Markets: Fixed Income
On Wednesday, global bonds rallied higher thereby in some maturities taking out important resistance level, as equities slid again towards last month’s fiveyear lows. Rising concerns about the state of the global economy and the shift in focus of the TARP away from buying toxic assets added to investor’s nervousness.
Hence, risk aversion reigned again and government bonds benefited from the safe haven flows. The short end gained the most, as US, German and UK 2-year yields fell to new cycle (closing) lows. In the UK, the Bank of England inflation’s report indicated that rates may fall much further, as the Bank now expects a steep drop in inflation and forecasts a recession for next year. At the longer end of the curve, German 10-year yields dropped below the year lows at around 3.67% improving the technical outlook significantly.
As such, the European and US yield curve steepened further. In the US, 2-year yields underperformed a bit (-8.1 bps), but 1- and 3-year yields fell 14.4 bps and 17.2 bps compared to a decline of 13.4 bps in 5-year yields, 9.7 bps in 10-year yields and 2.3 bps in 30-year yields. In the euro zone, 2-year yields fell 7.3 bps compared to 3.9 bps in 10-year yields.
US Treasuries profit from safe haven status as equities tank
Today, the calendar heats up with the weekly claims and September trade balance. In the week ended November 7, initial claims are expected to show an unchanged picture. After last week’s reading of 481 000, the consensus is seeking for a figure of 480 000. But more important might be the continuing claims, reported with a oneweek lag, which are expected to decline from 3 843 000 to 3 825 000, following a uninterrupted rise in previous weeks. The trade balance is expected to show smaller deficit in September (-57.0B from -59.1B).
Philly Fed governor Plosser speaks on the economy in Pittsburgh and Minneapolis Fed governor Stern, who spoke already yesterday but at a closed meeting (no news reports available), speaks in Winona. The Treasury will re-open its 30-year Bond (4.5% May 2038) for an amount of 10 billion $. The 10-year Note auction didn’t go very well, as the size of the issue is becoming a problem further out the curve. The bid/cover was solid: the Direct bid was the largest since May 2005 and the Indirect bid the largest since May 2004, but the Treasury had to go far down the bid list to get the offer filled. Today’s 30-year Bond auction will be the last of the cycle of 2 new issues a year that are re-opened once. From Q1 2009 onwards, there will be a new 30- year auctioned every quarter. The auction will raise all new cash, but the Treasury will pay out 10.3 billion $ in coupon interest on 30-year issues. Overall, the cash flows surrounding the quarterly re-funding are not very restrictive, but nevertheless far from as generous as in the refunding operations in recent quarters. We have no strong opinion on the outcome of the auction. The longer end isn’t exactly the best place to be currently, with 30-year yields at 4.26%, still at historical still relative low levels.
Treasury Secretary Paulson stunned markets and analysts as he dropped the plan to buy toxic assets, which was the centrepiece of the 700 billion $ TARP plan approved by Congress in October. He now wants to reorient the plan towards supporting the financial system (expanded recapitalisation), the consumer sector (via supporting the markets backed by consumer debts) and prevent foreclosures. There is still 410 billion $ available in the TARP plan, but Congress has to authorise the use of 350 billion $ of the remaining money. Some influential Congressmen already showed resistance towards the re-orientation suggesting new negotiations will be needed. As the new Congress will only start working in January, there might be delays in the implementation of the programme. Mr. Paulson said that the lack of availability of student loans, auto loans and credit cards was threatening the economic outlook. While the new ideas of Paulson might indeed be needed to support the economy, it sends a very bleak and confusing message to the world. Are the authorities losing their calm with their altering plans to help the economy and communications? This might continue to feed in the current state of gloom and doom that underpins the retrenchment in spending by companies and households.
Regarding trading, on Wednesday, the changes to the TARP, the bleak outlook for firms like Intel (that came with a profit warning) all contributed to economic pessimism and thus a risk aversion environment. Equities opened weak and slid further during the session, closing down 5.2% for S&P), while Treasuries made a synchronized upward move. The curve steepened, but the 2-year lagged a bit. Risk aversion was very apparent in the Bill sector with 3-month T-bill yield falling 28 basis points to 0.15%. The longer end of the curve might have been hindered by supply (10-year Note auction late in the session, 30-year Bond auction later today). Positively, Libors slid a few basis points, but the liquidity spread stabilized and so did swap spreads. In recent days, we were too conservative, waiting on corrections to add to long positions, while our longer term orientation, long at the 2-to-5-year segment, more neutral further out still remains appropriate, we think. The data won’t drive the markets today. It will be equities that reign. Indeed, the S&P (852) has now reapproached the cycle lows at 839. A sustained drop below would inject another dose of pessimism into the marketplace, especially if also the 2002 lows at 768 would be broken. It would paint a massive bearish double top on the charts.
