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

• Send
• Print
• Add To
• Rss

Sunrise Market Commentary

892f11ac-2164-41e4-911c-8820dad7954f

2

0

US Treasuries rally for the sixth consecutive session

Fri, Dec 19 2008, 09:42 GMT
by KBC Market Research Desk

KBC Bank

next full report on jan 05, 2009

Markets: Fixed Income

On Thursday, sentiment on the global bond markets remained constructive, even if in the European market an intra-day profit taking move occurred. The reaction on the eco data (see news section) was only momentarily. Profit taking in the European morning session, despite a very weak German IFO, and an early session US Treasury rally apparently still on the Fed’s quantitative easing announcement earlier this week were the main items intra-day.

Weakness in equity trading is usually positive for Treasuries, but yesterday this was only part of the story. The initial rally of US Treasuries happened when equities traded largely sideways. Only late in the session, equity weakness brought some support. At the closure, US yields were down 5 basis points in the 2-year sector and 11 to 13 basis points further out. In EMU, yields declined only very modestly, notably by 1.5 to 3 basis points with the exception of the 30-year sector where yields fell 11 basis points. This might have been due to the German debt issuance plans (see below). The ECB re-widened the band of its two standing facilities to 200 basis points in an attempt to restart the Interbank market (see below).

US Treasuries rally for the sixth consecutive session

Today, the calendar is completely empty. So market attention may go to other news. In this respect, there might be an announcement of the Bush administration on the bailout plan for the carmakers. However overall it looks to be an order-driven, boring trading session today. Given the thinning of conditions going into the final two weeks of the year and being at the end of an ebullient week for Treasuries, we have to bring the prospect of profit taking again to the forefront. During yesterday’s session, the 10- year approached the 2% (2.03% touched) and the 30-year yield tested 2.50%. Such eye-catching levels are in normal times often used as a pretext to take profit, especially when they are visited for the first time. This occurred also when the 10-year yield reached the 3 and 2.5% thresholds (and the 30-year reached 3%). However, these levels were a few sessions later easily broken. Needless to repeat that the LT technical pictures remain bullish, but overextended conditions point to a profit taking action that may be of moderate importance. Fundamentally, the quantitative easing policy officially in place of course caps the upside and many will be eager to enter the market from the long side in case of correction, making the latter less likely or less extended than corrections could normally go.

Dallas Fed Fisher, a hawk, spoke yesterday on the credit crisis and the economy in a historical perspective. He defended the FOMC policy of quantitative easing (he voted in favour last Tuesday). “We stand ready to grow our balance sheet even more should conditions warrant”. Interestingly, he said that currently the biggest concern was deflation and the Fed would worry about inflation later. It is the first time, to our knowledge that deflation concerns are publicly voiced. He added that the Fed knows it needs an exit strategy and at a certain moment the Fed will have to tighten. He promised that at that point in time, he would speak out loud about inflation risks again, but for now that wasn’t the issue. He also made the distinction between the Fed’s version of quantitative easing and the Japanese one. The Fed’s focus is on assets rather than on liabilities in an effort to lower private sector borrowing costs and boost spending. While interesting his comments carried few new elements and therefore didn’t affect markets.

ECB re-widens corridor standing facilities to 200 bps

Today, the euro zone calendar is thin as it only contains the French business confidence index (December) and Italian industrial orders (October). French business confidence is expected to drop from 80 to 78 in December and Italian industrial orders are forecasted to decline 2.5% M/M in October.

Yesterday, the German Finance Agency outlined its issuance plans for 2009. The total issuance volume will be raised from €213B this year to €323B next year. The substantial increase is mainly due to one-off issues related to the stabilization of the financial markets (€60B) and the higher amount of redemptions in 2009 (€31B). The vast amount of the increase will be financed through the money market, as the amount issued via Treasury discount papers will increase from €72B to €174B, while the amount issued via conventional bonds will only rise from €141B to €149B. Regarding the timing, the largest part of the increase in bonds is situated in the second quarter when Germany plans to raise €45B compared to €39B in the first quarter, €32B in the third and €33B in the fourth quarter. As such, Germany may try to avoid other government bond issuers, as the beginning of the year is typically a very busy period for issuance. The German Finance Agency also intends to continue building up the market segment for inflation-linked bonds, as it plans to issue €6-10B in inflation-linked bonds. Currently, Germany has only one inflationlinked bond 1.5% Apr 2016 with an amount outstanding of €13B.

