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

• Send
• Print
• Add To
• Rss

Sunrise Market Commentary

143b6aa0-08d8-41be-8d08-71b70eada60f

0

0

US Treasuries make further headway

Wed, Oct 22 2008, 07:12 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Tuesday, global bonds made further gains. Weaker equities played a role, but the intra-day negative correlation was far from perfect. The normalization on the short-term funding markets continued, but had little impact on the safehaven sensitive short end of the curve (2-year) contrary to Monday’s price action.

Recession fears swirled around, also because of disappointing earnings reports. While tentatively some calm returned in the ST funding markets, the financial crisis causes ever new victims with Central Europe and Argentina now very much in the focus. Also the wild movements in the currency markets need to be followed closely, as it doesn’t inspire confidence in the overall economic and financial situation and might easily spill over into other markets.

In a daily perspective, German yields fell by 4 to 7 basis points, the 10-year outperforming, while in the US, yields fell by 4 to 12 basis points, the belly outperforming the wings.

US Treasuries make further headway

The calendar remains very thin with only the weekly mortgage applications for release. The New York Fed will hold its schedule 2 TSLF auction. There are no public appearances of importance.

The situation in the funding markets continued to improve. 1 and 3m USD Libor fell 22 basis points to 3.52% and 3.83% respectively, bringing the decline to about 100 basis points in one week. The 3-month T-bill stabilized at 1.6%, but the 1 month T-bill that had shown little signs of normalization in previous days rose by 41 basis points to 0.47%. The swap spread declined too, but only marginally. The Fed Reserve created another liquidity facility, the Money Market Investor Funding Facility (MMIFF). The facility will provide senior secured funding to a series of SPV’s to facilitate an industry- supported private sector initiative to finance the purchase of eligible assets (like USD CD and CP of maximum 90 days) from eligible investors (US money market mutual funds, eventual to enlarge to other investors). In other parts of the world, authorities continued to unveil banking rescue packages that were often focused on new capital and guarantees.

Minneapolis Fed Stern, a middle of the road team player inside the FOMC, was pessimistic about the economic outlook. He said the downturn could be worse than the 1990-91 recession, with growth restrained for as long as one-to-three years. He hedged his comments by saying it is still an open question whether we witness a classic recession or something worse. He declined to comment on the outlook for rates.

Regarding trading, renewed equity weakness amid ongoing recession concerns supported Treasuries yesterday, despite more signs that conditions in ST funding markets are improving. The upward correction in longer-dated yields ran out of steam early last week and was followed by a down-move that became convincing yesterday, as the 10-year yield dropped below 3.91% (and the Dec Note future moved above 114-00+) making the picture again positive. The next important support level stands at 3.42%, about 25 basis points from current levels. The 2-year yield upward correction on Monday proved to be nothing more than a correction and was reversed yesterday.

German 2-year yields go for another test of the lows

Today, the euro zone data calendar is again empty, but on the supply front Germany will tap its 5-year Bobl 4% Oct13 for an amount of EUR 5 B. Demand at recent auctions has improved, even though yesterday’s demand for the tap of the Greek 10-year bond was rather sluggish. This may suggest that there is not much momentum yet for a significant correction on the recent widening of the intra-EMU spreads. Yesterday, spreads even widened again.

Yesterday, the IMF forecasted economic growth to slow down in the euro zone from 1.3% this year to only 0.2% next year amid a sharp fall in credit growth to non-financial corporations from 15% Y/Y last March to 2 to 3% next year. In September, the ECB staff projections still expected economic growth to come out in a range between 0.6% and 1.8% in 2009. The recent sharp deterioration in the growth outlook was also reflected in several downbeat comments of ECB governing council members. Today, ECB’s Gonzalez Paramo will speak on banking supervision.

On the money market, the Euribor fixings continued their recent downtrend, as 3- month Euribor rates fell below 5% for the first time since mid-September. Although, the Euribors are still elevated compared to the official interest rate of 3.75%, the recent decline is a sign that conditions are slowly normalizing following the drastic measures taken by the central bankers and governments. In its weekly tender, the ECB allotted EUR 305 B compared to 310 B last week at a fixed rate of 3.75%. A record number of banks participated in the weekly tender signalling the increased dependence from banks on the ECB for their funding.

Regarding trading, yields fell again lower yesterday highlighting the underlying positive sentiment. As such, 2-year yields are still close to the year lows ahead of this week’s national business confidence surveys. As these are expected to be very weak, the risks on a break lower have increased, which would further improve the technical outlook, although a lot of ECB easing has already been priced in. Based on the Eonia futures, another 50 bps easing is already expected against December and the through of the rate cycle is currently seen at 2.75% in comparison with our forecast for at least 2.5% next year. The sharp depreciation of the euro could be seen as a negative for the European bond market, but for now we don’t expect this to play a major role. At the longer end of the curve, 10-year yields fell again below the neckline of the head and shoulder formation at 4%, which opens the road for a re-test of the lows at 3.65%. In this context, the escalating crisis in Central-Europe may lead to more safe haven buying on the European bond market.

In the UK, the calendar contains only the Bank of England Minutes. In October, the BoE announced a 50 basis point rate cut in coordination with the Fed, ECB and other central banks. We expect all nine members to have voted for a rate cut. In the statement, the Bank noted that the balance of risks to inflation has shifted decisively to the downside, which may suggest that further rate cuts will follow despite current still elevated headline inflation rates. Yesterday evening, BoE’s King painted a very bleak picture of the UK economy, further underscoring the need for more interest rate cuts.

