during in christmas holidays from dec 22 till jan 02 there will be no reports available, next full report as from jan 05, 2009
Markets: Fixed Income
On Monday, global bonds started the week on a strong footing in very thin trading. The US and EMU yield curve shifted downward, but while it happened in a flattening fashion in the US, the curve steepened in EMU. EMU bonds outperformed the US ones, maybe a reaction on Friday’s underperformance in later US trading.
Safe haven buying, following more revelations on the giant fraud of Madoff, and weaker equities were an important ingredient of trading, as was corporate supply and the surrounding hedging activity. The eco calendar was empty in Europe, but busy in the US. The NY Fed manufacturing survey and the production data were very weak, but marginally better than expected. It very temporarily weighed on Treasuries. Corporate supply included a $1.5 B deal of BoA, a $5 B deal of Proctor & Gamble and a $1.25 B issue from United Tech. Also the proximity of the FOMC decision might have supported bonds.
Intra-day, the gains of the German Schatz were all made in the two first hours of trading, while the lion part of the Bund gains were also eked out in early trading, supporting the view that some catching up was behind the advance. US Treasuries were sideways oriented until early US dealings when they rallied higher, largely independent from equities. After the eco data, Treasuries retreated, but got another sprint higher when later on equities got hit.
US Treasuries at historical highs, as FOMC will unveil its quantiative easing framework
Today, the calendar contains the November inflation data, housing starts and building permits, but the economic figures will receive only limited attention as markets will be looking forward to the rate announcement later today. CPI inflation is expected to show another sharp decline in December. The consensus is looking for a 1.3% M/M decline, while the year-on-year figure is forecasted to come out at 1.5% Y/Y (from 3.7% Y/Y). Nevertheless, a sharper decline should not surprise as many retailers lowered their prices even before Thanksgiving, while discounting normally starts in earnest in December. Last month, core CPI showed its first decline since the double dip recession (1980-1982) and is expected to rise 0.1% M/M in November. The risks are on the downside of expectations and a lower outcome would raise fears for deflation. Both housing starts and building permits are at historical low levels and further declines are expected in November. Housing starts are forecasted to drop to 735 000 (from 791 000) and building permits are expected to fall from 730 000 to 700 000. For this month, we expect to see weak figure, but in the coming months, it will be interesting to see whether the actions taken by the government will help to stabilize the market.
When the Fed communicated that the December FOMC meeting would take two days instead of one, it became clear that important issues would be on the table, besides the inevitable rate cut. Regarding the rate cut, consensus goes for 50 basis points which would put the FF target rate at 0.50%. There is a risk they might do more, but as the effective Fed fund rate is already 0.25%, such a decision would have little impact on markets. More interestingly, will the FOMC go really towards 0% or stop slightly above it? It depends on the evaluation of the situation of money market funds and the repo market. Those behemoths might have problems with rates at zero percent, given their cost structure and their promise to investors not to break the buck even if it’s highly uncertain whether the Fed in a context of quantitative easing has the power to prevent the effective Fed Funds rate to stay above zero. Recent Fed talk clearly suggested that the issue of quantitative easing would be discussed and probably followed by communication towards the markets and public. This will be the most important item of the FOMC meeting. By buying CP and by promising to buy $500B of Agency MBS, the Fed already passed the stage of simply raising the amount of collateralized loans to ever more market participants. It already started to implement a quantitative easing. However, to do it successfully, it should clearly explain in all openness the conditions under which it will implement such a policy and also give market participants some guarantees about the duration of the policy or the conditions to exit it. There remain indeed still quite some questions on the table. Bernanke in the Japanese context pointed a few years ago to the option of buying Treasury Notes further out the curve, effectively capping the yield on some maturities. Such a policy would flatten the curve and shift yields considerably lower, ultimately giving stimuli towards the whole economy. He re-iterated this possibility some weeks ago. The yield curve already anticipated on such measures by pushing 10 and 30- year yields to respectively 2.5% and 3%.
