Markets: Fixed Income

On Friday, global bonds rallied, as equities tanked and another batch of dismal economic data and corporate news was published. In the EMU, this resulted in an ongoing steepening of the curve, as yields were down by between 5 and 1 basis points; the 2- and 5-year yields again setting new cycle lows. In the US, the curve bull flattened, yields declined by 2.5 to 13 basis points, as some profit taking occurred following Thursday very pronounced steepening (after the weak 10- and 30-year auctions).

Regarding the economic news, the EMU economy is now officially in recession, as Q3 GDP was recorded at -0.2% Q/Q (in line with expectations), the second quarter of negative growth, while HICP inflation for October fell sharply too to 3.2% Y/Y (as expected). In the US, the October retail sales (at -2.8% M/M, below consensus) were the weakest on record, October import prices tumbled for the third month in a row (- 4.7% M/M) and Michigan consumer sentiment for early November was barely above October’s rock bottom results (albeit slightly above consensus).

In corporate news, the dismal eco situation was reflected too. JC Penney, the retailer, cut earnings forecasts, Nokia said that the eco slowdown will weigh on 2009 sales. Siemens, while reporting reasonable strong results, warned that its customers had problems with obtaining loans and Freddie Mac reported a 25 billion $ loss for Q3.

In the US, Libors and liquidity premia went up again after Paulson said (on Wednesday) that the Treasury wouldn’t buy distressed toxic assets from banks, raising concerns that banks will need more funding.

Intra-day, the Bund tried to rise after the opening, but soon follow through selling occurred and the important 117.82 (previous MT high) level was tested, but the test failed and the Bund stabilized around opening levels. After US investors joined the fray, Treasuries (and Bunds) started to rise in a movement that would essentially continue until 18h20 CET and was driven by the above mentioned factors. US equities staged a comeback at that point in time, driving the Treasuries slightly from the highs, only for the latter to recoup these when a late selling wave pushed equities back down. Equities closed near the intra-day lows, Treasuries near the intra-day highs.


G-20 meeting & statement

The Washington G-20 meeting on the credit crisis concluded with a statement that lays down the various areas in finance where changes are needed (new financial architecture) and the timetable for these changes to be decided. The statement also asks for a broader policy response regarding fiscal stimulus and more rate cuts, but includes no pledge for coordinated action, which might be considered by some market participants as disappointing. Next meeting will be held before the end of April 2009.

We think that the G-20 statement is a good starting point from which the serious work can start/continue. It was always an illusion to think that time was already ripe for many concrete decisions, especially as long as the new US president is not officially sworn in. President-elect Obama will play a key role in the upcoming radical reforms. President Bush seems to have resisted stronger regulation and defended tooth and nails free financial markets, but nevertheless admitted that more transparency and accountability is needed. The list of subjects on the table show that all participants made some concessions.

Principle points:

  • G-20 (or at least the G-8 and countries like Brazil, China and India and “Middle East”) more than the G-8 will be the forum where decisions will be taken (no formal decision though). It might happen via the extension of membership in the Financial Stability Forum.

  • No coordinated monetary or fiscal measures, but actions “as deemed appropriate to domestic conditions”.

  • No new trade barriers will be erected. Look for ways to conclude collapsed Doha trade round before year end.

  • More resources for IMF; Question of country votes in IMF will be examined.

  • Regulation is first and foremost national responsibility, but intensified international cooperation is needed for firms operating in various countries/areas: creation of supervisory colleges for bank regulators to coordinate oversight and share info on international banks.

  • Capital standards should be raised, especially for banks’ structured credit and securitization operations.

  • Enhance disclosure by investors and institutions, including hedge funds, of their financial conditions.

  • Strengthened oversight rating agencies to ensure unbiased information and avoid conflicts of interest.

  • Accounting standards harmonized around the world. Regulators need to examine whether current rules properly value securities, particularly complex illiquid products, during times of stress.

