Markets: Fixed Income
On Friday, global bonds ended the session lower, moderately in EMU, pronounced in US. It was mainly the reaction on the steep gains eked out on Thursday, especially by US Notes and bonds, when equities plunged lower and panic reigned driving investors into government bonds. So, taking Thursday and Friday together, global bonds did extremely well and Friday’s correction shouldn’t as such cause alarm, even if on Friday yields were up 12 to 21 basis points and 4 basis points to flat in EMU.
So, it wasn’t a complete surprise that investors were looking to book profits on Friday. This happened mostly during the Asian session, as equities started to find their composure. Later on, in EMU morning session, European bonds tried to break above Thursday’s highs following disconcerting weak PMI data that suggested a fast deepening of the contraction. However the attempt failed and early gains were erased. During the US session, global bonds moved essentially sideways, albeit it in a rather wide range and not for all maturities, as the 30-year bond continued to drift lower. Given Thursday huge flattening, there was quite some curve trading visible, leading to a bear steepening in a daily perspective. In the euro area, the curve bear flattened.
There were no eco data released in the US, but equities got all attention. After Thursday plunge to new cycle lows, amid high volume and a new closing high in the VIX index, there were quite some expectations that a rebound would occur. However, equities opened only modestly higher, declined to new lows afterwards, when fears about the fate of Citigroup increased further, but reverted back to about unchanged levels afterwards. It was only very late in the session, apparently on the news that NY Fed governor Geithner would be the next Treasury Secretary that equities spiked higher, closing the session more than 6% up. However, at that time Treasury trading was already nearly finished, but its modest reaction to the equities’ jump was nevertheless eye-catching.
End-of-week profit-taking hits US Treasuries
Previewing this week’s Treasury trading, it will be a shortened week, as the market is closed on Thursday for Thanksgiving holiday, while on Friday, trading desks will traditionally remain sparsely staffed. During this shortened week, attention will go to the new supply with the 2- and 5-year Note auctions on Monday and Tuesday and to the eco calendar. Today, the October Existing Home sales are expected to show a decline to 5 million annual rate from September’s 5.18 million. Existing Home sales have stabilized in recent month and were even up in September. The impact might be due to the sales of (cheap) foreclosed houses. However, we are afraid that sales will again decline (moderately) in October and the next months due to the credit tightening in the wake of the demise of Lehman and other credit events. Also the Chicago National Activity index for October will look ugly at levels probably not seen since the 1980-82 recession. The Fed’s Money Market Investors Financing Facility (MMIFF) will start working today.
On Tuesday, the first revision of Q3 GDP, the September S&P and OFHEO home price indices, the October consumer confidence and Richmond Fed manufacturing surveys will all be released. GDP should be slightly downwardly revised, house prices should have dropped, while consumer confidence and Richmond Fed survey will confirm the extreme weakness in the consumer and manufacturing sectors. On Wednesday, there will be releases of the October New Home sales, the durable goods orders and the PCE & PI, besides the November Chicago PMI and the Michigan consumer sentiment. The initial claims, which were sharply higher in recent weeks will get quite some attention. We’ll preview these data in the next days.
Today’s 36 billion $ 2-year T-Note auction is the largest one on record. Its size is still 2 billion $ above last month’s, which was already upped from a far more modest size one year before. In October, the 2-year auction stopped 5 basis points below the WI at the stop and got the highest indirect bid ever. Indirect bidders took away a very large slice of the issue. The odds for today’s auction are cautiously positive, despite the 2-year yield trading now 45 basis points below the level traded one month ago. Indeed, the Fed is still expected to cut rates in December and risk aversion is still an important factor in trading. There are some negatives though. The auction will raise 16 billion $ upon settlement, about 2 billion $ more than last month and tomorrow’s 26 billion $ 5-year T-Note Auction (upped 2 billion $ on last month) will raise all new cash. Risk aversion might be still a theme, but Friday in late session, equities rebounded strongly. If this continues today, it might temper investor’s appetite for the new issue.
The objective of the MMIFF is to make assets of mutual money market funds more liquid, should these face redemptions. Being sure they may be able to sell the assets, the hope is the funds might start to buy again more bank paper (and of longer duration) than Treasury bills. The instruments that may be sold are dollar CD’s, bank notes and CP of about 50 financial institutions. The paper should have the highest quality and a maturity of 7 to 90 days. The assets are sold to 5 Private sector Special Purpose Vehicles (PSSPV) that are managed by JPM. The PSSPV’s pay 90% in cash and 10% in ABCP. The PSSPV is for 90% financed by the New York Fed. The total amount of the program is limited to 600 billion $, which is considerable. It will raise the asset side of the Fed’s balance sheet by 540 billion $, to about 2.7 trn. $, or a threefold rise since mid-September.
