Markets: Fixed Income
On Wednesday, global bonds had a really strong run, very temporarily interrupted by some profit taking, but closing with juicy gains. Interestingly, the short end continued to underperform, despite the flight to quality, as markets discounted already very low official rates, limiting the room for lower 2-year yields. Also profit taking on previous tremendous steepening and the surprise drop in core US CPI may have contributed to the outperformance of the longer end. We don’t exclude that the sharp deterioration in credit spreads, especially the CMBS, following the default of 2 CMBS caused some hedging needs. In a daily perspective, yields dropped by 7 to 21 basis points, while in EMU, yields fell by 1 to 11.6 basis points.
Bonds started the day on a strong footing, as equities rapidly hit the skids. Corporate news was ugly with now the world’s bigger chemical concern BASF announcing the temporary closure of 80 plants and carmakers taking measures to address plunging demand. There was some profit taking in early US trading, even as US CPI plunged more than expected and US housing starts and permits declined substantially. However, a bottom was found and Treasuries were already rising, when equities started to plunge, given Treasuries more fuel and keeping them climbing till the end of the session.
US Treasuries go through the roof, as gloom and doom holds markets in its grip
Today, the calendar is well-filled with the weekly unemployment claims, November Philly Fed and October leading indicators. Last week, both initial and continuing claims came out surprisingly weak. Initial claims rose to 516 000, the highest level in seven years. For this week, claims are expected slightly lower (505 000), but it would be wrong to conclude that the labour market is improving. If claims would report a decline, this might be associated with Veteran’s day and seasonal adjustment problems. Continuing claims painted an even bleaker picture, coming out at the highest level since January 1983. In the week ended November 8, continuing claims are expected to show a slight increase (3 900 000 from 3 897 000). Last month, the Philadelphia Fed showed an extreme drop in the headline index (-37.5 from 3.8), but also the details were very weak. The consensus is seeking for another very weak figure in November (-35.0). The leading indicators showed a surprise increase in September, while the August figures were sharply downwardly revised due to worsening consumer goods orders. In October, the consensus expects a significant plunge (0.6% M/M) in leading indicators. We put the risks on the downside of expectations as the economic outlook deteriorated very sharply in August and conditions in financial markets worsened significantly. The economic data are not expected to have a lasting impact in markets.
Fed vice-chairman Kohn said that as for the short and intermediate term outlook, weakness in real activity is likely to persist for a while. He acknowledged that the severe disruption here and abroad is likely to be considerably more severe than in past episodes. In other remarks, he re-iterated, the now very contested, viewpoint that it is hard to identify a bubble and even if it is identified, monetary policy is not very suitable to deflate the bubble in an appropriate manner. He explained why the Fed in 2003 couldn’t raise rates faster, notably a rising unemployment rate and inflation that might have been declining to undesirable low level. In recent days, some regional governors suggested that the Fed should raise rates quicker than before when the economy started to improve. However, it is far from certain that will have as the same two factors Kohn cited to explain the Fed’s attitude in 2003 might be again in play. Kohn blames the “great moderation” as the underlying root cause of the current crisis.
The October 28-29 FOMC Minutes show that the staff lowered growth expectations and raised unemployment rate projections for the period 2008-2010. Inflation forecasts were lowered. For 2009, flat growth is projected via a negative H1 and a rise in H2. The unemployment rate is expected to rise significantly through early 2010. The Minutes open the road for lower rates in the meetings ahead: Members anticipated that economic data over the upcoming intermeeting period would show significant weakness in activity and some suggested that additional policy easing could well be appropriate at future meetings.” The risk of deflation was mentioned several times and once it was said that this would pose important challenges for the Fed, given the likelihood the Fed Funds target rate would already be at its bottom. Some members were concerned that the effectiveness of rate cuts may have diminished by the financial dislocations.
Regarding trading, Treasuries prolong their winning course, and while the whole curve shifted lower, there was a pronounced flattening of the curve. Extreme weakness in activity, dimmed dropping core inflation, plunging equities to new cycle lows and a VIX fear index at 74.3%, all made a strong case for Treasuries. 3-month T-bills at 0.06% continue to blossom and yields are sliding lower. The 2- and now also the 5-year yield set all time lows and at 1.05% and 1.99% (the lowest since 1954 for the 5-year), have now approached, even reached our ambitious targets. The 10- year yield currently tests the 3.25%, the cycle low, which if broken would open the road to the historical low at 3.07%, while the 30-year yield at 3.86% is testing the all time lows.
