Markets: Fixed Income
On Monday, global bonds continued to correct lower, as equities raised out of its ashes. The Citigroup bail out was the trigger, but more news from the president- elect Obama might also have injected some confidence in the future. The hugely oversold character of the equity market and the near record high levels of the VIX fear index all indicated that such a relief rally would ultimately occur.
The eco news was once more disconcerted, but ignored. The German IFO business confidence index dropped to 16-year low and US Existing Home sales, following a period of stabilisation, dropped again. The Belgian OLO auction went reasonably well, but the US 2-year Note auction a bit sloppy.
Intra-day, EMU bonds opened little changed and tried to move higher ahead of and on the IFO release. However, the attempt failed miserably, convincing traders that the direction was down. EMU Bonds fell steadily, while in the US, the decline was most visible linked to equities that rallied after a small hesitation in the open. In the EMU, the curve bear flattened, while in the US, the belly of the curve was hit the most.
US Treasuries correct lower as equities rally for the second day in a row
Today, the calendar is well-filled with the preliminary third quarter GDP figures, S&P Case Shiller home prices (September), OFHEO house price index (September), consumer confidence (November) and Richmond Fed (November).
According to the first estimate, third quarter GDP contracted by 0.3%. The details showed an even worse picture as the headline figure was mitigated by a rise of 5.8% in government consumption, a slower pace of inventory liquidation and an improvement in net export deficit. The consensus is seeking for a slight downward adjustment to -0.5%. Negative revisions might be expected from consumption, non-residential investment and inventory investment sectors. The S&P Case Shiller house prices are forecasted to show a decline of 16.9% Y/Y in September, after falling 16.6% Y/Y in August. Although the index is still falling, the month-on-month declines became smaller recently, which might indicate that some signs of stabilization are appearing. However, yesterday, the Existing Home sales showed that prices fell the most on record, suggesting recent slower price declines may give way to faster declines at least for some months. The OFHEO house price index is expected to show a drop of 0.7% M/M in September, after falling 0.6% M/M in August. In October, the Conference Board’s consumer confidence showed an extreme plunge (38.00 from 61.40), coming out at its lowest level since series began in 1985. Consumers were especially more pessimistic about the labour market and business conditions. In November, consumer confidence is expected to stay unchanged at 38.0. We nevertheless still put the risks on the downside of expectations. Also the Richmond Fed dropped to its lowest level since series began (in 1993) in October and for this month, the consensus estimates an unchanged reading of -26.0.
The 36 billion $ 2-year T-Note auction yesterday was a bit sloppy, despite reasonable participation of the buy-side. Indeed, the auction stopped at 1.269%, which was above the 1.253% WI bid at the stop, no aggressive bidding. The bid-cover of 2.08 fell shy of the 2.3 average (12 months), but one should take into account the substantially larger size. Indirect bidders accounted for 34.9% of the auction takedown, which was far below last month’s stellar result, but nevertheless still above the 28.6% yearto- date and in line with longer term average. Today’s 26 billion $ 5-year T-Note auction, up 2 billion $ from October’s auction and a record large one, will raise all new cash at settlement. Last month’s auction stopped above the WI bid stop, but was solid nevertheless, as the bid/cover was okay and Indirect bid and takedown good compared to recent auctions with also a huge, unusual, direct bid. The rebound in equities in the past two sessions is of course a negative, as it lessens the risk aversion demand for Treasuries. However, on the brighter side, the 5-year has cheapened quite a lot with its yield currently at 2.14%, up from 1.89% in Thursday’s close.