The technicals remain bullish. The 2-year downtrend is intact and the 1.32/23% cycle lows are now broken, opening the way to yields around 1%. The 5-year is now testing key resistance levels at around 2.35% (now 2.33%), which if broken would make the picture outright bullish, even if the year lows at 2.16% might still be a hurdle further down the road. 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 that wasn’t washed away yesterday. We might see the yield testing support at 3.98% and even 4.10%, if risk aversion recedes.
German 10-year yields break lower
Ahead of tomorrow’s euro zone growth data, this morning’s German’s Q3 GDP data showed a much larger than expected contraction of the largest economy in the euro zone. It was the second consecutive quarter of negative growth, which means that the German economy has now entered a technical recession. Recent data suggest little improvement ahead. Further out today, Spain will also publish their growth data, while the ECB will publish its monthly bulletin. This may provide some further insight in the current thinking of the ECB and will include the new Survey of Profession Forecasters. Over the previous days, the ECB has already hinted towards a significant downward revision of both the growth and inflation outlook in the new ECB staff projections, which will be published at the December meeting. These should set the stage for another rate cut of at least 50 bps.
In this context, yesterday’s wage agreement of IG Metall should be rather reassuring for the ECB that no huge second round effects will occur. Instead of the demanded 8% wage increase, IG Metall has accepted a 2.1% rise in February, followed by another 2.1% in May as well as a variety of one-off payments. Struggling companies will be allowed to defer the second payment until December 2009. The moderate wage agreement is seen as a bellwether for other sectors too.
On the money market, the ECB yesterday injected a total amount of more than EUR 108 B via two supplementary 3- and 6-month refinancing operations. By flooding the market with liquidity, the ECB wants to avoid disruptive liquidity shortages and revitalize the money market. Until now, these efforts failed, as banks continued to prefer to park their overnight money at the ECB instead of lending it out to each other. Nevertheless, by flooding the market with liquidity at a fixed rate, the ECB ensures banks of ‘cheap’ funds and in fact subsidizes the banking sector.
On the supply front, Italy will tap three of its BTPs in the 5- and 30-year sector for a total amount of EUR 3.5-5 B. Ahead of the auction, Italian government bonds again underperformed. Yesterday, even the new German Bund Jan 2019 hardly attracted enough demand to get the issue sold. This raises further questions about the funding of the governments in the euro zone and may lead to a further widening of the spreads of those countries with the largest budget deficits and debts.
In contrast to the German Bund, the first 3-year bond (5 B) of France’s new agency Société de Financement de l’Economie Française was however met with decent demand, but only after it offered a huge spread of around 70 bps above the similar French OATs and BTANs. Contrary to the UK, where banks issue their own government- guaranteed bonds, France has set up an agency to issue the bonds. In a first assessment, the spread of new French bonds appears to be lower than those of the banks in the UK above the similar Gilt issues.
Regarding trading, the sell-off on the equity markets once again supported the bond markets. Following yesterday’s break below the year lows in German 10-year yields, the technical picture is now bullish at all maturities. Although this may bring the alltime lows again in the picture at 3%, we continue to favour the short end of the curve and further steepening of the yield curve given the supply issue.
In the UK, the calendar is empty today.
Currencies: Sterling crashes after BoE inflation report
On Wednesday, the crisis feeling dominated again sentiment on financial markets and EUR/USD reacted accordingly. There was not one specific item to explain this flaring up of the crisis sentiment. The crisis spreading further to emerging markets in general and Russia in particular is an additional negative element for the single currency. The BoE inflation report confronted the market with steep and quick deterioration of the economy. Later in the session, Mr. Paulson announced that money from the bail-out plan wouldn’t be used to buy distressed assets but that it could be used better otherwise. As such, this is probably a valid conclusion but it illustrates how difficult it is to manage this crisis. In the current negative environment, this adds to investor risk aversion and EUR/USD traders drew also their conclusions. The pair showed some forceful intraday swings, but the trend was downward oriented and EUR/USD slipped from the 1.2600 area at the start of European trading to intraday lows in the 1.2470 area and closed the session at 1.2505. Another down-leg in the oil price reinforced the pressure on the pair.