Needless to specify that markets are in panic mode and the break below the cycle lows in the S&P is indeed scary. There are some supports that might still play their role (802, projection 3e wave Elliot, 792, LT projection equality C wave, 784 target channel break monthly graph and 768 2002 lows), but if sustained broken and yesterday’s price action doesn’t bode well it would be Armageddon. While the outlook, also today, is Treasury bullish, we might be in an overextended, exhaustion-like phase. So while it may look odd, we think investors should contemplate profit taking on long positions, as our targets on the 2- and 5-year maturities are reached and the 10- and 30-year test key support levels. Gains on longs are extremely juicy and in case the current levels of 1, 2, 3.25 and 3.85% for 2-, 5-, 10- and 30-year yields hold, a correction may occur. So, even if the overall outlook remains bullish, we prefer profit taking and hope to get the opportunity to step again in at higher levels. The potential drivers of the day are the situation of the carmakers and sentiment regarding financials. It seems that markets are already contemplating about the need for the financials to raise capital once more.
German 10-year yields break lower
The euro zone eco calendar only contains some second tier data today, which aren’t expected to move the market. Most attention will continue to go out to the developments on the financial markets, anecdotal evidence on the fallout on the real economy and the policy response.
Yesterday evening’s closing below the cycle lows in the S&P 500 along with the announcement of a temporary closure of 80 BASF plants worldwide can be seen as more warning signals that the economic outlook is still deteriorating rapidly. As such, main attention will remain focussed on the measures taken by the policymakers to halt the current economic rout. In this context, the ECB non-monetary policy meeting will be closely monitored. Over the past days, several ECB governing council members have continued to hint at more interest rate cuts and called for more fiscal stimulus, of course within the framework of the stability and growth pact. In this context, the Austrian central bank governor Nowotny called on Germany to launch a more ambitious economic stimulus package as part of a concerted European plan. According to German government officials, the EU Commission would ask the 27 EU states to contribute 1% of GDP to a stimulus plan that would be worth about EUR 130 B. The plan is due to be approved by the Commission next Wednesday (Nov 26) and faces a vote by European leaders at a meeting on December 11-12. ECB’s Nowotny however said that Germany could afford a growth-boost package equivalent to 2% of the country’s GDP.
Although such a larger effort from Germany should push up supply of German bonds, yesterday’s strong demand for the German Bobl suggested that supply has not yet been an issue. Today, France and Spain will tap the market.
Regarding trading, the break higher in the Bund above the December 2005 highs and below the year lows in German 10-year yields caused some correction on the recent steepening too. Following the break higher, next resistance comes in at the January 2006 highs at 122.65 in the picture ahead of the all-time highs at 124.60. In 2-year yields, high profile support comes in at the 2% level, where we would consider some profit-taking.
In the UK, 2-year yields corrected higher despite very dovish Minutes. This may signal that the decline in short-term yields is exhausted for now.
Today, the calendar contains the October retail sales and M4 money supply data. Last month, retail sales surprised on the upside (-0.4% M/M), after two months of rising retail sales. In October, the consensus is looking for a drop of 0.9% M/M in retail sales. A weaker figure should not surprise as household consumption held up reasonably well in the previous months.
Currencies: Poor liquidity conditions cause wild wings in EUR/USD
On Wednesday, EUR/USD trading showed two completely different faces. During the morning session in Europe and even early in US trading it looked as if EUR/USD trading was going to experience a very boring trading session. The pair was locked in a tight 1.2600/50 trading range. The US data (CPI and housing data) left hardly any traces on the charts. However, around 15.00 CET a big dollar sell-order spooked the market and in no time EUR/USD jumped from 1.2650 to 1.2800 in an aggressive stop-loss move. The rise was quite spectacular, but the reversal of this move was even more spectacular. Over the next hour, EUR/USD was again hammered and tumbled to the 1.2565 area. The continuation of the sell-off on the stock markets and the decline in the oil price forced the pair into additional losses. The move is another illustration of the high degree of disruption on global financial markets. Even market that was supposed to enjoy unconditional liquidity, the most important cross rate in the deepest market, has fallen victim of the same liquidity trap that is hitting almost all other market sectors. EUR/USD closed the session at 1.2489 compared to 1.2618 on Wednesday.
Today, the calendar in Europe is again very thin but there will be a non-monetary policy meeting from the ECB. In the US, the claims, Philly Fed manufacturing survey and leading indicators are on the agenda. Once again, it is difficult to see these data bringing any positive news on the economy. We always keep an eye on the activity data, but recently eco data, and in particular the ‘less important’ series, at best had only a limited impact on EUR/USD trading.