Another option would be to concentrate its efforts at narrowing the spread between market yields and Treasuries, which have been very wide and effectively meant that the lower Treasury yields are only very modestly transmitted to the economy. The Fed’s venture into the mortgage and CP markets suggests that the Fed may opt for such a quantitative easing, directed to e.g. the mortgage, CP and maybe corporate bond markets. Needless to say that the way the Fed will act would have a huge impact on market movements. If the Fed would intervene in non-Treasury markets, all kind of spreads should come in and Treasuries may correct lower.
Regarding trading, Treasuries resumed their uptrend, following some hesitation on Friday. The doji (trend reversal signal) that appeared on the charts (March Note future) was negated by yesterday’s higher close. 2-, 5- and 10-year yields are again at the intra-day lows registered on Friday (0.66%, 1.40%, 2.48%), while the 30-year yield is below that level at 2.95% currently. The big question for today is whether the FOMC decision on rates and quantitative easing will be the catalyst of yet another down-move in yields or investors will decide that as year end nears, some profit taking is appropriate. We favour the correction as a kind of buy-the-rumour sell-the- fact reaction. We saw a similar reaction following the latest awful payrolls report. The way the FOMC will frame its quantitative easing (via Treasury buying or via spread product buying) is probably crucial for the market reaction.
European bonds reverse Friday’s losses
Today, the calendar contains the December flash PMI figures and third quarter employment data. In November, Manufacturing PMI plunged to 35.6 (from 41.1), a fresh record low. Also the details showed a very bleak picture with new orders dropping below 30. For December, the consensus is seeking for another decline (34.2 from 35.6). But a slightly higher outcome should not surprise as there is only a short period between the final November figures and flash December data. Services PMI is forecasted to drop from 42.5 to 41.4. In both surveys, we expect to see a sharp decline in the labour sub-index after ever more companies announced job cuts.
Yesterday, ECB’s vice president Papademos presented the ECB’s semi-annual financial stability review. In the report, the ECB singled out a number of risks and vulnerabilities, which still threaten financial stability despite the extraordinary measures taken by central banks and governments. In particular, the ECB pointed to a further deterioration of the US and euro area housing markets, a deeper and more prolonged slowdown than currently expected, a more pronounced deleveraging by banks and a surge in financial market volatility caused by a further unwinding of positions by hedge funds. During his presentation, Papademos warned that the longer bank funding costs are high, and the more banks respond by deleveraging or passing costs to borrowers, the greater the risk of ‘an adverse feed-back loop that could spark a more traditional credit-cycle downturn’. As such, Papademos welcomed the idea of a European clearinghouse as a way to reduce interbank counterparty risk and revitalize the money market, but declined to elaborate.
Over the past weeks, the ECB has become increasingly concerned about the slow return of confidence in the money market and has hinted at new measures, including a cut in the deposit facility rate. It’s clear that some/many members of the governing council first want to repair the monetary transmission mechanism before cutting interest rates any/much further, as they fear to fuel another asset bubble. This may also explain the differences of opinion within the ECB governing council with regard to the interest rate outlook. Yesterday, the Spanish governor Ordonez called all options open at the next January meeting, although Stark and Weber last week hinted that the ECB won’t cut rates below 2% and might leave rates unchanged at the January meeting. Today, the ECB will hold its weekly refinancing tender. Last week, the amount allotted dropped more than €100B and also the number of banks participating declined, which along with the decline in the liquidity spread suggests that conditions in the money market are improving.
Overnight, the FT reports that Germany is preparing a second multibillion euro fiscal stimulus package in exchange for a pledge from some of Germany’s largest companies to avoid mass job cuts. The package will focus on infrastructure investment instead of tax cuts, because of fears that the extra income would raise Germans’ high saving rate. The plan is expected to be finalised on January 5, but should exceed €10B on top of the €12B committed in the first package. Yesterday, the intra- EMU spreads widened again substantially, especially for the smaller countries like Greece, Ireland, the Netherlands and Austria, while France, Belgium, Spain and Italy traded rather stable. This may be related to current thin trading conditions, as well as the new recapitalization scheme announced in Ireland for an amount of €10B.
