Markets: Fixed Income
On Wednesday, global bonds continued to rally higher sending US 10-year yields below the 3% level for the first time ever. The rally higher was not directly related to the equity markets or data. Equities moved higher too, while the awful US eco data, often weaker than expected, hadn’t a visible immediate effect.
We suspect that the decline in yields comes in response to the recent unconventional policy measures taken by the Fed aimed at pushing short- and longterm interest rates lower. Indeed, the Fed measure to buy GSE’s debt or MBS debt backed by GSE’s may have resulted in more hedging activity, as lower mortgage rates often trigger a wave of refinancing of mortgages, which in turn pushed investors to hedge that risk by buying 10-year Treasury debt. These measures add to the feeling that a quantitative monetary easing policy may be just around the corner.
China’s decision to cut interest rates by 108 bps, its biggest rate cut in more than a decade, added to the bullish sentiment.
In contrast to the previous days, US short-term yields fell substantially lower too. 2- year yields declined 8.7 bps compared to 12.9 bps in 10-year yields. 5-year yields fell only 2 bps, but this was due to the benchmark change. As such, 2- and 5-year yields are closing in to the 1 and 2% level, while 10-year yields closed below the 3% mark for the first time ever.
In the euro zone, 5-year yields plunged 8.5 bps. 2-year yields declined for the first day in four by 5.6 bps, while 10- and 30-year yields fell respectively 6.6 bps and 12.3 bps to new cycle lows. Comments of ECB’s Weber, who saw ample room for the ECB to cut rates, indicated that the size of the December rate cut was still open for debate.
German 10- and 30-year yields fall to new cycle lows, but next support levels loom
Today, the euro zone calendar heats up with the October M3 money supply and credit growth data, European Commission confidence indicators (November), German labour market data (November) and Belgian CPI.
Since November last year, M3 money supply growth has been slowing from its peak of 12.3% Y/Y to 8.6% Y/Y in September and is expected to show another decline in October (to 8.1% Y/Y). Attention will go especially to lending growth to nonfinancials which remained rather strong in the past months, but is expected to decline sharply in the coming months due to the economic slowdown and the tightening of credit standards. Last month, economic confidence showed a record drop (from 87.5 to 80.4), as all sub-indices worsened significantly. In November, economic confidence is expected to show a more modest decline (to 78.0). German unemployment fell more than expected in October (26 000) but the number of jobs created declined. The number of vacancies stabilized at 572 000. German unemployment is expected to show a slight drop (5 000) in November, while the unemployment rate is forecasted to stay unchanged at the 16-year low of 7.5%. Although the labour market is a typical lagging indicator, it shouldn’t surprise if we would start to see first signs of deterioration this month. After the German CPI declined more than expected (-0.5% M/M and 1.5% Y/Y) yesterday, Belgium will release its November inflation figure. Last month, Belgian CPI disappointed with a slight decline of 0.18% M/M to 4.72% Y/Y, but is expected to show sharper decline this month. On Friday, the euro zone flash CPI is expected to fall to 2.4% Y/Y, but a lower figure is not excluded after the sharp drop in the German CPI.
Yesterday, ECB’s Weber indicated that ‘the receding inflation pressure has created ample room to move for European monetary policy, which will also be used given the rapidly deteriorating economic outlook’. Weber’s comments hold out the threat of more aggressive rate cuts in the months ahead and therefore contrast with recent comments of ECB’s Mersch, Bini Smaghi and Nowotny who all suggested that larger rate cuts could be counterproductive and hinted at a continuation of the current gradual easing cycle with rate cuts of 50 bps. This indicates that the size of the December rate cut is still open for debate. This should cap the rebound in 2-year yields, which fell yesterday for the first day in four, and suggested new longs can be considered. Today, ECB’s Trichet will speak after a meeting with central bankers from the Mediterranean region.