The substantial increase in issuance is a global problem, as governments across the globe have stepped up their investments plans to support the financial sector and the economy. The ECB signalled its concern that the EMU governments plans should comply with the Stability and Growth Pact. Otherwise, the ECB fears the plans could further undermine confidence and even work counterproductive. The sharp widening of the intra-EMU spreads since the start of the credit crisis may be a reflection of this concern. Yesterday, ECB’s Stark warned that the ECB would not bail out a euro area country if it would default and added that such a country facing default would have to ask the IMF to help. At the same time, Stark also warned that the current expansive policies could lead to higher inflation levels and that policy makers need an exit strategy for when the crisis is over.

Yesterday, demand was tepid for the two Spanish longer-term bond auctions. Spanish bonds however traded in line with the rest of the European bond market. Also Belgian bonds didn’t suffer from the ongoing Fortis saga and the escalating political crisis. A resignation of Belgian PM Leterme may nevertheless still lead to an underperformance of Belgian government bonds. A decision on an eventual resignation was postponed overnight, as the political parties that form the government apparently await a full report of the highest judicial authorities of the countries on the eventual attempts of the government to influence the judicial branch of government in the Fortis court case.

Following yesterday’s ECB non-monetary policy meeting, the ECB governing council as expected announced some changes to improve the functioning of the money market, which will be implemented from 21 January onwards. As such, the council decided to restore the corridor of the standing facility rates at 200 bps from 100 bps, as it was the case before the measures taken at the beginning of October. Hence, the marginal lending rate will stand again 100 bps above the policy rate, while the deposit facility will stand 100 bps below. By doing so, the ECB raises the penalty for banks, which lend from or deposit money overnight at the ECB. This should provide an incentive to re-start the interbanking market. At the same time, the ECB will continue to carry out its main refinancing operations through a fixed rate tender procedure with full allotment, at least until the last allotment of the third maintenance period in 2009 on 31 March. This should ensure banks of enough liquidity at rates in line with the ECB policy rate.

At the non-monetary policy meeting, the ECB also officially decided to continue its current voting regime and to introduce the rotation system only when the number of national central bank governors exceeds 18. At the same time, the Governing Council decided on the main aspects for the implementation of the rotation system, to be applied once the number of Governors exceeds 18. ‘Having analysed a number of models, the Governing Council opted for the following rotation model: Governors will rotate in and out of the voting right after one month. This rotation model achieves short periods without vote for individual Governors combined with relative stability of the composition of the voting college’, the ECB stated on its website. Following the entering of Slovakia to the euro zone on 1 January, the EMU will consist out of 16 members.

Regarding trading, European bonds traded little changed yesterday. Over the past days, the surge in the euro, ongoing very weak data and the aggressive easing in the US put immense pressure on the ECB to cut rates further. As a result, German 2- year yields have dropped decisively below 2% for the first time ever. Nevertheless from a technical point of view, the Bund is still struggling to recoup the broken uptrend line (today at 124.86), while the Schatz didn’t break above the recent highs at 107.39. As such, the technical picture isn’t decisively bullish. Given the thin calendar both in the euro zone and the US, we look for sideways trading today. The 30-year Bund outperformed following the debt issuance plans of the government that showed reduced new supply at the long end of the curve. The bulk of the extra supply will be financing in the money market, which at the margin is a positive for the bond sector.

Currencies: EUR/USD experiences hectic trading session, Sterling crash continues.

On Thursday, EUR/USD experienced again a very hectic trading session. The pair made brief dip towards the 1.4350 area at the start of trading in Europe, but this euro weakness/dollar strength was short-lived. The dollar sell-off that started earlier this week resumed with even more power than was the case over the previous days. The German Ifo release came out at an astonishingly low level, but this couldn’t stop the assent of EUR/USD at that time. On the contrary, at some point there was even some kind of euro buying panic and this caused EUR/USD testing offers in the 1.4700 area. Headlines from an interview with ECB’s Stark stressed the need for an orthodox, restrictive policy in the post-crisis period and added to the upward pressure on the single currency. Volatility remained at an elevated level at the start of US trading. However, the dollar panic eased later in the session. The steep decline in the oil price at that time might have been an excuse for short-term players to look in intraday profits. A second profit taking move occurred at around the close of the European markets and this even hammered EUR/USD below the levels seen at the start of trading in Asia and in Europe. This move occurred at the time when the ECB announced additional steps to improve money market functioning. Those measures contain a windening of the corridor of the standing facility rates to 200 basis points from 21 January on. However, we don’t see a direct link between this ECB announcement and the price action in EUR/USD. Trading was very much order driven with few references to the economic environment. EUR/USD even closed the session at 1.4240 compared to 1.4419 on Thursday. The sharp swings in the euro apparently are also taking the attention of European policy makers. Mr. Trichet said that he had always looked with great interest to what was said by the US on the strong dollar. France’s Lagarde voiced is concern on abrupt FX volatility.

Today, eco calendar in Europe and in the US is almost empty. So, order driven trading will again be the name of the game.

