Markets: Fixed Income
On Tuesday, global bonds reversed course following a two-day equity-induced correction lower, closing moderately (EMU) to sharply higher (US). Equities kept a more sideways trading profile and eco data, while mostly again very weak, weren’t the driver either. The Fed’s announcement about the creation of yet another facility, notably the 200 billion USD TALF or the Term Asset-Backed Securities Loan Facility, that should support collateralization of student loans, car loans, credit card loans and small business loans and of a 600 billion US dollar program to buy GSE’s debt and MBS debt backed by the GSE’s bolstered Agency bonds and spread products. The need for hedging meant that Treasuries were bought too. The US 5-year auction went extremely well, helping the market further up.
In EMU, French business confidence plunged, but didn’t shock investors anymore following all the bad news thrown in their face recently. A number of ECB members suggested that the ECB should lower rates, but in an orderly fashion (50 basis points?), which weighed on the shorter end of the curve. Bonds at the longer end of the curve went up in sympathy with their US peers.
US Treasuries rally, as Fed unveils more rescue programs
Today, the calendar is again well-filled as markets are closed tomorrow in observance of Thanksgiving holiday. The weekly claims, October durable goods, personal income and spending data (October), Chicago PMI (November) and final figure of Michigan consumer confidence are all scheduled for release.
In the week ended November 22, initial claims are expected to come out slightly lower (537 000 from 542 000), after increasing sharply in the week before. But it would be wrong to conclude that labour market conditions are improving as the only reason why a decline is anticipated is the pattern of seasonal adjustment factors. Continuing claims, which are reported with a one-week lag, are forecasted to show another increase (4 078 000 from 4 012 000). In September, the durable goods orders came out surprisingly strong (0.9% M/M) due to a sharp rebound in transportation. In October, the consensus is looking for a decline of 3.0% M/M in the headline figure, while durables ex transportation are expected to show a more modest decline (1.6% M/M). We see the risks on the downside of expectations due to a sharp plunge in Boeing orders. Last month, Chicago PMI surprised on the downside coming out at 37.8 (from 56.7), while a figure of 48.0 was expected. The details were very weak with an extreme drop in production, but also other sub-indices showed sharp plunges. For this month, a marginal decline is expected (37.0), but a lower outcome is not excluded. September new home sales showed an unexpected rebound (2.7% M/M to 464 000) in sales and a drop in the number of homes for sale. In October, new home sales are expected to weaken by 5.0% M/M to 441 000. We put the risks on the downside of expectations as new homes are more expensive and are therefore losing buyers to the existing market. All other housing market indicators weakened considerably during the month under review. October personal income is forecasted to show a modest increase (0.1% M/M), while the consensus expects a drop of 1.0% M/M in personal spending. Michigan consumer confidence is expected to come out slightly lower (57.5 from 57.9) from the first estimate.
The 26 billion dollar 5-year T-Note auction went extremely well. The auction stopped at 2.096%, well below the WI bid of 2.155% at the moment of the stop. The bid/cover of 2.44 compared to last month’s 2.28 and a 2.15 average (12 months), despite the record size of the auction. The size of the Indirect bid of 13 billion USD was a record one and resulted in an above average Indirect takedown.
Goldman was the first US bank to issue FDIC backed debt. It issued a 5 billion USD June 2012 with a yield of 3.367% at a spread 200 basis points over comparable Treasuries. Other banks are preparing similar issues. This is of course affecting the other segments of the fixed income market.
Regarding trading, Treasuries, but still more Agencies and spread products were the star performers. The Fed’s new lending program (worth 800 billion USD) was the trigger. The Fed plans to buy up to 600 billion USD in GSE’s debt and GSE’s MBS, while 200 billion USD is devoted to a Term Asset-Backed Securities Loan Facility that should support securities backed by student loans, credit cards and small business loans. It is obvious that these measures are directed to Main Street in an attempt to push mortgage rates lower and make other loans are available.
The fixed income markets reacted enthusiast. Fannie’s 30-year mortgage rate fell 45 basis points to 4.88%, the lowest since last January, while 30-year conforming mortgages fell to 5.77% from 6.06%. Across the curve, Agencies fell 30 to 59 basis points, the 10-year sector outperforming. Swap performed well too, as their spread fell between 15 to 9 basis points across the curve. Interestingly, Treasuries fared well too. We would have thought that these measures (including Goldman issuance and upcoming guaranteed issuance of other banks) increase the attractiveness of non-Treasury fixed income products at the expense of Treasuries. However, Treasury yields fell between 2.5 basis points in the two year segment and 16 to 21 basis points further out. There might be two explanations. Firstly, the decline in mortgage-related bonds led to hedging activity in Treasuries, as investors bought Treasuries to hedge their books. Also Swaps may have profited from hedging. This may explain why especially the short Treasuries lagged, even after taking the benchmark change into account. The 5-year profited from a strong auction. Secondly, the Fed is shifting ever more to a policy of quantitative easing and some investors might anticipate that it won’t take long before the Fed officially turns to quantitative easing and also becomes active in explicitly bringing Treasury yields down. Indeed, equities lingered more sideways yesterday and the eco data were bad, but not excessively and not out of line of recent data releases and thus don’t qualify to explain the moves.
