Markets: Fixed Income
On Friday, financial markets ignored an awful US payrolls report, as equities rebounded following two days of severe losses and US Treasuries declined. European bonds outperformed and closed the session at the highs.
In a daily perspective, US 2- and 10 year yields rose 3.9 bps and 10.5 bps compared to declines of 1.9 and 2.3 bps in German yields. As a result, the spread between US and German 10-year yields turned again positive and is close to the recent highs at around 20 bps.
US Treasuries ignore awful US Payrolls report
Previewing this week’s Treasury trading, the eco calendar is thin and backward loaded, but investors will closely watch the 55 billion $ refunding operation that kicks off today with a 25 billion $ 3-year Note auction, followed on Wednesday by a 20 billion $ 10-year Note and on Thursday by a 10 billion $ 30-year bond auction (reopening of the 4.5% that was auctioned in August). Fed speakers are few and include regional Fed governors Stern and Lockhart, and on Friday chairman Bernanke, who takes part in a panel discussion at an ECB conference. Attention will also go to politics. Markets will eagerly await the name of the new Treasury Secretary and the nomination of other bigheads in the Obama administration. The Congress will reconvene for a lame-duck session and try to assemble a new fiscal stimulus package for an amount of maybe 300 billion $. The trading week will be shortened by Veteran Day holiday tomorrow and an early close today.
Looking to the eco calendar, the initial claims and the trade balance will be published on Thursday. They shouldn’t be very influential for trading, but Friday is more interesting with the October import prices & retail sales and the early November Michigan consumer sentiment. Import prices will tumble for the third consecutive month, confirming that inflationary pressures are disappearing fast. The retail sales will have declined for the fourth month in a row. Unit car sales have been published and were catastrophic emphasizing the precarious situation of the carmakers that are in danger of running out of cash and facing insolvency, unless the government intervenes with fresh money. The chain store sales showed plunging sales at all stores except the hard price discounters. Friday’s payrolls report suggests that households will have to trim their spending for many more months to come. Similarly, weakness in the labour market may have pushed the Michigan consumer sentiment to new multi-decade lows. So, all in all again a batch of very dismal economic news.
Today’s 3-year Note auction is the first one since the Treasury stopped issuing that maturity in 2007. From now on, it will be issued on a monthly basis with a mid-month coupon. It is difficult to gauge how investors will react on this novelty. In the 2003-to- 2007 period, the 3-year Note auctions generated on average a 2.2 bid/cover and a stop marginally below the bid in the WI. The new issue will raise 7.4 billion $, as a 17.5 billion $ 3-year Note matures, while the Treasury will also pay out a 4.1 billion $ coupon interest. So the cash flows surrounding the auction are not too bad. Given the bad economic outlook and the expectation that the Fed will cut rates further out, probably already in December, we suspect that demand will be decent.
Regarding trading, Friday’s session was special. A disastrous bad payrolls report (see news) was followed by declining Treasuries, as the equity markets decided to ignore it and rallied higher. It seems that the 10% loss on Wednesday/Thursday convinced traders that markets had gone too far in discounting eco weakness. So Treasury traders decided to take profits too, especially as the week brought some juicy gains. Indeed, in a weekly perspective, yields fell by 22 to 9 basis points, driving the curve steeper. The 2-to-10-year yield spread reached a cycle high of 247 basis points, both on Monday and Friday. There were more signs of improvement in the money markets. The 3 month Libor fell 73 basis points to 2.29%, while the 3-month liquidity spread, that subtracts the OIS from the Libor, fell 63 basis points to 175 basis points. 2-year swap spreads narrowed 12 basis points to 107 basis points, while the 30 year swap spread fell too but at 1 basis point still trades very special. The TED spread narrowed to 200 basis points (-59 bps). The situation in the CDS market was mixed. Investment grade spread fell 10 basis points to 190 basis points, while the high yield spread rose 29 basis points to 1127 basis points, close to the record high.
The technicals are bullish for the 2-year and moderately bullish for the 5-year, but the 10- and 30-year pictures are more neutral, but not bearish. The 2-year downtrend is intact and currently the 1.32/23% cycle lows are under test. A break below would open the way to yields around 1%. The 5-year has some problems, as the yield was unable to break below the 2.35% post-Lehman low despite three tests. However, we wouldn’t draw the conclusion yet that this level won’t be broken this cycle. A buy-onupticks in yields around 2.80/3% looks still fine. The pictures of the 10- and 30-year are more neutral. In a post-Lehman spike, the 10-year yield tested the 3.25% cycle low, but the test was rejected. Since the yield moved a few times up and down, but setting always a higher low. This is disappointing and we might see the yield testing support at 3.98% and even 4.10%.
Volumes are declining and the open interest statistics last week didn’t support the bullish case. Given the upcoming supply, the technicals and the empty eco calendar until Thursday, we start the week on a defensive note. For the shorter end, we favour new long positions, but only in case of an upward correction in 5-year yields towards 3%, while for the 10- and 30-year we are neutral and would consider profit taking on longs in case of rallies (yields at 3.25% or even somewhat higher), while contemplating about new longs around 4.10% (10- year).