Regarding trading, we were surprised by yesterday’s strong gains, especially at the short end of the curve, but shouldn’t draw too many conclusions out of it, as it didn’t completely reverse Friday’s down-move and occurred in very thin trading conditions. Overall, as long as the Bund hasn’t recouped the broken uptrend line today at around 124, the risk is still for more downward correction. The more if a buy the rumour, sell the fact movement should occur in the US Treasury market following this evening’s Fed rate decision. At the short end of the curve, we would remain also cautious, as many within the ECB governing council have shown their reluctance to cut rates at the next meeting in January.
In the UK, inflation is expected to show the second consecutive drop in November. The consensus is looking for a decline of 0.3% M/M, while on a yearly basis, CPI inflation is forecasted to drop to 3.9% Y/Y (from 4.5% Y/Y). Also core CPI is expected to show its second straight decline (1.8% Y/Y from 1.9% Y/Y).
Yesterday, the UK Treasury has cut the credit guarantee fees it charges banks when they issue bonds to raise funds, in an attempt to ease tight credit conditions.
Currencies: EUR/USD extends rebound
On Monday, the EUR/USD rebound that started last week accelerated. There was not much news to ‘explain’ this acceleration, but the uncertainty ahead of the FOMC meeting for sure played a role. Technically inspired traders also had a good reason to adopt a more EUR/USD positive stance as the pair clearly settled above a series of key resistance levels. EUR/USD hovered sideways in the 1.3430/1.3500 area during the morning session in Europe, but it made a forceful step higher from the start of the US trading day. The US eco data, at margin, we slightly less negative than expected, but had again no impact on the dollar. On the contrary, the USD selling pressure intensified. This occurred at a time when the oil price declined and also the stock market performance at that time was far from convincing. This is another illustration that the drivers that had set the tone for EUR/USD trading over the previous months are losing their grip and that markets are looking for something different. EUR/USD closed the session at 1.3688 compared to 1.3369 on Friday.
Today, the advanced reading of the European PMI’s will be published and the US eco calendar contains the CPI data, housing starts and building permits. The PMI’s are interesting, especially as the recent ECB talk suggested that the Bank would prefer to delay additional interest rate cuts to February. Regarding the US data, inflation is no item for markets anymore and the housing data are expected to confirm the deep crisis the sector is going through. If anything, this should be no help for the dollar.
Of course, the key event for today will be the Fed interest rate decision and statement. A 50 basis point rate cut is largely expected. However, the most important point for global markets will be which additional steps the Fed will take in its quantitative easing. This approach obviously is becoming a factor of importance for USD trading. We don’t have a strong view on what additional steps exactly the Fed will announce, but an aggressive stance on this item will cause additional dollar
Since the end of October, the EUR/USD pair has developed a consolidation pattern between 1.2330 and 1.3294. The correlation between EUR/USD and indicators of risk aversion/risk appetite continued to play a role, but since end November, the euro has gradually shown more resilience. Recently, we suggested that this might be an indication that markets looked out for a new trading theme, which would be less USD supportive. The aggressive Fed approach could be a trigger for more dollar skepticism. Already at the end of last week, EUR/USD extensively tested to top of the sideways trading range and yesterday, the break has been forced. Today’s Fed’s decisions will have an important say on the next big move in the dollar. However, the red alert on the USD has been raised and if the dollar fails to stage a convincing rebound on today’s Fed statement (which is not our preferred scenario), the dollar might face more trouble in the near future.
Today’s Fed meeting is also the last high profile event on this year’s eco calendar. From now, markets will soon enter illiquid end of the year market conditions. This makes trading even more unpredictable than usually is the case. However, we don’t see this rather dollar negative than dollar positive.