For quite some time, negative eco news and risk avers investor behavior have supported the dollar (and the yen) and have weighed on the single currency. This theme was an important factor behind the decline of EUR/USD from highs above 1.60 to the correction low in the 1.2330 area. We are going to hold onto our EUR/USD negative bias longer term. However, since end October the single currency has developed a short-term consolidation pattern. The correlation between EUR/USD and the stock markets is not one-for-one, but (the degree of) risk aversion remains an important factor for EUR/USD trading. The price action over the last 24 hours has illustrated that this trading pattern is still valid. After yesterday’s decline, the bottom of the range long-standing 1.2330/1.3294 trading range is again coming within striking distance. Whether the bottom of this range will continue to hold will be highly dependent on whether or not the major stock market indices will be able to avoid another forceful down-leg below the recent lows. A first hurdle, the recent low in the S&P at 818, was cleared yesterday evening. So, the red alert has been raised, both for the S&P and for EUR/USD. The 2002 low (768.63) is new the next high profile line in the sand in for the S&P and sustained break below this level might have material consequence for almost all other markets including EUR/USD. Testing times are ahead of us.
From a technical point of view, since the last week of September EUR/USD has tumbled from the 1.4866 reaction high to 1.2330 on October 28. High profile intermediate supports have all been taken out with remarkable ease. Over the last three 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 has established a sideways trading pattern. Recently, we favoured a sell-on-upticks approach in case of return action higher in the above mentioned trading range. We are holding on to that tactics. However, we also advocated not to front-run on a break below the range bottom and even took partial profit in case return action towards to bottom of the long standing trading range. We are aware that the pressure on this approach is mounting, but for now we are keeping to our MT framework. A swift break below 1.2330/00, would indicate that a new (and forceful) down-leg could be in store.
On Wednesday, USD/JPY to some extent avoided the wild intraday swings that were recorded in EUR/USD and EUR/JPY. However, the sentiment on global (stock) markets left no doubt on where USD/JPY had to go. Mounting pressures on the (US) stock markets triggered another run on the yen and USD/JPY closed the session at 95.73 compared to 97.03 on Tuesday.
This morning, Japanese markets had to digest an awful trade balance figure. The trade balance showed a bigger than expected deficit as exports, especially towards other Asian countries, dropped faster than expected. In theory, this can only be considered as yen negative but in the current market context other factors continue to outweigh the importance of local data. The reaction to the trade data are hardly visible on the USD/JPY chart. Whether Japan likes it or not, the meltdown on the stock markets is only accelerating the rush to the yen. USD/JPY is now traded in the 95.00 area.
Looking at the charts, global market stress hammered the USD/JPY cross rate through the key 103.50 range bottom early October and the pair set a new reaction low at 90.93 three weeks ago. A temporary easing of global market tensions sparked a USD/JPY rebound. The pair set a reaction high in the 100.55 on November 04, but the rebound ran into resistance. Longer-term, we are preferring 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 easy short-term. A sell-on-upticks approach remains favoured as long as the pair holds below the 100.55 mark. A sustained drop below the 94.48 support would open the way to the lows (90.87).
EUR/GBP traded very nervous in the run-up to the publication of the minutes of the BoE. The surprise BoE rate cut two weeks ago as such was already a clear signal that the BoE had come to the conclusion that forceful action was needed to address the financial and economic crisis. However, the bank took notice of the fact ‘that projections in the inflation report implied that a very significant reduction in the Bank Rate – possibly in excess of 200 basis points, might be required in order to meet the inflation target in the medium term’. In other words the surprise could have been even bigger. The poor outlook for the UK economy and the risk of the sterling losing more interest rate support temporary weighed on the sterling and EUR/GBP returned to the 0.8440 area. However, the rebound could not be sustained and in order driven trade, the pair returned to the intraday lows and later even dropped below the Tuesday correction low. Apparently, there was still some unwinding to do on the steep sterling decline of late. EUR/GBP closed the session at 0.8355 compared to 0.8434 on Tuesday.
Today, the UK retail sales are on the agenda. After the recent rebound of the sterling, it will be interesting to see whether the market reaction, in particular in case of a weaker than expected figure.
The aggressive BoE rate cut two weeks ago and the negative assessment from the BoE on the UK economy 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 have caused sterling losing a lot, if not all, its attractiveness. The break 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 of last week, some correction has kicked since Friday. Longer-term we continue to put the risk for additional sterling losses. The pair must return below the 0.8215/40 area (Break-up/uptrend line) to call off the red alert for the sterling. We continue watching out how far this correction has to go. We are not yet in a hurry, but we are still looking to buy/add to EUR/GBP long exposure in case of addition signals that the correction has run its course.