Regarding trading, during the week trading was dominated by deepening recession and deflation fears, resulting in a steep downleg of equities that on Thursday even caused a close below the 2002 lows (S&P). In a weekly perspective, yields plunged by 11, 30 and 54 basis points in the 2-, 5 & 10-30 sectors, flattening the curve tremendously. 2, 5 and 10-year dropped during the week below 1, 2 and 3% setting their lowest levels for at least half a century. Thursday was an exhaustion day in both Treasury and equity markets, but the correction that followed Thursday’s outsized moves was still moderate. The significance of the spike higher in equities at the very tail end of trading Friday might be the key for trading this week. Did we got an exhaustion in equities than consolidation and correction may be the code words for equities this week. This would also make Treasuries vulnerable for more correction. The fact the eye-catching levels of 1, 2 and 3% were tested severely, but kept up in Friday’s close may also be a sign that the market is in for a pause.
We advocated last week to consider profit taking at 1 and 2% in case the 2- and 5- year yield would touch these levels and if the 10-year yield would test the 3.25%. The latter was certainly a too conservative call. For this week, 2 and 5-year Note auctions may weigh on the short end of the curve. The eco data should again be Treasury friendly and may even mostly again fall short of the already weak expectations. However, given the recent price action, quite some bad eco news is priced in. The presentation of the Obama nominations (Geithner, Summers, Richardson), revealed late on Friday may still have some positive impact on equities, as investors are desperately looking for some positive elements and the start of the MMIFF may lead to signs of a thawing of funding markets. The technicals of all maturities remain of course bullish, but as the break below major levels wasn’t confirmed on Friday, in the short term cautiousness is warranted. Concluding, we would still consider to book profits at the mentioned levels of 1, 2, 3% and wait for an eventual correction to contemplate new longs. Current yields levels are vulnerable in case some easing of risk aversion occurs.
Intra-EMU spreads explode at short-term horizons
Today, the euro zone calendar contains the German IFO indicator and Belgian business confidence. The German IFO business climate indicator showed its fifth straight monthly decline in October. The current assessment stayed broadly unchanged while the expectations sub-index dropped sharply. For November, another decline (88.7 from 90.2) in the headline index is expected. We see the risks on the downside of expectations after the sharp plunge in the German flash manufacturing PMI figure last Friday. In Belgium, the consensus is looking for a business confidence level of -17.0 in November (from -14.8). Later on during the week, we will also get the national business confidence surveys from France (Tuesday) and Italy (Wednesday), the EU Commission confidence indicators and M3 money supply and credit growth data (Thursday) as well as the euro zone flash CPI (Friday).
Although all these data are likely to come out bond friendly, Friday’s reaction on the awful PMI surveys may indicate that the down-move in yields, in particular at the short end, is exhausted for now and some digestion is needed. Last week, we already advocated some profit-taking if 2-year yields would test the eyecatching 2% level and expected some correction on the recent steepening following the highly important break below the 3.65% level in 10-year yields. Whether some pause/correction will occur this week will highly depend on the equity markets, which are at critical levels in the US. A sustained break below 2002 lows may push yields still lower, but this is currently not our preferred scenario. Following the failed test of 2% level and the ever lower ECB rate expectations we expect some range-trading ahead of next week’s ECB’s monetary policy meeting. With regard to the meeting, markets currently fully discount a 75 bps rate cut. Recent comments have however made clear that this is not a done deal yet. Although all ECB governors hinted at another rate cut at the meeting, the size of the rate cut still appeared to be open for discussion. Some governors, like ECB’s Mersch, feared that a larger rate cut than the 50 bps cut seen in October and November could be counterproductive and add to the uncertainty and lack of confidence in the financial markets.
On the supply front, Belgium and Italy will tap the market this week. Belgium plans to sell EUR 1.9-3.9 B of four OLO’s in the 3-, 5- and 10-year sector. Over the past week, intra-EMU spreads have widened sharply, especially on the shorter maturities. As a result, the spreads in the 2-year sector are now larger compared to these in the 10-year sector for a whole range of countries, including Belgium. This may point to increasing concerns about the solvability position of these countries and calls for cautiousness to fiscal stimulus plans. Later on this week, the EU Commission will publish its fiscal stimulus plan, but it’s clear that this plan has to fit well into the stability and growth pact, otherwise one risks to diminish confidence in the fiscal framework and an explosion in the intra-EMU government bond spreads.