German 10-year yields fail to break lower
Like in the US, the euro zone calendar is also backward loaded this week with the Q3 GDP growth and CPI data on Friday. These are expected to confirm that the euro zone economy has entered a recession and that inflationary pressures are rapidly disappearing. Ahead of these data, France and Italy will publish their industrial production data today. On Friday, German industrial production sharply disappointed and as such, we put the risk on the downside for today’s output data too, although the consensus has already been downwardly revised over the weekend. The impact should however remain limited.
Over the weekend, the Finance Ministers and Central Bank Governors of the G- 20 met in Sao Paulo ahead of next weekend’s Leaders’ Summit on Financial Markets and World Economy in Washington. In the statement, the G-20 countries affirmed their determination to take all necessary steps, including through monetary and fiscal policy, to foster non-inflationary growth in a stable and sustainable manner. In an attempt to halt the slowdown, China on Sunday unveiled a ‘massive infrastructure spending programme’ as part of a new economic stimulus plan worth USD 586 B. The policy mix of expansive fiscal and monetary policy supports further steepening of the yield curves. In the euro zone, Germany last week announced an economic stimulus plan and over the weekend ECB’s Trichet hinted that rates could decline again in December. As such, we continue to favour the short end of the curve and a further steepening of the European yield curve.
On the money market, the Euribor fixings accelerated their decline in the aftermath of the ECB rate cut by 50 bps. The decline in the Euribors was even somewhat larger than in the OIS, which resulted in a slight narrowing of the still elevated liquidity spread. This week, the ECB will hold a weekly (Tuesday), 3- and 6-month (Wednesday) refinancing operation again under full allotment and a fixed rate. It will be interesting to see whether the ECB will set a spread above the official policy rate of 3.25% for the longer-term operations. Another hot issue are the large amounts parked at the ECB deposit facility. On Thursday, the amount deposited surged to a record high of EUR 297.4 B. During last week’s press conference, ECB’s Trichet signalled that the ECB is not happy with the current situation and is looking at the issue. If there is no improvement following this week’s major operations, one can expect the ECB to make the facility less attractive and eventually lower the deposit rate by for example widening the spread between its deposit and main refinancing rate from the current level of 50 bps. Only some weeks ago, the ECB has narrowed the spread from 100 to 50 bps for both the deposit and marginal lending facility rate to alleviate the strains in the money market.
On the supply front, a lot of countries are again planning to tap the market. But in contrast to last week, the concentration of supply will shift from the short end to the 10-year sector, due to the launch of a new 10-year Bund Jan 2019 on Wednesday.
Regarding trading, the increase in supply will make it more difficult to break below the year lows in 10-year yields at 3.65%. Such a break lower would have brought the all-time lows at 3% again in the picture, but this may remain a hurdle too high for now. As such, we wouldn’t front-run on a break lower and would only install new long position in case of a rebound towards 3.90%. Friday’s reaction in US Treasuries on the awful US Payrolls also supports a cautious approach.
In the UK, the PPI will point to a further easing in inflationary pressure following the recent sharp decline in commodity prices and the recessionary economic environment. By cutting interest rates by a stunning 150 bps last week, the Bank of England has indicated that the growth outlook is much more important for now. This week’s inflation report (Wednesday) will indicate how much further UK interest rates may fall.
Currencies
On Friday, markets in general and the currency market in particular looked out for the US payrolls report. EUR/USD moved higher at the start in Europe, setting an intraday high in the 1.2850 area at the end of the morning session. The EUR/USD had to give back some of the early gains going into the key US payrolls report. This report only confirmed the steep downturn in the US economy as 240K jobs were lost in the month of October. On top of that the report showed a sharp rise in the unemployment rate to 6.1% and a big upward revision in the job losses over the previous month. However, as was the case for most other markets, the reaction in EUR/USD to the report was very subdued. The pair hovered up and down in the 1.28-area, but with no clear directional bias. Towards the end of the session the pair drifted towards the lower end of the intraday trading range (despite a positive stock market close in the US) and closed the session at 1.2718, little changed from the 1.2715 close on Thursday.
This morning, the market focus is on the announcement of CNY 4 trillion plan to boost the Chinese economy in an attempt to try to counterbalance the fall-out of the world-wide financial crisis. The plan spurs investor risk appetite in Asia this morning with commodities and stocks showing fairly strong gains. This also supports the single currency and EUR/USD trades in the 1.2850 area at the moment of writing. Later today, the eco calendar contains the French and Italian Production data. While interesting, they are no market movers. In the US the calendar is also very thin. So, global market sentiment will probably again set the tone for trading today. With the focus on the Chinese plan, the odds don’t look that bad for EUR/USD trading at the start of this new trading week.