Currencies: EUR/USD hammered through the 1.30 mark

On Tuesday, EUR/USD was detained in a continuous downtrend throughout the whole trading session. There were hardly any eco data scheduled for release in the US and in Europe but this was no help to calm the sentiment with respect to the single currency. The pair traded in the 1.33 area at the start of trading in Europe and uninterruptedly drifted lower to end the session near the intraday lows at 1.3063 (compared to 1.3344). There was not one specific factor to explain this euro sell-off. This is still very much an order driven market and recently it became already clear that the single currency has become very vulnerable to bad (economic and financial) news. In a broader perspective, this move probably should be considered in the first place as dollar strength. The single currency yesterday traded more or less stable against the likes of the Aussie dollar and even regained some ground on the sterling. Mounting tension in some central European markets may also have been a (minor) negative factor for the single currency, adding to the negative market sentiment toward the European economy. The poor stock market performance in the US later in the session and the resumption in the decline of the oil price added to the downward pressure for the single currency. However, the impact of these factors shouldn’t be exaggerated anymore. On Monday, they pointed in the other direction but at that time they were also of no support anymore for the single currency. A (protectionist) pleading of French President Sarkozy for Europe to have its own sovereign wealth funds to support domestic companies and to defend national and European interests is probably also no vote of confidence for the single currency.

Today, the calendar is again almost empty both in the US and in Europe. However, this didn’t prevent EUR/USD from tumbling towards the 1.28 area.

Recently, sentiment on the single currency was already quite negative and the developments in central Europe apparently only reinforce the feeling that the European economy is heading for a strong setback. In line with the Canadian interest rate decision yesterday this may also cause the ECB to cut interest rates in an aggressive way sooner rather than later. Already for quite some time we advocate that a prolonged period of sub par growth and/or some kind of deflationary environment is more supportive to the dollar than to the single currency and this is also the main reason why we are EUR/USD negative longer term. However, we didn’t expect the decline to accelerate at the aggressive pace as seen over the last 24 hours. Earlier this week, we hoped that an easing in global market tensions could cause some kind of consolidation/technical rebound in EUR/USD, creating an opportunity to add/step in for dollar longs. However this hope obviously is in vain. EUR/USD currently is a falling knife and there is no reason to try to catch it.

From a technical point of view, EUR/USD over the previous month tumbled from the 1.4866 reaction high to levels below 1.30 at the moment of writing. High profile intermediate supports (the longstanding daily uptrend line since 2002 (today in the 1.4025 area; the previous low in the 1.3882 area and the 1.3259 10 Oct reaction low) were taken out with ease. 1.2481 (the Oct 2006 low) is now the first high profile support on the charts. EUR/USD needs to return above to 1.3259 reaction low to get a first indication that the pressure is easing.

After a disappointing performance on Monday (given the decent stock market performance), USD/JPY came under pressure again yesterday. The dollar trades strong against almost all other currencies, but at times of resurfacing market stress, the yen apparently is still the preferred safe haven, even its lead on the dollar is obviously less compared to what it was a few moths ago. USD/JPY closed yesterday’s session at 100.14, compared to 101.86 on Monday.

This morning, Japanese eco data confirmed the slide in the economic momentum in the country (All industry activity index, supermarket sales). The Nikkei dives more than 6% at the moment of writing, with financials hit hard on rumours that a lot of banks will have to come out with lower than expected profits. This stock market selloff and global economic and financial uncertainty help the yen to strengthen to USD/JPY 99.75 at the moment of writing.

On the charts, global market stress hammered the pair through the 103.50 range bottom two weeks ago and the pair set a new reaction low at 97.92. Since, the pair rebounded and set a reaction high in the 103.05-area but a test of the key 103.55/85 resistance area (previous lows) didn’t occur. A sustained re-break above this area is needed to call off the downward alert. Recently, we advocated that it is dangerous to buy a safe haven asset (like the yen) at the top of market stress and suggested a buy-on-dip approach in case global market stress would ease. From a technical point of view, USD/JPY still holds the 97.91/103.05 trading range. Despite the elevated global market stress, we have the impression that a break below this high profile barrier won’t be that easy. In a day-to-day perspective, there is of course no reason to row against the tide. A break below 97.91 would signal the risk for another downleg (Stop-loss) towards the 95.77 year low. In EUR/JPY, the technical picture is now more or less similar compared to EUR/USD.

On Tuesday, EUR/GBP rebounded off from the intraday lows at around 0.7738 at the start of trading in Europe and the pair then hovered in a sideways trading pattern between 0.7750 and 0.7780. A poor CBI industrial trends report caused to pair to revisit the upper limits of that trading band after the publication. However, the key factor for sterling trading was a speech of BOE’s King in the evening. The BOE Governor warned that the UK economy probably entered its first recession in 16 years and that the outlook has not worsened as rapidly as it has been in the past month for a very long time. He also warned that investors might be less willing to put their money in the UK and this might mean that the adjustment in the trade deficit and the exchange rate will need to be larger and faster than otherwise would have occurred. The latter is of course no good news for the sterling; EUR/GBP spiked higher upon this news and closed the session at 0.7816 (compared to 0.7778 on Monday). The move was extended this morning in Asia with the pair trading in the 0.7875 area at the moment of writing.

Today, UK calendar contains the minutes of the previous BOE meeting.

Already for some time, we advocated that we don’t see the need for a major/ sustained comeback of the sterling against the euro based on the eco (and financial) picture in both areas. However, this view came under pressure recently with EUR/GBP extensively testing the key 0.77 support area. However, our view/strategy was saved by Mr. king yesterday evening. Despite the overall euro negative sentiment, EUR/GBP is now again in the longstanding sideways trading range. In a dayto- day perspective, EUR/GBP could move still somewhat higher in this range. Longer-term we think that the established sideways trading pattern between 0.7700 and 0.8100 can hold in the foreseeable future.

• Download Full Sunrise Market Commentary

Published on  Wed, Oct 22 2008, 07:23 GMT