In a similar vein, the UK pre-budget report will be assessed. Although the Bank of England supports a fiscal stimulus, it has always said that it has to be temporary and that there has to be a plan included to ensure the longer-term sustainability of the public finances. This will also be where markets will be looking for.
Currencies: EUR/USD and USD/JPY are off from the recent lows despite ongoing global uncertainty
On Friday, global markets fell again victim of rather wild swings in investor sentiment and this left its traces on EUR/USD trading. The pair traded below the 1.25 area at the start of trading in Asia. However, Asian stock markets tried to ignore the awful closing of the US stock markets on Thursday and this constructive investor attitude supported EUR/USD. Investors in Europe remained very hesitant and the EMU PMI data for the month of November came out at an astonish low level. However, most stock market indices didn’t react much to the report and also EUR/USD extended its rebound. Later in the session, sentiment on the stock market turned again very instable. US stocks couldn’t hold on to the early gains and this also dragged EUR/USD lower. The pair dropped even temporary below the 1.25 mark, but a late session rebound on the stock markets helped EUR/USD to close the session at 1.2587 compared to 1.2453 on Thursday.
Today, the US calendar contains the existing home sales. In Europe, the German Ifo Business climate will be published. One can expect those data to confirm the sharp deterioration in the global economic environment, but as showed by the European PMI’s on Friday, this shouldn’t come as a big surprise for the (currency) markets. Traders will again continue to take a close look at the global stock markets and the acceptance from the Citigroup deal in the market with the authorities could be important. Asian stock markets are not overly positive this morning, but at least for now this doesn’t prevent the single currency from moving cautiously higher.
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 indicators of risk aversion and economic stress still exists, but the euro is gradually showing more resilience. The bottom of the consolidation pattern between 1.2330 and 1.3294 is still not that far away but despite the heavy global market stress no real test has occurred yet. The jury is still out on this item, but the price action during last week has shown that probably a high profile event will be needed for EUR/USD to clear the 1.2330 barrier. The trading theme that global bad news is a negative for the euro is still working. However it is becoming less obvious whether high profile bad news from US, through the stock markets, will continue to have a negative impact on the euro the way it was the case recently.
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 long term. However, over the past week; we also have been advocating not to front-run on a break below the range bottom and we even indicated to take partial profit in case return action towards to bottom of the range. Short-term, we continue to have the impression that the chances are rising for a more pronounced EUR/USD rebound within the above mentioned trading range. So, while still LT EUR/USD negative, we’re not in a hurry to reinstall EUR/USD shorts.
On Friday, USD/JPY continued to mirror the swings in global investor sentiment, but in a daily perspective, the pair traded with a positive bias. Resurfacing uncertainty in the run-up to the start and during the first hours of US trading temporary halted the USD/JPY rebound, but the late session US stock market rebound caused the pair to close the session with a decent gain at 95.94, compared to 93.69 on Thursday.
The Japanese stock markets are closed this morning. At the end of a two-day summit in Lima, APEC countries in a statement promised to ‘take all necessary economic and financial measures to solve this crisis.’ They also agreed not to adopt new trade barriers. Other major Asian stock markets mostly trade with losses of roughly 1 to 3 %. So, the jury is still out as to whether European and US markets will be able to build on the strong close in the US on Friday evening.
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 four 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. 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 this 100.55 mark. The ST technical picture is still yen positive, but in a day-to-day perspective we have the impression that downside in USD/JPY might become more difficult short-term.
On Friday, EUR/GBP trading showed two different faces. During the morning session in Europe, sterling was rather well bid and EUR/GBP temporary dropped below the 0.84 mark. However, renewed nervousness on global market at the end of European/ UK trading put the sterling again under pressure and the pair closed the session at 0.8437, compared to 0.8455 on Thursday.
Today, the UK eco calendar is empty, but markets will take a close look at the UK pre-budget report. Finance Minister Alistair Darling is expected to announce a ‘big plan’ to support the ailing UK economy. In theory, this kind of stimulus package should be a positive for the sterling. However, in the current environment we wouldn’t give too much weight to this consideration. The package probably won’t refrain the BoE from executing additional aggressive interest rate cuts in the near future. In this respect, we are cautious to expect a sustained sterling positive reaction on the announcement.
The aggressive BoE rate cut three 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. 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 two weeks ago, some correction/consolidation has kicked in last week. 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 still need confirmation, but tentative signs of bottoming out at the end of last week might be an indication that the recent (sterling positive) correction has already run its course. We start the week with a cautious buy-on-dips approach in EUR/GBP. The reaction of the sterling to the pre-budget report will be published.