Regarding trading, equities rallied yesterday for the second session in a row. On Friday, it was the nomination of Geithner and Summers as future Treasury Secretary and head of the White House eco team that bolstered some confidence in the future, although if we think it was more the exhaustion of the market on Thursday than the news itself that led to bottom fishing. And on Monday, confidence improved further on the government recue of Citigroup, suggesting that the government won’t led any big bank go, but also by more signs of Obama that he will intervene forcefully on the economic and financial crisis. As a consequence, the correction in the fixed Income markets continued and government yields went up 9 to 17 basis points, the belly of the curve hit the most. The correction was also due to yields hitting the key and eye-catching levels of 1, 2 and 3% for 2-, 5- and 10-year yields that convinced longs to book profits. Eco news was ignored. We suspect a similar situation today. Eco data should continue to paint a grim picture of the eco outlook, but the Treasury markets will look to equities for guidance, while the 5-year T-Note auction may weigh on trading. The recent correction has, of course, upped again the attractiveness of Treasuries, but we would wait on signs that the equity rally is running out of steam. There may be more Treasury investors looking for profit taking. The technicals show first key support levels, one may consider enter long positions, at 1.33%, 2.36%, 3.25% (under test) and 3.90% for 2, 5,10 and 30-year that trade currently at 1.24%, 2.15%, 3.26% and 3.75%.
European bonds ignore awful IFO indicator
Today, the euro zone calendar is fairly thin and contains no market moving data. Markets will however look for more hints on the size of the expected ECB rate cut in December, as a lot of ECB governing council members are scheduled to speak. On the back of the dramatic deterioration of the euro zone growth outlook and the improvement in the inflation outlook calls have been increasing for a rate cut of more than 50 bps. Currently, markets fully discount a 75 bps rate cut. Recent comments have however indicated 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 could be counterproductive and add to the uncertainty and lack of confidence in the financial markets.
Besides, markets will also continue to look for more details on the EU stimulus package that is to be presented tomorrow. According to recent press report, the plan should represent 1% of total GDP of the region and may be worth as much as EUR 130 B, but questions remain as to the contribution of each member state. This is very important, as the long-term sustainability of the public finances in the individual member states is increasingly becoming an issue. This is mainly reflected in the widening of the intra EMU spreads and the rise of the sovereign CDS that at least yesterday stopped. Yesterday, France and Germany ruled out a VAT reduction to boost growth. On the supply front, the Belgian auction went very well, as Belgium sold EUR 3.815 B of its four OLO’s for sale, which was at the top end of the pre-announced range. The largest amount (1.45 B) was also sold in the 10-year segment, where demand has been very weak of late. Later on this week, Italy will tap its inflation-linked bonds tomorrow and two BTPs in the 3- and 10-year sector (Thursday). Over the past week, the intra EMU spreads widened sharply especially at 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. 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 a further widening in the intra-EMU government bond spreads.
On the money market, the ECB will hold its weekly refinancing operation. The large amounts deposited overnight at the ECB have indicated that there is still a lack of confidence within the financial sector and have suggested that banks will continue to rely heavily on the ECB for their funding needs. Yesterday, the ECB has also set the fixed rate for its three monthly tender at 3.25%. Hence, the ECB will again ask no spread above the current policy rate, as this could have diminished demand given the expectations for more rate cuts in the months ahead.
Regarding trading, the corrective bear flattening of the European yield curve continued on Monday, as equity markets ignored a very weak German IFO indicator. Although the technical picture is bullish at all maturities, we advocated profit-taking following the failed test of the 2% level in 2-year yields. Whether the rebound in yields will continue will mainly depend on the equity markets. From a technical point of view, levels at around 2.50% in 2-year yields and 3.65% in 10-year yields should offer excellent opportunities to go long again.
In the UK, several members of the MPC, including governor King, will testify on the November inflation report before parliament. This may give some more indication on the rate cuts to be expected over the coming months. Currently, markets expect the Bank of England to cut rates again by 100 bps in December and see the trough at 1.50%. The easing of risk aversion pushed also UK yields higher (by 10 to 4 basis points) and the curve bear steepened.
