Markets: Fixed Income
On Tuesday, European bonds gained further ground amid thin trading conditions, as US market participants were absent in observance of Veterans’ Day Holiday. Dovish comments from ECB officials and rising concerns about the state of the global economy once again supported the short end of the curve leaving the European yield curve steeper on the day.
As such, the slight improvement in the German ZEW indicator as well as the ongoing decline in the money market rates failed to lift the gloom. Several ECB governing councils hinted that the ECB staff will have to revise down their growth and inflation projections substantially next month and thereby hinting at another rate cut in December. At the same time, concerns about the emerging markets flared up again, as Russia had to raise interest rates for the fifth time this year and allowed the rouble to weaken 1% against its basket of dollar and euros. Several credit rating downgrades in the emerging markets added to the concerns.
In a daily perspective, 2-year yields fell by 4.8 bps compared to 1.2 bps in 10-year yields. The very long end underperformed, as 30-year yields were up 4.8 bps following the announcement of the Dutch National Bank that it was postponing the need for Dutch pension funds to submit recovery plans for depleted solvency ratios. Last week, ABP, one of the largest pension funds, revealed that its cover ratio had dropped below the requirements set by the Dutch central bank.
US Treasury trading resumes following Veteran’s Day holiday
The calendar is thin today, as it contains only the 20 billion $ 10-year Note auction, the second leg of the 55 billion $ quarterly refunding operation. Tomorrow, the Treasury will still issue a 10 billion 30-year bond, which is actually the reopening of the 4.5% that was auctioned in August. There are no eco releases scheduled. Minneapolis Fed Stern speaks in Minneapolis, Board Fed Kohn on financial services in Luxembourg and Treasury Secretary Paulson on the financial rescue programme.
Regarding the 10-year Note auction, Monday’s 3-year Note auction that kicked of the refunding operation went very well. There was strong demand from all corners that resulted in a very strong 3.07 bid/cover (average 2.26) and a stop at 1.80%, or 4 basis points below the WI bid at the time of the stop. Dealers, Indirect bidders and direct bidders were all good for new record high bids. The statistics for the 10-year Note auction show an average bid/cover of 2.3, a stop of 1.5 basis points below the WI bid and an indirect bidder takedown of 37% of the auction. The cash flows surrounding the refunding operation are not very restrictive and thus should facilitate the operation. A 21.5 billion $ 10-year notes will be maturing and the Treasury will pay 9.2 billion $ coupon interest. The 10-year Note auction might attract fewer investors than the 3-year Note auction that is more sensitive to monetary policy. However, all in all, we might see enough interest to prevent damage to the overall market.
Minneapolis Fed Stern is a team player inside the FOMC. In his latest comments, of which we are aware, Stern said that the banking sector and markets will recover slowly from the financial crisis. He drew a comparison with the experiences in the early 1990s, which led to a severe contraction in the US. He was also concerned that the consolidation in the banking sector, a consequence of the crisis, would lead to institutions whose size and reach would pose systemic risks. He admitted though that it was not the time, in the midst of a crisis to address these concerns. Governor Kohn will speak about the financial services. His remarks might be interesting for the sector, but probably won’t affect the overall market. The speech of outgoing Treasury Secretary Paulson might be interesting too, after the Fed/Treasury took new measures regarding AIG. The Fed lowered the price of the loans it gave to AIG, while the Treasury took preferred shares in the framework of the TARP. Whereas until now, the Treasury always said that it would only take stakes in healthy institutions, the stake in AIG stretches once more the way the TARP legislation is used. With American Express getting bank holding status (and applying for 3.5 billion $ in aid) and the carmakers lining up for help, concerns rise about the debt situation slipping out of control of the authorities.
Regarding trading, on Monday, in very thin volumes, Treasuries recouped early substantial losses, closing with some decent gains. In even thinner conditions (US market was closed) some minor additional gains were booked on Tuesday. Equities couldn’t sustain their bizarre rise on Friday (on extremely weak payrolls) and ended lower on both Monday and Tuesday, but once more the thinness of conditions should withhold us of drawing conclusions.
The technicals remain bullish for the 2-year and moderately bullish for the 5-year, while the 10- and 30-year pictures are more neutral, but not bearish. The 2-year downtrend is intact and the 1.32/23% cycle lows are broken (but need confirmation today). A break below would open the way to yields around 1%. The 5-year has some problems, as the yield was unable to break yet below the 2.35% post-Lehman low despite three tests. However, we wouldn’t draw the conclusion that this level won’t be broken this cycle: A buy-on-up-tick 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, a disappointment and we might see the yield testing support at 3.98% and even 4.10%.
Given the new supply, the technicals and the empty eco calendar, we keep a somewhat defensive stance today, even if the newsflow remains bond supportive. 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 testing the lows ahead of today’s Bund auction
Today, the eco calendar contains only the euro zone industrial production data for September. In August, industrial production rose by 1.1% M/M, but is expected to shrink (-1.8% M/M) in September. We put the risks on the downside of expectations on growing concerns about the economic outlook and increased turmoil in financial markets. Regional data released earlier this month surprised on the downside as German, Italian and Spanish industrial production figures came out weaker than expected, but French industrial production came out in line with the expectations.
On the money market, the ECB will carry out a 3- and 6-month supplementary longer-term refinancing operation with full allotment and at a fixed rate. Yesterday, the ECB has set the fixed rate at 3.25%. As such, once again no spread is demanded, despite the longer maturities. At the weekly refinancing operation, the ECB yesterday allotted a new short-term record of EUR 334 B. The number of banks participating continues to grow too. Although money market rates continued their decline, banks are still not willing to lend to each other and still prefer to deposit their excess liquidity at the deposit facility of the ECB. To counter the large positive liquidity balance, the ECB yesterday drained 79.9 B in a one-day auction at an average rate of 3.51%.
