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Sunrise Market Commentary

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Equities up, bonds down on government's rescue plans

Mon, Oct 13 2008, 07:43 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Friday, government bonds once again couldn’t benefit from the panic in the financial markets. On the contrary, US equities recouping part of their opening losses and governments preparing for more actions to restore confidence led to a sell-off on the bond markets.

In a daily perspective, US yields rose between 10.2 bps in 2-year yields and 3.4 bps in 30-year yields leaving the US yield curve somewhat flatter. In the euro zone, the steepening of the curve however continued with 2-year yields down 3.8 bps and 30- year yields, which had been trading very volatile over the past week, up 24.4 bps.

Latest developments on the financial crisis:

Given its importance for markets, an extensive overview of recent developments looks appropriate.

The main message is that after a terrible week, authorities have been woken up to the enormous task they face and are now using all instruments at their disposal. This is very important and raises chances of an improvement of the situation. Four main areas are covered: new capital for banks, unfreezing credit and money markets (guarantees wholesale lending), deposit guarantees and accounting issues. This looks to go a good way in addressing the current failures and it seems the UK, US and EMU are now taking measures on all those four fronts.

G-7 statement contains no specific co-ordinated new measures, but gives a nice catalogue of 5 objectives that will lead countries, blocs when taking action to address the financial crisis.

These objectives look currently quite comprehensive.

1. Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure.

2. Take all necessary steps to unfreeze credit and money markets and ensure that banks and other financial institutions have broad access to liquidity and funding.

3. Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to reestablish confidence and permit them to continue lending to households and businesses.

4. Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits.

5. Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.

G7 says "all available tools" will be used to solve crisis The

The EMU top, note this is the first EMU top ever, in the weekend outlined the steps national governments might take to shore up their banks. It is a kind of menu from which individual countries could choose. There is no pan-European bailout fund created. Germany, France and Italy are expected to announce their national plans later today. It will be worth billions of euros in guarantees for new, medium term bank debt issuance, for taking capital in banks and providing extra liquidity.

Guarantees will be offered on commercial terms, available to banks of all nationalities, conditions may be attached including assurances on providing credit to companies and households.

EMU leaders agreed to loosen mark-to-market rules.

ECB would create an unsecured lending facility to buy CP from banks.

full text available at: http://www.elysee.fr

This morning, the ECB, BoE and SNB announced further measures to address the elevated pressures in the short-term dollar funding markets. From now on, the three central banks will conduct tenders of US dollar funding at 7-day, 28-day and 84-day maturities at fixed interest rates for full allotment in cooperation with the Federal Reserve. The Bank of Japan will consider the introduction of similar measures. http://www.ecb.de/press/pr/date/2008/html/pr081013.en.html

Equities up, bonds down on government’s rescue plans

As stated above, over the weekend the US, UK and EMU took important measures to improve the strained conditions on the financial markets. Any improvement will also have important consequences for the global bond markets, which showed already vulnerable at the end of last week, when the inverse relationship between equities and bonds already disappeared and both plunged lower. The short end however outperformed, as the ECB’s rate cut by 50 bps confirmed the dramatic change in stance over the past months.

Although the conditions on the financial markets may improve from now on, it’s clear that the fall out of the crisis will have severe consequences on the real economy. In this context, one can expect the ECB to cut rates further in the months to come. A further steepening of the European yield curve looks therefore inevitable. Lower short-term rates should improve the financing conditions in the economy and the profitability of the banking industry. At the same time, the government actions will continue to raise concerns about the issuance, which may drive longer-term yields higher. The omission of an EMU funded bail out plan also implies that the individual governments remain responsible for their own actions, which justifies the recent widening of intra EMU credit spreads.

Today, the EMU calendar is empty and also in the US and Japan markets are closed. As such, we should be cautious to draw too much conclusions out of today’s trading action. Nevertheless, this morning’s reaction in the Asian equity markets and the plunge in the European bond market at the opening do suggest that markets are cautiously optimistic about the plans. Hence, European yields continue last week’s rebound off important support levels. Last week, 10-year yields failed to break below the neckline of a major double top formation at around 3.65% and currently stand at 4.09%. Strong resistance is seen at 4.30% (neckline previous double top formation). 2-year yields tested the March lows at 2.90% and currently stand at 3.14%. As we expect ECB rates to fall to 2.5% next year, we remain bullish at the short end of the curve, although the improvement in the financial market conditions may lead to some short-term profit-taking.