On the supply front, Italy will tap its 3- and 10-year BTP for an amount of respectively €1-1.5 B and 2.5-3.5 B. Yesterday, Italy sold in total 1.5 B of its 10- and 30-year inflation–linked bonds. Ahead of today’s auction, the spread with German yields widened again at the 10-year maturity, but narrowed slightly in the 2-year sector. Currently, both spreads are almost equal at around 110 bps. Yesterday’s plan of the EU Commission contained no specific measures, but sought the coordinate the national stimulus packages, which could amount to €170 B besides an effort of €30 B from the EU budget. As a consequence, there was no immediate impact on the spreads.
On the money market, the ECB allotted €42 B in its three-month refinancing tender, the smallest amount since the start of the credit crisis in August last year. Although this indicated that the market has been awash with liquidity, the large amounts deposited at the ECB signalled that there is still a lack of confidence and that banks were still not lending to each other. Yesterday, the ECB withdrew its recent measure to accept syndicated loans governed by the laws of England and Wales.
Regarding trading, yields fell substantially across the European yield curve yesterday with the 30-year sector outperforming. Both 10- and 30-year yields closed at new cycle lows, respectively 3.28% and 3.78%. As such, 10-year yields are approaching intermediate support levels at 3.23%, the January 2006 lows, ahead of the all-time lows at 3%. 30-year yields fell already to the January 2006 lows at 3.78%. A sustained break lower would bring the all-time lows at 3.47% in the picture. The proximity of these intermediate support levels suggests that the recent corrective flattening of the curve may be over for now and supports again a steepening of the European yield curve.
In the UK, there was some bad corporate news, as two retailers, Woolworths and MFI, fell into administration putting more than 30 000 jobs at risk. House prices however fell a less-than-expected 0.4% M/M and 13.9% Y/Y in November according to the Nationwide house price index. Today, the DMO will also tap a 5-year Gilt 5% Mar12 for £3.75 B.
Currencies: Euro cannot sustain its rally
On Wednesday, EUR/USD reversed course following a three-day winning streak that got a boost on Tuesday after the publication of the Fed stimulus package. The pair ultimately closed at 1.2880 compared to Tuesday’s closure at 1.3064. Profit taking in the pair started right at the start of Asian trading and a shy attempt in European trading to regain the 1.30 area failed miserably. This was a bad omen for the euro that was well captured by traders, who pushed the pair further down early in the US session. US data as Chicago PMI business sentiment, final Michigan consumer sentiment and especially durable orders and household spending were again very weak, but didn’t weigh on the dollar. The announcement of a €200 billion EU stimulus package left no traces on the EUR/USD charts. The amount of the plan is probably ok, but the lack of coordination and its implementation through the Member States instead through the EU is a negative that may dent the impact of the plan. At margin, the lack of coherence of the plans across Member States might even be slightly euro negative short-term. US oil inventories came out very high, but could however only very temporarily push oil prices lower, later on oil prices rallied to close up 3.67 dollar. However, also oil prices couldn’t prevent some further EUR/USD losses. Later in the session, the equity rally gave EUR/USD some downside protection, but it could lift the pair only very modestly to a 1.2880 in the close. Summarizing, the market considered that the recent rebound in EUR/USD had gone far enough ignoring traditionally euro positive factors like higher oil prices, stronger equities and a fiscal stimulus package.
Today, the US markets are closed, In Europe, the EU economic confidence indicators are on the agenda, but these should only confirm that the EMU economy is in dire straits as numerous eco report stated recently. The euro started on a stronger footing in today’s trading, currently changing hands at 1.2924. Trading will be thinned by the absence of US traders. The terrorist attacks in India have little impact on trading.