So, the two-day, equity-induced correction in Treasuries might be over. The technical remained bullish during the correction and in the case of the 10-year, the yield tested even an important resistance (3.25%) that held, a positive. Despite yesterday’s turnaround, we don’t feel the irresistible need to enter the market from the long side at current levels. The 1, 2 and 3% levels in the 2-, 5- and 10-year sectors might play their role. So, we take on a neutral stance for now in attendance of new information (was yesterday’s move hedging-driven?), while examining more closely the potential impact of quantitative easing on Treasuries.
European Community to issue 3-year bond (FT)
Today, the euro zone calendar is again rather thin and only contains the German CPI figures and Italian business confidence (November). In October, German CPI fell 0.3% M/M to 2.5% Y/Y and is expected to show another drop of 0.3% M/M in November. On a yearly basis, German inflation is expected to come out at 1.7% Y/Y, which would support current market expectations for a drop in the euro zone CPI from 3.2% to 2.5%. The first estimate will be published on Friday. Italian business confidence is forecasted to come out at 76.0, from 77.7 in October, but following the downside surprises in the PMI, German, French and Belgian surveys the risk is on the downside.
In spite of the awful November business sentiment surveys across the euro zone, 2-year yields continued their rebound over the past days. As such, following the failed test of the eye-catching 2% level last week, yields have rebounded more than 25 bps to close at 2.26% yesterday. Yesterday’s ECB comments supported the rebound, as they echoed last week’s comments of ECB’s Mersch, who suggested that larger rate cuts could be counterproductive and hence hinted towards a 50 bps rate cut at the December meeting instead of the 75 bps rate cut expected by the markets. Although ECB’s Nowotny left the size of the rate cut open for debate, he also appeared to favour a 50 bps rate cut, as he said ‘the ECB does well in maintaining some leeway for further moves and not to use up all the ammunition at once’ and added that he believed that the ECB would continue to act like it did so far. In a similar vein, ECB’s Bini Smaghi warned that a sharp interest rate cut ‘may contribute to, rather than obviate, a worsening of market sentiment if it’s interpreted as a signal that the central bank has a more pessimistic assessment of the economy than market participants’. Looking at current market expectations derived from the eonia futures, it’s however important to note that these overestimate the expected rate cut, as the eonia rates are currently way below the official policy rates of 3.25% at 2.93% yesterday. So, it’s difficult to say whether there is much more rebound potential at the short end of the curve. Yesterday, the OECD urged the ECB to cut rates by 125 bps to 2% and today the EU Commission is also likely to recommend more monetary easing as part of its stimulus package for the euro zone economy. As such, we would be cautious to expect much more rebound in 2-year yields and new longs can be considered.
Today, much attention will also go out to the details of the EU stimulus package. This morning, ECB’s Stark issued another warning in Handelsblatt in which he feared that ‘increased government spending now may lead to investors and consumers to behave more restrictively as they fear that new debt will lead to higher taxes in the longer run’. The recent widening of the intra EMU spreads indicates that bond investors share this concern. So besides the specific growth measures, it will be important to see whether the plan will fit in the stability and growth pact, otherwise one risks diminishing confidence in the fiscal framework and a further widening in the intra-EMU government bond spreads. This risk may also increase calls for issuance on the EU level and in this context the FT this morning states that the EU is planning to sell a three year bond via the European Community for an amount of 2 B EUR to finance its rescue package for the Hungarian economy. The issue is expected to raise a further 4 B EUR next year. The last time the EC raised a significant amount in the capital markets was in 1993 when it raised 1 B DEM. The EC is rated AAA and so it will be very interesting to see at what spread the issue will be sold.
On the money market, the ECB will hold its 3-month refinancing operation.
Regarding trading, the corrective flattening of the European yield curve continued on Tuesday, as 2-year yields extended their rebound and longer-term yields tracked US yields lower. We still see this flattening as a correction on the recent steepening and are increasingly looking for signs this correction is over and to reinstall steepeners.
In the UK, the GDP numbers are expected to confirm the flash reading.