  • Use of clearinghouses for financial derivatives that should be traded on exchanges or electronic trading platforms.

  • Executive compensation should be managed to avoid excessive risk taking, but no specific caps were put forward.


US Treasuries move higher on renewed equity weakness and distressed eco data

Today, the calendar contains the October industrial production and the NY Fed (November). In September, industrial production surprised on the downside, showing the steepest drop since 1974. After the sharp drop, industrial production is expected to show a more modest decline (-0.2% M/M) in October, as the Boeing strike that affected production negatively in September ended. Nevertheless, we put the risks on the downside of expectations as the car industry might have a big negative impact on manufacturing output. The New York Fed survey showed a disastrous weakening of conditions in October. The headline index plunged from -10 to -24.6, a record low. Also the new orders index fell to its lowest level in survey history. This month, the consensus is looking for a (modest) further worsening in the headline index (-26.8). We have no reasons to distance ourselves from consensus that would suggest ongoing pronounced weakness in the sector.

Later on this week, the eco calendar remains well filled. The PPI on Tuesday and CPI on Wednesday are expected to have declined sharply on the back of lower energy prices, while the core readings might show a very modest price rise in the month. Housing market indicators should remain very weak with the NAHB index on Tuesday stabilizing at 14 and the housing starts (Wednesday) showing a further decline. The regional manufacturing surveys (NY Fed today and Philly Fed on Thursday) should validate the economy is sliding ever deeper in recession. Overall the eco data should confirm that the economy is contracting and price pressures are easing fast, a picture that was already apparent in previous weeks.

Fed public appearances are manifold. Today, Kansas Fed governor Hoenig speaks on regulation, while on Wednesday, Fed governor Kohn and Richmond Fed Lacker speak at a conference on sub-prime crisis. On Friday, regional Fed governors Bullard (St-Louis), Lacker (Richmond), Plosser (Philadelphia) and Evans (Chicago) on various subjects. We look especially for hints how the Fed may modulate policy further out when the zero rate constraint is an item. Governors Plosser and Stern touched the item last Thursday, with the latter suggesting quantitative easing might be needed and the former stating he was comfortable with the 1% Fed funds rate. In the same vein we will look closely to the meetings of the October 28-29 FOMC meeting for hints about the policy outlook. This week, there is no new Treasury supply outside the bill sector and neither have Agencies planned Note issuance. Issuing in the corporate market remains very modest and limited to the investment grade sector.

Regarding trading, Treasury yields dropped last week by 11-to-23 basis points in the 2-to-5-year sector, but by only 4-to-6 basis points in the 10 and 30-year sector. For the 10-year, a benchmark change should be taken into account. The short end continues to profit from dismal eco data and from the safety bid linked to equity weakness. The longer end was adversely affected by extra supply that was very apparent by the weak results of the 30-year T-bond auction. They were some new signs about stress re-appearing in the funding markets that needs monitoring this week. Indeed, following Paulson’s statement that the Treasury won’t buy toxic assets, the original main object of the TARP plan on Wednesday, Libors and liquidity spreads widened: the former (3-month) by 11 basis points, the latter by 16 basis points. On a weekly basis, Libors and liquidity spreads were still marginally lower. This wasn’t the case for 2 and 5-year swap spreads that widened in a weekly perspective by 7 and 5 basis points. The swap curve should some curious features: the 10- and 30-year swap spreads fell by 8 and 14 basis points, driving the latter to -14 basis points. The Fed Funds continue to trade way below the Fed funds target of 1%, suggesting quantitative easing has already been introduced, even if that might not yet been a voluntary act of the Fed. We would like to draw the attention on the low trading volumes in recent weeks, suggesting that investors are increasingly staying aside, raising the risks for some violent moves. Is the end-of-year effect already playing?