From a technical point of view, EUR/USD broke above the previous sideways trading pattern and an important downtrend line (today at 1.3350). This makes the picture for EUR/USD outright positive. If the market reaction today’s Fed decision doesn’t change this picture, the way is open for substantial EUR/USD gains. The 1.40 level (and beyond) could be reached sooner than deemed possible until now.
On Monday, USD/JPY was still downwardly oriented. However, the losses of the dollar against the yen were less pronounced compared to the losses against the single currency. This might look a bit strange. The poor eco picture as painted form the Tankan report left no big marks on the USD/JPY charts, but might have been a minor negative factor for the Japanese currency. However, investors’ risk appetite and the global sentiment on the US currency probably will continue to be the main drivers for USD/JPY trading. US/D/JPY closed the session at 90.65; compared to 91.21 on Friday. However the Friday lows were not really challenged.
This morning, the Japanese tertiary industry index came out surprisingly better than expected (+0.4% M/M). The Nikkei lost 1.12%. In appearance before a parliamentary commission, BOJ governor Shirakawa said the bank was examining the effects of quantitative easing. However despite government pressure, we have the impression, that the Bank remains rather cautious on take a lot of credit risk directly on its balance sheet.
Looking at the charts, global market stress hammered the USD/JPY cross rate and the pair set a new reaction low in the 90.90-area at the end of October. A temporary easing of global market tensions sparked a USD/JPY rebound but the rebound ran into resistance (100.55/Nov 04). Longer-term, the yen will continue to trade strongly as long as the global economic and financial picture remains downbeat. Two weeks ago, the pair fell below the 93.55 support and this opened the way for a retest of the year lows, which occurred on Friday when a new low was set. Recently, we advocated not fighting the well-established downtrend in this pair but adopted a more cautious approach (profit taking/Stop loss protection on USD/JPY shorts) ahead of the (previous) year low. We don’t add to yen long exposure at the current levels, but it is obvious that the long-standing ascent of the yen is still well established. So, a sell-on-upticks approach looks the appropriate. Global dollar weakness, if it would become a market theme, would have important consequences for USD/JPY, too.
On Monday, sterling trading again developed in a very nervous environment. Sterling again faced an uphill battle during the morning session. The poor rightmove house prices were again no support for GBP. On top of that, the strong overall performance of the single currency causes upside pressure on EUR/GBP. However, to be honest, the intraday correlation between EUR/GBP and EUR/USD was not really that big. Nevertheless, EUR/GBP reached a new reaction high in the 0.9020 area around. Later some profit taking kicked in, the pair closed the session at 0.8943, even marginally lower compared to Friday’s 0.8948 close.
Today, the UK calendar contains the CPI data. Inflation is expected to extend the decline that started last month and should confirm the BoE assessment that there is every room for a proactive monetary policy. We don’t expect today’s CPI data to have a lasting impact on sterling trading. Tomorrow’s BoE minutes have more market moving potential.
On the technical charts, the break above a series of high profile resistance levels has made the long term technical picture outright positive for EUR/GBP. We hold on to our view that a negative interest rate differential vis-à-vis the euro, combined with ongoing negative eco news contains the risk for additional sterling losses over time. On top of that, the BoE (and the government) looks still pleased with the support the weaker currency is providing to the UK economy. So, for now, the market context and the fundamental story remain sterling negative. EUR/GBP last week met our long-standing target of 0.8824 (Target of Multi year double bottom formation, neckline 0.7253). This made us turning a bit more cautious on the EUR/GBP uptrend short-term. However, the UK currency remains under pressure. The trend is sterling negative and at least for now it is difficult to see a trigger that changes this pattern. If EUR/USD would continue its ascent, it might keep EUR/GBP under upward pressure, too, as cable probably won’t be able to keep up with the single currency. We hold on to our standing view that down moves in EUR/GBP are corrective in nature and look the buy back into this pair in case of a correction. The 0.8662 previous high now becomes the first obvious support. The 0.8568 is the next one. Return action to this area, if it occurs, is still seen a buying opportunity.