On the supply front, Germany will issue a new 10-year Bund Jan 2019 for an amount of EUR 7 B, while Spain and Portugal will respectively tap their 2-year Bono Jan 2010 and 5-year OT Sep 2013 for an amount of 1.8-2.4 B and 1 B. Yesterday, the intra-EMU government bond spreads widened again.
Regarding trading, the weak eco data and decline in inflation as well as the increase in supply all favour the short end and a further steepening of the yield curve. Shortterm however a potential break lower in 10-year yields below the year lows at 3.67% could lead to a temporary pause or even some corrective flattening, as this would improve the technical picture and open the road, in theory even, towards the all-time lows at around 3%. Any correction on the steepening should be seen as an opportunity to set up new steepeners.
In the UK, the calendar contains the jobless claims and earnings data. The labour market is expected to deteriorate further with the jobless claims expected to show a rise of 40K in October, following an increase of 31.8K in September. Average earnings including bonus are expected to slow further (3.3% from 3.4%). Today, the Bank of England will also present its quarterly inflation report, that will provide a further indication how far interest rates may fall this cycle after the impressive rate cut of last week.
Currencies: Global negative sentiment sparks ‘usual’ reactions on the currency markets
On Tuesday, it appeared soon that Monday’s optimism on the Chinese stimulus package would be very short-lived. Already on Monday, the plan was not able to give the US stock markets a lasting support and yesterday the negative sentiment also again dominated the Asian and the European markets. On top of that, the data and the corporate news headlines only reinforced the investor feeling that the crisis is far from over. The ZEW confidence indicator came out slightly less negative than expected, but this was not able to change the course of events on global markets. On the currency markets, this new batch of negativism caused EUR/USD (and EURJPY) to show the usual reflexes. The carry currencies including the euro came under pressure and the yen and the dollar again attracted safe haven flows. Growing uncertainty on the health of some emerging markets (Russia) reinforced this move. In Europe, EUR/USD at first developed a sideways trading pattern in the 1.27 area, but during the US trading hours, the pair fell below the 1.2675/50 support area and this triggered a new selling wave. Oil at that time also set a new correction low, but the downward momentum in oil was not that forceful. So, the impact from oil on EUR/USD yesterday probably shouldn’t be exaggerated. Nevertheless, EUR/USD closed the session at 1.2522, a decent loss compared to the 1.2748 close on Tuesday.
Today, the US calendar only contains some second tier releases. In Europe, the September industrial production data are on the calendar. However, this figure for sure won’t change the global (negative) picture. So, global financial and eco headlines will again set the tone for EUR/USD trading. Sentiment on the Asian stock markets this morning is slightly less negative than yesterday, but underlying market negativism obviously is far from over yet.
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. Over the previous two weeks, the single currency showed somewhat more resilient, but yesterday’s price action illustrates that the underlying market sentiment is still supportive for safe haven like the dollar and the yen and that the euro is still fighting an uphill battle. 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. Whether this bottom holds will highly depend on whether or not the major stock market indices (which often show a similar technical pattern compared to EUR/USD) will be able to avoid another down leg below the current range bottom (840 area for the S&P).
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 protected. Within the 1.2330/1.3294 range the pair even cautiously tried to set up a series of higher lows, but this pattern is aborted after yesterday’s downmove. 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. We hold on to that tactics. Even as the picture in EUR/USD becomes again heavier, we do not yet front run on a break of the downside of the range. So, short-term players can consider partially profit taking in case of return action towards the bottom of the range and try to re-buy higher.
Yesterday, USD/JPY trading showed no spectacular moves despite the overall negative sentiment on global markets. The pair traded in the 98.00 area at the start of trading in Europe and hovered slightly lower throughout the session. The pair closed the session at 97.65 compared to a 98.00 close on Monday. So, after all, the yen gains against the dollar were limited. The save haven flows were apparently more directed towards EUR/JPY.
This morning, Japanese consumer confidence dropped further to new cycle lows, but as usual this had no impact on trading. Japanese and Asian stocks markets entered calmer waters with most indices showing limited losses.
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. Recently, 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. A sell-on-upticks approach is favoured as long as the pair holds below the 100.55 mark. A rebound above this level would indicate a change in the shortterm picture fro the pair (partial stop-loss protection).
After last week’s spectacular 150 basis points rate cut, EUR/GBP tested already twice the life-time highs. In this respect, the EUR/GBP trading pattern was more or less similar on Monday and Tuesday. The sterling came under pressure during the Asian/European trading hours, key resistance in the 0.8200 area was tested, but no brake occurred and EUR/GBP returned back lower with the barriers of the established trading range. Yesterday, different series of UK housing data confirmed the poor state of sector. The trade data were better (less negative) than expected, but understandably, this had not positive impact on sterling. EUR/GBP closed the session at 0.8140, compared to 0.8167 on Monday.
Today, UK labour market data and the BoE quarterly inflation report are on the calendar. Both series have the potential to move the currency markets. Especially the latter could be interesting literature as markets will be keen to see how last week’s rate cut is framed by the global economic context as it appears out of this inflation report.
For quite 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 country with an external deficit 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. Short-term, we expect EUR/GBP to continue trading in the upper part of the standing trading range (0.8000/0.8200 area) and the highs of the range might continue to be under test. The risk for a (sustained) break of the 0.8200 barrier and for an additional stop-loss sterling selling wave has grown materially. So, stop-loss protection to cover such a break is (highly) warranted. We continue avoid EUR/GBP short exposure.