Our standing view is that a prolonged period of sub par global growth and a deflationary environment is more supportive to the dollar than to the single currency and this theme was an important factor behind the decline of EUR/USD from 1.60 to below 1.24. We hold on to this EUR/USD negative bias longer term. However, over the previous two weeks, the single currency showed somewhat more resilient, even at times when the global market environment was not really euro supportive. The payrolls, while much weaker than expected, had no lasting impact on trading too. For now, we hold on to our view that the pair entered a sideways consolidation pattern within the boundaries of 1.2330 and 1.3297.
From a technical point of view, EUR/USD since the last week of September tumbled from the 1.4866 reaction high to levels below the 1.24 mark. High profile intermediate supports like the longstanding daily uptrend line since 2002, the previous low at 1.3882 and the 1.3259 10 Oct reaction low were all taken out with remarkable ease, but over the last two weeks the EUR/USD decline shifted into a lower gear and the downside in the pair apparently became better protect; Within the 1.2330/1.3294 range the pair even tries to set up a series of higher lows. EUR/USD needs to return above the 1.3259/94 (previous reaction low/reaction high) in a sustainable way to get a first indication that EUR/USD sentiment is improving. Recently, in line with our long-standing view, we favoured a sell-on-upticks approach in case of return action higher in the above mentioned trading range. From a technical point of view, there is no need to change tactics yet, but a break above the 1.33 area would be an indication that the EUR/USD rebound/correction could have some further to go (at least partial stop loss protection).
On Friday, USD/JPY mostly traded in the lower 97 area going into the US payrolls report on Friday. The poor payrolls report triggered a very brief spike lower with the pair testing bid in the 97-half immediately after the release of the report. However, the market reaction on most other markers (especially in the stock markets) was very forgiving and later in US trading, the pair even recorded some cautious gains in step with the US stock market performance at that time. USD/JPY closed the session at 98.24, compared to 97.75 on Thursday.
This morning, the Japanese eco data (machinery orders and machine tool orders) confirmed that the global crisis also fully impacts the Japanese economy. However, as is the case for almost all other Asian markets, the focus for yen trading this morning is on the Chinese plan to support the economy. Investors apparently consider this as a positive signal that China joins the global efforts to support the economy. This optimism weighs on the yen this morning.
On the charts, global market stress hammered the pair through the key 103.50 range bottom early October and the pair set a new reaction low at 90.93 two weeks ago. An easing in global market tensions sparked an USD/JPY rebound with the pair reaching a reaction high in the 100.55 area early last week, but the rebound ran into resistance. Longer-term, we prefer a scenario of the yen remaining well supported as there is still very little prospect for a sustained improvement in the global economic picture anytime soon.
In a short-term perspective, last week we were neutral on USD/JPY, but we had the impression that further gains beyond the 100.55 reaction high wouldn’t be that easy short-term. If global markets were to take a more constructive approach on the Chinese economic plan, a retest of this level is very well possible. We do not front run on a break above this level, but in case it occurs the 103.50 area is the next high profile resistance area.
On Friday, the fall-out for the surprise 150 basis points BoE rate cut still caused rather nervous trading in EUR/GBP with some wild intraday swings. In an order driven market, EUR/GBP came again close to the key 0.8197 range top at the start of trading in Europe, but once again the test was rejected and some profit taking kicked in. EUR/GBP tested bits in the 0.8070 area around the publication of the US payrolls but later returned higher in the intraday trading range, despite global investors reacting in a constructive way to the poor payrolls report. The pair closed the session at 0.8131, little changed from the 0.8169 close on Thursday. However, Friday’s EUR/GBP price action at least doesn’t give much credence to a scenario that the aggressive BoE approach would be a lasting support for the sterling.
Today, the UK calendar contains the PPI data. However, in the current environment, inflation data in the market are considered as backward looking and should only have limited impact on trading. The focus is on (the absence of) growth and the measures that fiscal and monetary authorities are prepared to take to kick start the economy. This morning, in illiquid trading conditions, EUR/GBP again came close to the key 0.8197 resistance area. Unwinding of GBP/JPY longs were said to be behind the move.
Already for some time, we advocate a range trading strategy for EUR/GBP within the barriers of the 0.77/0.82 range. Sterling trading within this range implies already quite a negative reassessment of the UK economic performance and structural weaknesses, especially as the situation in the Euro-zone area is growing ever more challenging, too. Nevertheless, the UK is a trade deficit country and its growth was highly depended on credit and domestic demand. In the current environment, these kinds of structural ‘imbalances’ make that sterling remains vulnerable over time. Last week’s aggressive BoE action might provide some temporary relieve, but doesn’t change the broader picture, we think. So, we remain very sterling sceptic. In a dayto- day perspective, we expect EUR/GBP to continue trading in the upper part of the standing trading range (0.8000/0.8200 area). We still tend to put the risk for a retest of the highs. In case of a (sustained) break above the 0.8200 barrier, the risk for an additional stop-loss sterling selling wave has grown materially. So, stop-loss protection to cover such a break of the longstanding range is (highly) warranted. We continue avoid EUR/GBP short exposure.