Today, the US calendar contains the trade balance and the jobless claims In Europe, a long series of ECB speakers is scheduled to speak. However, stock markets and the global investor sentiment will probably continue to be the most important drivers for trading on the currency markets. At the current juncture, it is the big picture that matters. ‘Local’ details most often only have a temporary impact on trading in the major cross rates.
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. 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 and developed a shortterm consolidation pressure. However, as the negative economic sentiment has again become the dominant factor for currency trading since last week, the euro feels again strong headwinds, especially from the dollar and the yen. 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 be highly dependent on whether or not the major stock market indices (which by and large 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). Looking at those charts (and to the oil price), it becomes obvious that the risk of a break has become a decent possibility. This is no support for EUR/USD.
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 have all been taken out with remarkable ease, but over the last two weeks the EUR/USD decline shifted into a lower gear but the pair failed to regain the first important resistance area 1.3259/94 in a sustainable way and gradually returned south. 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 partial profit taking in case of return action towards the bottom of the range and try to re-buy higher, even as we are well aware of the risk that a brake below the lows might pull the trigger for another downleg in this pair.
Last week and early this week, EUR/JPY temporary entered calmer waters, even as tensions on other markets remained high. However, yesterday’s sell-off on the European and US stock markets was enough a reason for investors to rush again to the yen. Throughout the session, severe selling waves hammered the USD/JPY cross rate through a series of (minor) support levels. In a daily perspective the pair dropped from a 97.65 close on Tuesday to 95.01 at the close yesterday evening. EUR/JPY was hit hard as well, tumbling from levels above 123 at the start of trading in Europe to below the 119-mark at the end of the day in the US.
This morning, quite a long series of Japanese eco data were published, but most of them were final figures, hardly bringing any additional info to the market. The Domestic Corporate Goods prices showed a steeper than expected monthly decline, indicating that the deflation risk will soon come to the forefront again.
Elsewhere in the region, the Reserve Bank of Australia stepped into the market to support the Aussie dollar after the recent losses. AUD/USD stabilises in the 0.6350/6450 area in Asia 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 a temporary USD/JPY rebound with the pair reaching a reaction high in the 100.55 area early last week. However, 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 indicated that gains beyond the 100.55 reaction high wouldn’t be that easy short-term. A sell-on-upticks approach remains favoured as long as the pair holds below the 100.55 mark. Shortterm, the previous low (96.76) is the first resistance to watch out for.
Since last week’s BoE rate cut the sterling came under renewed pressure. Yesterday all eyes were on the BoE inflation report as markets were keen to see the reasoning behind last week’s spectacular move. As expected, the BoE painted a bleak picture of the economy going forward. The risk for inflation to materially undershooting the BoE target perfectly justified last week action and the BoE governor opened the way for more bold steps in the near future. Regarding sterling, the BoE indicated that it doesn’t pursue a sharp fall from the sterling but on the other hand it indicated that ‘some fall back form the level where it was at in the summer is probably an inevitable part of the rebalancing that ‘s going on. The combination of a prospect for further interest rate cuts and the feeling that the BoE is preparing any steps to stem the fall of the sterling triggered a new, sharp sell-off of the sterling. EUR/GBP smashed the top of the long-standing trading range and tested offers above the 0.84 mark. The pair closed the session at 0.8356 compared to a 0.8141 close on Tuesday.
Today the UK calendar is empty.
For quite some time, we advocated a range trading strategy for EUR/GBP within the barriers of the 0.77/0.82 range as 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. However, after last week’s aggressive BoE rate cut we warned that sterling could again enter stormy waters. 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 it vulnerable. Yesterday’s brake above the high profile 0.8200 resistance area makes the technical picture outright negative for sterling/positive for EUR/GBP. After yesterday’s crash some consolidation/ correction is very well possible. However, a buy-on-dips approach is now again favoured. The pair needs to return below the 0.8211 area (uptrend line) to call off the red alert for the sterling. Longer-term we put the risk for additional sterling losses, even from the current levels.