Regarding trading this week, the eco data should be again Treasury market constructive, but that is no surprise anymore. Equities might be a stronger market mover and it will be interesting to see whether last Thursday (failed) retest of the cycle lows will have calmed the bears. Friday’s price action is, of course, inconclusive in this regard and Asian mixed performance overnight doesn’t help us either. While the outlook for Treasuries is still reasonable bullish, especially at the shorter end, we would like to see a correction before entering the market. The technicals, which remain bullish, will guide us in the day-to-day tactics.

The downtrend of the 2-year yield is intact and the 1.32/23% cycle lows are now broken, opening the way to yields around 1%. The 5-year is still testing key resistance levels at around 2.35% (now 2.32%), 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 (now 3.73%) 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 last week. We might see the yield testing support at 3.98% and even 4.10%, if risk aversion recedes.


European yield curve steepens further

Today, the euro zone calendar is thin as it only contains the September trade balance, traditionally no market mover. Further out during the week, the calendar remains thin and will only heat up on Friday when an advance reading of the PMI surveys will be published.

On the ECB front, ECB’s Nowotny, Tumpel-Gugerell and Weber are scheduled to speak today. Over the weekend, the G20 meeting in Washington supported a broader policy response regarding fiscal and monetary policy. The head of the IMF Strauss-Kahn suggested that the ECB has scope to cut interest rates further, when he said that ‘in some parts of the world – Japan, the US – interest rates have been cut very much, but it can be done more aggressively in other parts’. On Saturday, ECB’s chief economist Stark sounded again downbeat on the economic outlook, as he foresaw ‘a prolonged recession, well into 2009, before we see a gradual recovery’. As such, despite the impressive decline in short-term yields over the past weeks, we see little reason to row against the flow and continue to prefer the short end of the curve as well as a further steepening.

The technical picture of both the 2- and 5-year yield is also bullish. In 2-year yields, first important support is seen at the 2005 lows at 1.98% and in 5-year yields the all-time lows at 2.45% are coming into the picture. Although these are extremely low levels, a test shouldn’t surprise given our expectation for ECB rates to fall at least towards the previous cycle low at 2%. At the longer end of the curve, 10-year yields tested the year lows at 3.67%, but no sustained break occurred yet, partly due to a benchmark change with the issuance of a new 10-year Bund last week. In the Bund future, a new contract high has been set, but on the continuation charts the Bund has to break first above the December 2005 highs at 118.88 to improve the technical picture further (see graph below). There were however some signs of improvement with regard to the intra-EMU spreads, which narrowed slightly despite the huge issuance last week. This week, there is again a lot of issuance expected, as Greece, Germany, Spain and France are expected to tap the market. Except for Spain (10-year), all will focus on the shorter end of the bond market, where demand has been best.

On the money market, the decline in the Euribor fixings has continued over the past week 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.

In the UK, there was again some downbeat news about the economy overnight, as the CBI revised down their growth forecasts to a drop of 1.7% Y/Y in 2009 and the Rightmove index signalled that the average asking price for a home fell 7.1% Y/Y, the most since records began six years ago. On the supply front, the UK will tap its 50- year Gilt today for an amount of GBP 1.25 B. It will be a good test for investor’s appetite at very long maturities. Over the past weeks, 50-year yields have been remarkably stable despite the slump in short-term yields.


Currencies: FX: major cross rates continue to show intraday volatility, but no clear directional trend

On Friday, EUR/USD trading was again driven by global investor sentiment. The swings between hope and fear continued to set the tone for trading. The Eco calendar in Europe and in the US contained some interesting releases as there were the European Q3 GDP data and CPI and the US retail sales and Michigan consumer confidence. However, those data had only a limited and temporary impact on trading, at best. EUR/USD started Friday’s session on a strong footing supported by the gains of US stocks on Thursday and the positive start in Europe. Nevertheless, underlying doubts on the sustainability of this rebound persisted and EUR/USD drifted lower going into the early morning data. The retail sales were again very weak but in line with the market reaction recently, poor eco data from the US were an ambiguous signal for the single currency. US stock markets at first didn’t react too negative to these data and this even helped EUR/USD to regain part of the previous intraday losses. However, a late session decline on the US stock markets also hammered EUR/USD and the pair closed the session at 1.2605, compared to 1.2769 on Thursday.