Since the end of October, the EUR/USD pair has developed a consolidation pattern between 1.2330 and 1.3294. However, investors’ anticipation that the Fed had come close to the point where they had no option but to shift to a policy of quantitative easing recently brought the dollar under pressure. Tuesday’s Fed interest rate decision only confirmed this market assessment. Markets have entered a new era. The biggest economy in the world, which holds the reserve currency, has now the lowest official interest rate and the yield of its long-term bonds is nose-diving too. The US is still a big deficit country and the prospect that the Fed has the intentions to keep interest rates low for a prolonged period of time and that more unconventional measures might be in store can only be considered as bad news for the US currency. On the other side of the equation, the ECB continues to indicate that it was in no hurry to take aggressive additional steps of policy easing any time soon. This approach might come under heavy pressure too and high profile bad news from Europe over time might also question the Euro’s ability to play this role. However, for now the euro is the ‘by default’ overflow currency to counterbalance the inevitable dollar weakness.

From a technical point of view, EUR/USD broke above the previous sideways trading pattern and an important downtrend line (cf graph). This makes the picture for EUR/USD outright positive. The break was fully confirmed after Tuesday’s Fed meeting. Some ST consolidation on the recent EUR/USD rally is possible, but the trend in this pair is clearly upwardly oriented. The targets of the downward channel break are at 1.5271. A sustained rebound below the 1.3800 area (previous break-up area) would be an indication that the pressure on the dollar is easing. From now, trading will develop in ever more illiquid conditions. This contains the risk for more erratic trading, even in this most liquid EUR/USD cross rate.

On Thursday, USD/JPY tried to fight back from the year low levels below 87.50 set on Wednesday evening and at the start of trending in Asia. This move was a bit remarkable as the dollar initially was under heavy pressure against the other major currencies. Japanese officials stepping up their rhetoric on possible interventions might have played a role. Yen investors probably also shifted to a wait-and-see approach ahead today’s BOJ interest rate decision. Later in the session, USD/JPY also joined the rebound of the dollar versus other currencies and the USD/JPY closed the session at 89.43 compared to 87.24.

This morning, the BOJ cut interest rates as expected from 0.30% to 0.10%. The Bank also announced to increase the outright purchase of government. The yen lost a few ticks against the dollar and the euro after the decision, but the market reaction is muted. At the moment of writing, we don’t have any info on the content of the BOJ press conference. The all industry activity index came in less negative than expected, but this had no lasting impact on JPY trading.

Looking at the charts, global market stress hammered the USD/JPY cross rate and the pair set a new reaction low in the 90.90-area at the end of October. A temporary easing of global market tensions sparked a USD/JPY rebound but the rebound ran into resistance (100.55/Nov 04). Longer-term, the yen will continue to trade strongly as long as the global economic and financial picture remains downbeat. At the end of last week, the pair fell below the previous year low. Recently, we advocated not fighting the well-established downtrend in this pair but adopted a more cautious approach. After the Fed decision, the market theme has become dollar weakness rather than yen strength. Nevertheless, we are still a bit reluctant to add to yen long exposure at the current levels even it is obvious that the long-standing trend is USD/JPY negative. Short-term, market fear of BOJ interventions might also slow the ascent of the yen.

On Thursday, sterling remained under pressure and EUR/GBP set a new lifetime high. In particular during the first hours of European trading the pressure was immense. Overall euro strength and maybe also the declarations from BoE’s Bean (rates might go all the way to zero and quantitative easing is not excluded as a policy option) propelled EUR/GBP to the 0.9550 area. The better than expected UK retails sales at the time of their publication brought no relief for sterling. Later in the session, the correction in EUR/USD temporary filtered through into EUR/GBP trading. However, sterling could not hold on to its intraday ‘gains‘ and closed the session at 0.9488 compared 0.9287 on Wednesday.

Overnight, GFK consumer confidence improved slightly from -35 to -33. Later today the Business investment data are on the agenda. Usually, they are not market mover.

On the technical charts, the break above a series of high profile resistance levels has made the long term technical picture outright positive for EUR/GBP. We hold on to our view that a negative interest rate differential vis-à-vis the euro, combined with ongoing negative eco news contains the risk for additional sterling losses over time. On top of that, the BoE (and the government) looks still pleased with the support the weaker currency is providing to the UK economy. The phrase in the BOE minutes that the risk for a sterling sell-off prevented the Bank from a more aggressive rate cut failed to cool the sterling negative market sentiment. The trend is sterling negative and at least for now it is difficult to see a trigger that changes this pattern. We hold on to our standing view that down moves in EUR/GBP, if they occur, are corrective in nature and look the buy back into this pair in case of a correction.

• Download Full Sunrise Market Commentary

Published on  Fri, Dec 19 2008, 10:34 GMT