Markets: Fixed Income
On Thursday, global bonds multi-day rally was stopped, as US equities staged a violent rebound after testing the cycle lows. The curves still steepened. In Germany, the 2- and 5-year yield still managed to close 1 to 2 basis points lower, the 10-year was marginally higher, but the 30-year rose by 6.6 basis points. In the US, 2- and 5-year yields were up 7 basis points, the 10 and 30-year respectively 21 and 18 basis points, but for the 10-year a benchmark change played a role.
The eco data were very weak, but couldn’t really drive bonds higher: German Q3 GDP shrank a bigger-than-expected 0.5% Q/Q, US claims jumped above the 500 000 for the first time since the 2001 recession and while the US trade deficit narrowed, the decline of both import and exports points to global eco weakness. The IEA cutting oil demand forecasts and some weak earnings reports or guidance gave a similar picture than the hard eco data.
Fed and ECB speakers (see below) were unisone pessimistic on the eco outlook.
The awful US 30-year bond auction and the distributing of the new 3- and 10-year supply certainly played a role too, especially at the longer end of the curve.
The intra-day price action was largely driven by equities: Sideways in the European session, with a better tone in early US session, until equities rebounded mightily late in the session bringing bonds down and mostly into negative territory (with the exception of the short end in Europe).
Rebound in equities and poor 30-year T-bond auction drive Treasuries lower
The calendar is interesting today with the October retail sales and U. of Michigan consumer confidence (November), besides the import prices and the business inventories. Import prices should have tumbled sharply lower for the third consecutive month, as energy prices are lower and the dollar stronger. Retail sales are expected to show the fourth consecutive monthly decline in October. In September, retail sales showed the steepest drop since August 2005 due to a sharp decline in car sales (- 3.8% M/M). But the weakness was broadly based. For October, the consensus is looking for a 2.1% M/M plunge in retail sales as conditions deteriorated sharply due to increased turmoil in financial markets and deterioration in the global economic outlook. University of Michigan consumer confidence showed an extreme plunge in October (57.6 from 70.3) after improving in the three months before. Both sub-indices deteriorated significantly. Consumer sentiment is expected to decline further in November, coming out at 56.2, but a lower outcome should not surprise.
The 30-year bond auction went poorly. The auction stopped at 4.31% or about 9 basis points above the bid in the WI at the moment of the stop. So the bidding was absolutely not aggressive. The bid/cover of 2.07 was light (average 2.19). Indirect bidders took down 18.2% of the auction, which wasn’t that bad, but their hit ratio of 40% was very low.
The Fed’s 25 billion $ schedule 1 TSLF auction generated a 17.6 billion $ bid for a bid cover of 0.7, while the stop out rate was at the minimum 10 basis points. This suggests that dislocations that hit the market since the Lehman demise in mid- September have eased considerably and normalcy has returned. Indeed, in the previous 8 auctions, the bid/cover was above 1 and the stop above the minimum stopout rate.
Fed speakers continued to paint a gloomy picture of the economic outlook. Minneapolis Fed Stern said the current downturn look similar, but potentially worse than the one in the early 1990s. Economic growth could be held down by financial headwinds for one to three years. In a similar vein, Philly Fed governor Plosser forecasted a sharper decline in Q4 GDP than the 0.3% decline in Q3 and expects the jobless rate to top 7% in 2009. Interestingly, Plosser said that technical problems confront the Fed in potentially pushing the rate lower and he is comfortable with rates as they stand. He especially referred to problems for investors in mutual funds in short term money markets. Stern suggested that by rates at 1%, the Fed might be pushed to quantitative easing. They both stressed that the current (loose) Fed policy is temporary (to support financial system) and that the Fed must shrink its balance sheet in due time. Both saw signs the Fed’s policy was having the desired effect of normalization of financial markets.
Regarding trading, on Thursday, a rebound in equities and an awful 30-year bond auction led to profit taking that hit the longer end hard. The eco data should be constructive today, but are already expected very weak and therefore might once again lack strong market moving power. Equity bargain hunters stepped in yesterday when the lows were tested. From a market technical point of view, that shouldn’t be a surprise. It will be interesting to see whether there is follow through buying today or that profit taking already kicks in. The huge volatility probably doesn’t entice long term real money investors. We are neutral on Treasuries. There might be more profit taking today, in case equities would book more gains. However, at least in Asia, the equity rebound is far from convincing.