Over the weekend, all eyes were on the G20 meeting in Washington. As one could expect in advance, this meeting delivered a long to do list with a lot of good intentions. From a market point of view, it contains too few specific measures to change the course of events on global markets. EUR/USD trades around the closing levels of last Friday at the moment of writing.

Today, the European calendar only contains some second tier releases. In the US, the NY Empire state manufacturing survey and the production data are scheduled for release. Especially, the timely surveys are interesting, but we doubt they will have a lasting impact on global trading and on EUR/USD in particular. So, sentiment on global stock markets will continue to be the most important single driver for EUR/USD also today.

Already for quite some time, negative eco news and risk avers investor behavior has supported the dollar (and the yen) and has weighed on the single currency. This theme was an important factor behind the decline of EUR/USD from highs above 1.60 to current correction low in the 1.2330 area. We hold on to this EUR/USD negative bias longer term. However, since end October, the single currency has showed more resilient and has since 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 continue hold on to our view that the pair might continue trading within the barriers of this 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). Considering the large swings at the end of last week, the jury is still out on this item.

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 but we do not yet front run on a break of the downside of the range. In this respect, we still tended to reduce/take profit on EUR/USD short exposure in case of dips towards to range bottom and look to re-buy in a case of return action higher.

On Friday, USD/JPY trading again showed some intraday swings, but at the end of the day the changes were rather limited. The pair was traded in the 97.00 area at the start of trading in Europe, it lost some ground going into the start of the US trading session (the correlation with European equities at that time was not really on-to-one) but regained most of the intraday ‘losses’ later in the session, despite highly volatile trading conditions on the US stock markets at the end of the session. The pair closed the session at 97.14, compared to 97.68 on Thursday.

This morning, the (preliminary) Japanese Q3 GDP data came out in negative territory for the second consecutive quarter, sparking a lot of headlines on Japanese recession on the newswires. Negative eco data in theory are no good news for the yen, but this is not the way the markets usually react these days. Bad economic news, a poor start of the Asian stock markets and maybe also some disappointment on the outcome of the G20 supported the yen at the start of trading this morning. The pair was traded in the 96 area early in Asia but regained some ground as Japanese (and some other Asian stock markets) managed to overcome the early weakness.

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 three 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 on November 04, 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 Friday, EUR/GBP again showed some wide intraday swings. A lot of market players apparently still had to adapt positions after the recent sell-off of the sterling. There were no important UK data on the calendar and trading was again very much order driven. As was the case in the previous sessions, the sterling came under pressure in the run-up the US trading session. EUR/GBP at that time set an intraday high in the 0.8635 area but Thursday’s highs were not really challenged. Ahead of the weekend, this apparently inspired some short-term players to reduce sterling short-exposure; EUR/GBP closed the session at 0.8541 compared to 0.8606 on Thursday.

This morning, the Rightmove house prices index showed again a steep decline (- 2.9% M/M, -7.1 % Y/Y). On top of that, the CBI came out with a very negative assessment of the UK economy going forward. However, at least for now this release caused the big swings in sterling trading. EUR/GBP trades in the 0.8545 area at the moment of writing.

The aggressive BoE rate cut two weeks ago and the negative assessment from the BoE after the publication of the inflation report pulled the trigger for an aggressive sterling selling wave last week. The quick loss of interest rate support and the very negative outlook for the UK economy going forward made sterling lose all its attractiveness. Wednesday’s brake above the high profile 0.8200 resistance area has made the technical picture outright negative for sterling/positive for EUR/GBP After the sterling crash last week, some consolidation/correction is well possible. However, a buy-on-dips approach remains favoured. Longer-term we continue to put the risk for additional sterling losses, even from the current levels. The pair needs to return below the 0.8215 area (uptrend line) to call off the red alert for the sterling.