Based on the rise in the December ‘08 and March ‘09 Euribor futures, some easing in tensions on the European money market can be expected today, which would be a very welcome development, as it would reassure the impaired monetary transmission mechanism.

In the UK, the government will invest GBP 37 B in RBS, HBOS and Lloyds TSB and will detail its new debt-sale program tomorrow. The nationalization of the banks fit into last week’s rescue plan of the UK banking sector.

Currencies: Euro drops to new cycle lows against dollar, as credit crisis intensifies

On Friday, EUR/USD resumed its down-move, after digesting in the previous days a previous sell-off. In the Asian and European morning session, the pair still moved in a sideways range, but when the US equities dived lower after the opening. The euro recouped some of the ground in late session, when equities turned around. Also oil hit the skids, especially, but not exclusively when equities dived lower. EUR/USD opened at 1.3604, set an intra-day high at 1.3650, before sliding towards 1.3259 and closing at 1.3408.

During the weekend, authorities all over the world were working on new, more extensive and far-reaching plans to help the financial sector out of its deepest crisis in more than 60 years. Success is not guaranteed, but we have the impression that it might work. Overnight, Asian equity markets gave it a cautious positive reception (see bond markets intro and headlines for more details).

Good news on the financial crisis is also good news for the euro, one of the most prominent victims of the financial crisis. Also the rebound in oil points to dollar losses. So, it isn’t a surprise that EUR/USD climbs to 1.3640 at the time of writing, up more than two big figures. Today, trading will still be thinner than recently, as both US and Japanese market participants enjoy a holiday.

From a technical point of view, EUR/USD rebounded from the 1.3885-area and set a new reaction high in the 1.4865 area. This was a significant correction, but the key 1.4900/10-area (reaction highs) was not challenged and last week EUR/USD turned again south and the pair fell below the previous low (1.3882) and the longstanding daily uptrend line since 2002 (today in the 1.4000 area) making the MT picture outright negative for the pair. Sustained return action above the previous low (1.3882) is needed to speak of an easing in the euro sell-off. Obviously, we are not at that point yet, even if today’s rebound, if sustained, would negate the negative consequence of Friday’s drop below the sell-off low. A break 1.3408/1.3259 could indicate a resumption of the sell-off.

Today, Japanese markets are closed for the Health-sports holiday, meaning little trading in Asian markets. On Friday, USD/JPY showed extreme volatility, setting first a new low at 97.92 before rebounding and closing at 100.67. In a context of extreme risk aversion this is a yen usual movement that may tentatively be a sign that the downside is becoming better protected. The developments over the weekend point to a reversal of flight-to-safety money, which would be intrinsically yen negative. However, this is not reflected ion the pair. USD/JPY trade little changed at 100.44. However, given the closure of Japanese markets, we would be cautious in drawing too many conclusions from today’s price action.

On the technical charts, global market stress hammered the pair through the 103.50 range bottom on Monday. Until the end of last week, we were not always impressed by the yen performance, but earlier this week the global tensions have become severe enough for the yen to take advantage of the situation with the pair setting an a ST low at 97.92 on Friday. The ST picture in this pair remains negative as long as it holds below the 103.50 previous range bottom. There is still no reason to row against the yen positive tide. Recently, we advocated that it is dangerous buying a safe haven asset (like the yen) at the top of market stress. If the global stress eases, like it looks to be the case now, this kind of safe haven positions might yield steep losses, too. It is too early to draw final conclusions about the positive developments on the financial markets, but if the positive reaction is confirmed in the next days, the yen may have to give back its hard won gains of late. The new reaction low of 97.22 and the 95.77 area (year low) are the next important support levels.

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Published on  Mon, Oct 13 2008, 08:08 GMT