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 2.40%), which if broken sustainable would make the picture outright bullish. 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.
Bund cannot build out gains following break higher
Today, the euro zone calendar contains the first estimate of Q3 GDP growth and the October CPI figures.
Yesterday, the German economy slid into a technical recession, as the economy contracted for the second consecutive quarter. German economic activity showed a steeper-than-expected fall in the third quarter (-0.5% Q/Q). The second quarter reading was slightly upwardly revised from -0.5% Q/Q to -0.4% Q/Q. Ahead of the German data, the euro zone economy was expected to shrink by 0.2% Q/Q in the third quarter following a decline of 0.2% Q/Q in the second quarter of 2008. Following the disappointing German data, we now put the risks on the downside of expectations. This would be the first technical recession since the birth of the EMU and signals the need for further aggressive rate cuts over the coming months.
According to the flash estimate, euro zone HICP fell from 3.6% Y/Y in September to 3.2% Y/Y in October. The final CPI figure is expected to confirm the flash estimate. We put the risks on the downside of expectations. Core CPI is expected to stay unchanged at 1.9% Y/Y in October. According to the ECB monthly report, published yesterday, the HICP inflation rate will continue to decline in the coming months and reach a level in line with price stability during the course of 2009. They added that even stronger downside movements in inflation cannot be excluded around the middle of next year. This clearly indicates that the inflation theme is off the table and leaves the door open for more (aggressive) rate cuts.
On the ECB front, ECB’s Nowotny subscribed this view yesterday, as he said that the euro region economy is already ‘in recession’ and added that ‘inflation expectations should come down fast’, which will ‘give the ECB room for additional rate cuts’. He sounded also very pessimistic on the growth outlook, as he said that the EU commission forecast of 0.1% growth may be ‘too optimistic’ and feared ‘it’s going to be a lot worse than that’. ECB’s Constancio was more cautious and said that ‘a recession is not yet confirmed’. Today, ECB’s Trichet, Bini Smaghi, Orphanides and Stark are scheduled to speak. Until now, the ECB governing council members have done nothing to prevent markets from discounting further rate cuts.
On the money market, the Euribor fixings continued their decline and the liquidity spread even declined slightly on the shorter maturities. The overnight deposits at the ECB fell too, but more evidence is needed before we would conclude that there is material improvement in the money market conditions.
Regarding trading, there was no strong follow-through buying in the Bund following Wednesday’s break higher. Trading was volatile but without clear direction, at least until a late session surge in equities pushed the Bund towards the 118 level (after official close). However, as US Treasuries are moderately higher overnight, the Bund shouldn’t fall below 118 in the opening. In yield terms, daily changes were modest, but the steepening continued. Only the long end showed a steep drop pushing yields 6.6 basis points up, at least partly in sympathy with the sell-off of the US long end. For today, equities will probably be the driver, even if the GDP and HICP data should be bond-friendly. US equities staged a powerful rebound after setting intra-day a new cycle low. However, the move was technical in nature and already in Asia, the optimism has cooled. Following this week’s impressive move, some end-of-week profittaking shouldn’t surprise, if equities don’t tumble lower again, like we have seen on the back of last week’s US Payrolls report. In a longer-term perspective, we continue to be bullish and prefer the short end of the curve and thus a further steepening.
In the UK, the calendar is empty today.
Currencies: Sterling stays under heavy pressure
On Thursday, at first it looked as if EUR/USD trading was going to experience a rather calm trading session. The pair dipped to an intraday low in the 1.2390 area after data showed that the German economy fell into recession with negative growth in Q2 and Q3. However, this dip was soon reversed and the pair settled in a 1.2450/1.2590 trading range for most of the day. European stocks showed moderate gains and gave the pair some downside protection. The US initially jobless claims came out much higher than expected but had no lasting impact on EUR/USD trading. Later in the session US stock markets had quite a surprise in the offing. US stock market indices extensively tested the key support area (cycle lows). However, the test was rejected and this triggered an impressive rebound during the afternoon session in the US. This rebound left its traces on almost all other markets and EUR/USD joined this broader relieve rally. The move was probably reinforced by EUR/USD shorts taking profit on the recent USD-gains as the key 1.2330 area was apparently one step to far for now. EUR/USD closed the session at 1.2769, compared to 1.2505 on Thursday.