Negative eco news and risk avers investor behavior have supported the dollar (and the yen) at the expense of the euro during several weeks, even months. This theme was the main factor behind the decline of EUR/USD from highs above 1.60 to the correction low in the 1.2330 area. Since end October, the EUR/USD pair 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 resilience. Over the previous days, we suggested that markets may start looking out for another trading theme, which by hypothesis would be less USD supportive. Yesterday’s price action doesn’t fit in this search for a new trading theme. Nevertheless, it might have been profit taking and therefore alertness for a change in trading theme remains warranted. Do the aggressive measures of monetary easing become a negative factor for the dollar or will EUR/USD continue to trade in line with the swings in global risk aversion?
From a technical point of view, during the last three weeks, EUR/USD has established a sideways trading pattern. The charts suggest the EUR/USD trend is negative longer term. However, over the past week; we indicated to take partial profit in case of return action towards the bottom of the range as chances were rising for a more pronounced EUR/USD rebound. After yesterday’s EUR/USD correction, the jury is still out as EUR/USD is now again in the middle of its sideways range. Shortterm players may still look to sell EUR/USD on a return action towards the top of the range (1.31/32 area). A sustained break above the 1.3294 area would be an important technical signal of a change in the USD constructive market sentiment. (Stoploss on EUR/USD shorts).
Yesterday, USD/JPY traded mostly sideways, closing slightly up at 95.67 from 95.22 at the end of Tuesday’s session. During Asian, European morning and early US trading, the pair traded sideways, but with a negative bias. The 95.22 closing level capped the upside, but the rally of US equities after a weak opening gave the pair enough stimulus to move higher, albeit modestly and from a technical point of view insignificant. It shows though that the risk aversion/appetite motive is still a driver for the pair.
This morning, the yen is regaining some ground trading again close to the 95.00 level. There were no data releases, while the minutes of the BoJ meeting weren’t really surprising. We retain that BoJ member Mizuno called for steady rates at the meeting the board decided to cut rates by an unusual 30 basis points. It seems three members proposed a 25 basis points rate cut. The terrorist attacks in India seem to have only a very modest impact on trading. Asian equities are mostly higher (Indian markets are closed), and even the Indian rupee is only slightly lower versus the dollar.
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 (Nov. 04), but the rebound ran into resistance. Longer-term, the scenario of a well supported yen on the idea that prospects for a sustained improvement in the global economic picture remain very downbeat remains intact. We are holding to a sell-on-upticks approach as long as the pair holds below 100.55. Yesterday, we suggested that the (upward) correction in USD/JPY could go further if risk aversion eased further, but yesterday’s price action was disappointing from a dollar point of view. The USD/JPY downtrend remains very well in place.
On Wednesday EUR/GBP basically held a sideways trading pattern in the 08520/80 area, except for a very brief spike lower during the US trading hours. The details of UK Q3 GDP brought no new insights for the currency markets and EUR/GBP didn’t react to the EU stimulus package. So, after all it was a rather uneventful day for EUR/GBP trading, but with sterling closing a bit stronger at 0.8446 compared to 0.8443 on Tuesday. From a technical point of view, the drop below the medium term moving average at 0.8428 (today) makes us a bit nervous and the inability to recapture the level today may point that sterling strength has to go further.
Today, UK housing prices (Nationwide) fell much less than expected, which in a UK perspective might be an important feature, if confirmed in the next months and in other surveys. However, the pair fell in the minutes before the release recouped these losses immediately following the release. In EMU, economic confidence indicators are on the agenda, but these should only confirm that the economy is in dire straits, something numerous eco report stated in recent days.
So, all in all trading in EUR/GBP may be technically inspired today, but the absence of US traders may bring more volatile intra-day moves.
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 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. 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. The price action on Tuesday and Wednesday was disappointing though. Nonetheless, we hold on to our cautious buy-on-dips approach for EUR/GBP. A drop below 0.8334 would be a warning signal for our ST EUR/GBP positive bias, but the drop below MTMA (see above) might be an indication that this level will be tested. The pair must return below the 0.8215/53 area (Break-up/uptrend line) to call off the sterling red alert.