Currencies: EUR/USD jumps in step with stock market rebound
On Monday, EUR/USD set an intraday low in the 1.2570 area early in European trading, but from that moment on, the pair performed quite an impressive, uninterrupted ascent that lasted into the close of trading in the US. The strong euro performance mirrored the improvement in global investor sentiment as risk aversion declined after the US measures to support Citigroup that were taken over the weekend. German IFO business confidence came out at an awful 15 year low, but in line with market behaviour recently, these kinds of macro data had hardly any impact on trading. The Obama team that announced high profile measures to support the economy might also have played a role in the change in sentiment. Aside from the improving global (stock) market sentiment, technical factors also played a role. Already last week, there were some tentative signs that the downside in EUR/USD had become better protected and in this context the spectacular rebound on the stock markets was a good excuse to lock in gains on EUR/USD short positions. EUR/USD closed the session at 1.2953, close to the intraday highs. This was quite a spectacular gain compared to the 1.2587 close on Friday. Overnight, EUR/USD had to give back part of yesterday’s gain and is now traded in the 1.2850 area.
Today, the calendar is well filled. In Europe, the final German Q3 and the French Business confidence are on the agenda. In the US the second reading of the Q3 GDP, the S&P CS house prices, the consumer confidence and the series of less import economic indicators are scheduled for release. However, recently macro data most often had only a limited impact on trading. They usually confirm the dire state of the economy, but this is not really big news for the markets anymore. Markets are currently looking more to equities and other indicators that are giving a timely indication on global investor sentiment. These factors are the drivers for short-term trading on almost all markets and the currency market is no exception.
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. Yesterday’s u-turn in market sentiment illustrated that the market logic is still working in the opposite direction, too. This helped EUR/USD to leave the range bottom behind and the make a big step higher in the 1.2330/1.3294 consolidation pattern. Swings in global risk aversion will continue to set the tone for EUR/USD trading short-term. So, the key question is whether global markets have entered calmer waters and whether this stock market rally is more than a one day correction. At least for now, there are no (technical) indications that something has changed in fundamental way. In this respect, yesterday’s EUR/USD at this stage is also nothing more than a rebound within the established framework.
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. Over the last three weeks the EUR/USD decline shifted into a lower gear and has established a sideways trading pattern. We are EUR/USD negative and are holding on to that tactics long term. However, over the past week; we also have been advocating not to frontrun 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 as we had the impression that the chances were rising for a more pronounced EUR/USD rebound. Yesterday’s rebound perfectly fits our short-term approach. The power of yesterday’s move could be an indication that the correction may have somewhat further to go. So, we are still not in a hurry to reinstall EUR/USD short positions at the current levels.
The story of USD/JPY trading was very much alike to what happed in EUR/USD. The steep rebound on the equity markets caused USD/JPY to perform a steep rebound from the 95-area in Asia to session highs in the 97.35 at the end of trading in the US. This compares to a 95.94 close on Friday. The gains in EUR/JPY were even more impressive, with the pair recording a gain of more than 5 yen compared to the close on Friday (126.08 compared to 120.71).
This morning, Japanese stocks have resumed trading, showing gains of around 5% just before the close. Japanese corporate service prices dropped 1.4% M/M illustrating that the deflation theme might soon come to the forefront again. In theory this is no support for the yen.
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. Recently, we favoured a sell-on-upticks approach as long as the pair holds below this 100.55 mark. We are holding on to that view. However, in a day-to-day perspective, we take a wait and see approach and look how far the stock market rebound will go. The correction in USD/JPY might have some further to go.
On Monday, EUR/GBP joined the broader rebound in the single currency. Especially during the first hours of US trading, the sterling underperformed the single currency. So, sterling couldn’t really profit from the declining risk aversion at that time. Markets at that time were also waiting for UK pre-budget announcement. The sterling temporary gained some ground after the announcement of the fiscal measures to support the economy. However, the steep rise in government borrowing and the awful growth projections (the UK economy were projected to contract between -1.25%/-0.75% in 2009) only illustrated the huge problems the UK economy will face going forward. So, the ‘rebound’ in sterling was very short-lived and EUR/GBP closed the session at 0.8532 (compared to 0.8437 on Friday).
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 0.8215/48 area (Break-up/uptrend line) to call off the red alert for the sterling. The tentative signs of bottoming out at the end of last week were confirmed yesterday and suggest that the recent (sterling positive) correction has probably already run its course. We started the week with a cautious buy-on-dips approach for EUR/GBP. We continue to hold on to this approach.