Today, the US calendar is much more interesting compared to the previous days. In Europe, several countries report Q3 GDP figures and the EMU CPI is scheduled for release. The US calendar is even more interesting with the retail sales, the import prices and the Michigan consumer confidence to be published. Activity data (retail sales and consumer confidence) are the most important from a market point of view. Recently, negative data, even if they came from the US, most often weighed on the euro. However, as was illustrated by yesterday’s price action, the reaction on the stock markets will be the key driver. In this respect, investors might be reluctant to hold positions over the weekend with the G20 meeting on the agenda.
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. However, since end October, the single currency showed somewhat more resilient and developed a short-term consolidation pressure. The correlation between EUR/USD and the stock markets is not one-for-one, but (the degree of) risk aversion is still the dominant factor for EUR/USD trading. 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 the bottom holds is highly dependent on whether or not the major stock market indices to avoid another down leg below the current range bottom (840/818 area for the S&P). In this respect, yesterday’s S&P creates also some breathing space 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, 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 and we do not yet front run on a break of the downside of the range. Yesterday, in a day-to-day approach, we advocated that short-term players could consider partial profit taking in case of return action towards the bottom of the range. The correction in EUR/USD may have some further to go if stocks were to enter calmer waters after yesterday’s extensive, (but failed) test of the key support levels. We look to re-sell higher in the mentioned trading range but we are in no hurry to do so at the current levels.
Yesterday’s, price action in USD/JPY was also dominated by the spectacular rebound on the US stock markets. Earlier in the session, USD/JPY trading was locked in a 95.15/96.40 trading range. The rebound on the stock markets, caused the pair to close the session at 97.68, compared to 95.01 on Wednesday.
This morning, there were no eco data on the calendar in Japan. Investors prepare for the G20 meeting this weekend. Asian stocks are in positive territory this morning, but the gains are not as spectacular as one could have hoped after yesterday’s spectacular rebound in the US. USD/JPY has returned to the 97 area at the moment of writing. In the markets there is also a lot of talk of potential repatriation flows linked to big coupon payments on US Treasuries. In theory, these flows should be USD/JPY negative. Usually we don’t give too much weight to this coupon flow factor, but in the current environment of reduced market liquidity it deserves some more attention.
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 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 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.
On Thursday, EUR/GBP built on upward momentum that was already apparent over the previous sessions. Last week’s spectacular rate cut and the BoE’s assessment on the economic environment in the press conference after yesterday’s BoE inflation report pulled the trigger for a new sterling selling wave. EUR/GBP did break above the high profile 0.8200 resistance area on Wednesday. Yesterday, more follow through trading on this brake occurred. Stop-tripping was the name of the game in EUR/GBP trading as well as in cable. Around noon, the pair moving above the 0.8415-area (Wednesday high) triggered a first buying move. Later in US trading, cable failed to join the stock market driven rebound in EUR/USD and this temporary pushed EUR/GBP beyond the 0.86 barrier. Poor liquidity conditions only make things worse for sterling. BoE’s Sentance in an interview said that it will take time for the interest rate reductions to affect the economy. This is of course not really a support for the sterling. EUR/GBP closed the session at 0.8606 compared to 0.8356 on Wednesday.
Today the UK calendar is empty.
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 the UK currency vulnerable. Wednesday’s brake above the high profile 0.8200 resistance area has made the technical picture outright negative for sterling/positive for EUR/GBP and yesterday’s quite some spectacular follow-through action occurred. After the sterling crash of the previous to session, some consolidation/correction is well possible. However, a buy-on-dips approach remains 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 continue to put the risk for additional sterling losses, even from the current levels. The fact that cable hardly managed to regain any ground in step with EUR/USD yesterday evening illustrates the deep market skeptics with respect to sterling.
