or at least the less worst) out of this financial hurricane over time. However, at least for now markets apparently still tend to give the dollar the advantage of doubt, even after the rejection of the Bail-out plan. As is the case in almost all other markets, the currency market also becomes an order-driven market, with an important part of the deals driven by some kind of obligatory action/forced selling. This implies a growing risk of erratic trading, especially if market makers reduce the amount of deals they are prepared to execute. In this context, the technical picture might help to apply a disciplined damage control/stop-loss strategy. Of course; in the current environment, the ‘chance’ of some kind of coordinated action is always possible.

From a technical point of view, EUR/USD started a correction three weeks ago. The pair rebounded from the 1.3885-area, regained a first important resistance and set a new reaction high in the 1.4865 area on Monday last week. This was a significant correction, but the key 1.4900/10-area (reaction highs) was not really challenged. The technical picture remains indecisive. However, we have the impression that the 1.4910 area gradually becomes better protected. We maintained a cautiously USD positive/EUR/USD negative stance as long as this resistance holds. Short-term, the picture for EUR/USD also deteriorates. The pair dropping below the MTMA (1.4444 today), if confirmed, would be an additional indication of the pair losing momentum short-term.

While the dollar was able to gain ground against the single currency yesterday morning, the picture was slightly different for USD/JPY. In Asian trading and during the morning session in Europe USD/JPY showed remarkable resilience, probably as the market focus at that time was on the turmoil in the European banking sector. However during US trading hours the sell-off on the US equity markets and the rising uncertainty (and the rejection) on the Paulson plan finally also hammered the floor beneath USD/JPY. The pair closed the session at 104.18, compared to 106.01 on Friday. This is a decent loss but given the extreme level of market stress, this still looks more or less as orderly relatively orderly trading.

Overnight, USD/JPY briefly tested the key 103.54 area but at least for now the test is rejected. There were also quite some important eco data on the calendar. In general they point to a further deterioration in Japanese economic activity going forward, but this is not really a major time for the currency markets at this juncture. Asian stocks also feel the fall-out from the sell-off in the US, but after all the damage could have been even worse. This could be an explanation why the test of the 103.55 area didn’t succeed yet.

On the technical charts, USD/JPY set a reaction high on August 15 and since then, the pair gradually slipped through a series of support levels. The pair set a new reaction low in the 103.55 area after the Lehman crisis. The hope on a US bail-out plan propelled the pair again higher in the 103.55/110.68 trading range, but for now the gains could not be build out and yesterday’s global market stress causes the pair to again test the range bottom. Recently, indicated that we were not impressed by the yen performance. In case of a further collapse of global investor sentiment one should expect USD/JPY to drift lower. A sustained break below 103.55 would signal more trouble for USD/JPY. However, we prefer the stand aside for now. One could raise the question whether it is still time to run to the yen at the current juncture. Buying a safe haven at the top of the crisis also contains a material risk.

On Monday, flaring up of the credit crisis this time also left its traces on the sterling with the Bradford & Bingley nationalisation the most obvious trigger. EUR/GBP (despite material pressure on the euro) gradually trended higher throughout the session. The pair showed a spike above 0.8000 on the rejection of the US bail-out plan but closed the session at 0.7981, compared to 0.7922 on Friday.

This morning, the Gfk consumer confidence came again out at a distressed level. Later today the final GDP data are scheduled for release. However, also for sterling trading to focus will be on the credit crisis. The financial and economic picture in the euro area is far from bright, but in the current environment of financial stress the sterling probably remains (slightly) more vulnerable.

Early September, EUR/GBP tried to break out of the longstanding sideways 0.7760/0.8098 trading range, but the test was rejected and this triggered a significant correction sending the EUR/GBP pair again in the previous range. Recently, the sterling showed remarkable resilience vis-à-vis the euro (despite global market stress) and dropped below a series of intermediate support levels, but last week, the rebound of sterling against the euro lost momentum. Medium term, we hold on to our view that it is too early for a major/sustained comeback of the sterling. 0.7760 remains the key medium support for this pair. In a day-to-day approach we are neutral to cautiously positive for EUR/GBP.

• Download Full Sunrise Market Commentary

Published on  Tue, Sep 30 2008, 09:46 GMT