Currencies: EUR/USD revisits 1.30 after the Fed announcement of new liquidity measures
On Tuesday, EUR/USD showed very interesting price action. The pair hovered in a 1.2800/1.2900 trading range during morning trading in Europe. However it jumped from the 1.28 area to levels above 1.30 early in US trading. The move occurred after the Fed had announced two new facilities to encourage a better functioning of the credit markets. In this respect it is important to try to understand the driver behind this move. One explanation might be that the markets considered the measures as a positive step to support stability of the financial system and revitalize the economy. In the recent past, this kind of positive news tended to support EUR/USD. However, the reaction on the stock (and of the oil price) on those measures was rather muted and short-lived. In our view this creates some doubts on the reason behind the forceful jump in EUR/USD. At least part of the explanation could also be that markets grow a bit uncertain/nervous that the Fed is moving less to conventional measures. The fact that USD/JPY also lost ground after the announcement (USD/JPY is supposed to rise in case of global positive news) suggests that at least part of the move could be interpreted as dollar weakness rather than EUR/USD strength. On top of that, the move only indicates the Fed’s determination to go far in the process of monetary easing while at the same time the ECB is holding on to a much more gradual approach. Also this is an ambiguous factor for currency trading (some will say that the ECB is behind the curve), but it could have played a role. Whatever the reason behind the move, EUR/USD for the second day in a row recorded a decent gain. The pair closed the session at 1.3064 compared to 1.2953 on Monday evening.
Today, in Europe, the first German inflation data are scheduled for release. The EU will also publish its economic stimulus package. The US calendar is well filled with the durable orders, the income and spending data, the claims, the Chicago PMI, the Final Michigan confidence and the new homes sales scheduled for release. With such a long list of eco indicators, it is almost sure that at least one will bring some kind of surprise. Question is whether it will impact the currency market. Recently, global market sentiment has been the dominant factor EUR/USD trading. However, after yesterday’s move, we are very keen to see whether something has changed in the ‘established’ trading logic on the currency market.
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. However, since end October the single currency has developed a consolidation pattern between 1.2330 and 1.3294. Until recently, the correlation between EUR/USD and indicators of risk aversion and economic had remained relatively high, but the euro gradually showed more resilient.
We don’t draw firm conclusions from yesterday’s price action yet. However, over the previous days we already suggested that markets could look out for another trading theme. The jury is still out, but we grew more alert. Could the aggressive measures of monetary easing potentially become a (temporary?) negative factor for the dollar or will EUR/USD continue to trade in line with the swings in global risk aversion has been the case in the recent past?
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 indicated to take partial profit in case of return action towards the bottom of the range as we had the impression that the chances were rising for a more pronounced EUR/USD rebound. The price action on Monday and Tuesday perfectly fits our short-term approach. The power of this 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. We’re not that far yet, but break above 1.3294 would be the indication that something has changed in the EUR/USD trading framework (Stop-loss).
Yesterday, USD/JPY drifted lower throughout the trading session. The pair started trading in Asia in the 0.9700 area and ceded gradually ground during the day to close the session at 95.22, rather close to the intraday lows. The move was a bit surprising as the stock markets didn’t perform that bad. The pair gained a few ticks on the Fed announcement of the new measures, but almost immediately resumed its decline. In line with our analysis for EUR/USD, we tend to raise the question whether this move, at least partly, should be considered as underlying dollar weakness.
This morning, there were no important Japanese eco data. Japanese stocks show some moderate losses (1.33%). USD/JPY is holding close to yesterday’s lows 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 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-onupticks approach as long as the pair holds below this 100.55 mark. We are holding on to that view. Yesterday, we suggested that the (upward) correction in USD/JPY could go somewhat further in case of an easing in global market tensions. However, in this respect, yesterday’s price action should be considered as very disappointing from a dollar point of view. The USD/JPY downtrend remains very well in place.
On Tuesday, EUR/GBP traded sideways in the 0.8500/0.8565 area during the firs hours of European trading. Early in the US, it even looked as if sterling was heading for a substantial daily loss. However, sterling regained ground later in the session. We didn’t see much fundamental news behind this move. Cable outperformed EUR/USD after the announcement of the Fed measures. BoE’s Bean indicated that the fall in sterling over the past year has been a central part of rebalancing Britain’s economy. Nevertheless, EUR/GBP closed the session at 0.8443, compared to 0.8532 on Monday evening.
Today, the details of the UK Q3 GDP will be published.
The aggressive BoE rate cut three weeks ago and their negative assessment of the UK economy triggered an aggressive sterling selling wave. The quick loss of interest rate support and the very negative outlook for the UK economy have caused sterling to lose 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. Longer-term the risk is for additional sterling losses. The tentative signs of bottoming out at the end of last week were confirmed earlier this week. Yesterday’s, EUR/GBP performance was a bit disappointing. Nevertheless, we hold on to our cautious buy-on-dips approach for EUR/GBP. A drop below 0.8334 would be a first warning signal to our ST EUR/GBP positive bias. The pair must return below the 0.8215/53 area (Break-up/uptrend line) to call off the red alert for sterling.
