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US Treasuries go hesitantly higher post payrolls

Fri, Jan 9 2009, 09:33 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Friday, global bonds ended mostly higher in a volatile session dominated by the all-important US payrolls data for December. These were once more awful, even if the headline December figure was close to expectations. An early buy-therumour, sell-the-fact reaction pushed bonds initially lower, but later on bonds rallied as equities hit the skids and both the Bund and the US March Note contract broke through key resistance. However, end-of-week profit taking erased some of the gains, especially in the US market, going into the close. In the US the curve bull steepened with the 5-year outperforming the 2-year and the 30-year lagging. In EMU, the belly of the curve slightly outperformed the wings.

Intra-day, the Bund traded sideways before it started to grind higher around 11.00 CET, breaking above key 123.75 resistance. The EMU data, French and German production data (November) were once more very weak, while retail sales were a tad better than expected. However, the move higher transformed in sideways trading as traders awaited the US payrolls. The report was awful even if the December job loss of 524 000 was in line with expectations. However the details (downward revisions previous months, unemployment rate and aggregate hours worked were horrendous) printed an even worse picture than the headline. In 4 months about 2 million jobs were lost and for the whole of 2008, 2.6 million jobs were shed, the highest since World War 2. In previous days, the market had prepared itself for a very weak report. So, on the release, Treasuries fell lower and equities higher, while also the dollar gained. The moves in the Treasury and equity markets reversed though, also because of some dismal corporate news items, and even after equities stabilized, Treasuries went further up, helped by the March contract pushing through key resistance. Later on, some week-end profit taking occurred, leaving Treasuries with some moderate gains in the close.

US Treasuries go hesitantly higher post payrolls

Previewing this week’s calendar the dataflow is abundant and very interesting. Firstly, the market will receive extensive new information on the activity in the cyclical manufacturing sector. Secondly, the December retail sales will give us a critical insight in the crucial Christmas holiday spending season and help us gauge the outlook for consumption in early 2009. Finally, the inflation data might give us clues about the pace of the easing in inflation and the chances that deflation will get grip. The Beige Book that prepares the January 31 FOMC meeting will also give a very up-to-date picture of the economy and might influence the FOMC growth and inflation projections that will be deliberated at that meeting.

The cyclical manufacturing activity decelerated in the past four months at an historical unprecedented fast pace. The market will be eager to know whether the pace of deterioration is slowing at the onset of January. The NY Fed and Philly Fed surveys stabilized in recent months at very low levels, suggesting the pace of slowing remained constant. We see little reasons to expect a noticeable change in January (and this is in line with the consensus).

The retail sales report for December will give us a good picture of how the Christmas selling season ended. Given the disappointing weekly ICSC sales statistics and bellwether Walt-Mart sales/outlook and the soft car sales, the monthly retail sales should again have fallen for the sixth month in a row, while the core sales (that excludes the car sales) should have done so for the fifth time. The report will underline the fast adjustment that is taking place in the consumer sector.

The three inflation measures, import prices, PPI and CPI will all show that inflation is dropping like a stone. Interestingly, headline CPI is expected to show a drop on a yearly basis, the first one since 1956. Also the core measures of inflation that exclude energy and food and that held well up during most of 2008 in spite of slower growth, showed in recent months a more pronounced decline. From a market perspective, fast slowing inflation would stoke fears of deflation.

Fed speakers are very active. Fed governors Lacker, Lockhart, Plosser, Stern, Yellen and last but not least Bernanke will all take the stage. We suspect that while interesting most speeches won’t contain new info. The Fed fund rate is now out of the focus and on quantitative easing, there shouldn’t be yet new info from the Fed. If we would be wrong, the speech of Bernanke on Tuesday is the one to watch out for.

Reviewing last week’s trading, Treasuries had a rollercoaster ride, losing ground early in the week and gaining again in the second half. In a weekly perspective, 2- and 5-year yields dropped 7 and 14 basis points, but 10 and 30-year yields were still up 2-to-3 basis points. Initially, Treasuries were hit by renewed optimism that the aggressive monetary easing and the upcoming bold fiscal stimulus package would help the more risky asset market revive during 2009, following an historical bad 2008. So, investors started to contemplate that the worst possible scenario was priced in and any improvement would help risky assets and hit the super safe Treasuries. The dataflow in the first week was indeed more mixed compared to consensus expectations than in the previous three months. However, the ADP employment report on Wednesday and the payrolls on Friday sewed again doubt. Indeed, they suggested that the unprecedented fast tumbling activity hadn’t stabilized yet. So, equities had to give back their early 2009 gains.

However, at the same time, there is further improvement in the money and credit markets that legitimizes some optimism, even if cautiousness remains fully warranted. The 3 month Libor continued to decline and was fixed at 1.26% on Friday, down from 1.42% on Monday. As the OIS rate stabilized at 0.18%, the liquidity spread narrowed to 107 basis points, the lowest level since early September. Outstanding CP popped up ($83 billion) in the most recent week and this time not because of Fed activity (CPFF purchased less than $1 billion CP). The Fed balance sheet contracted $69 billion, probably a result of the turn of the year activity dropping off the sheet. The NY Fed started to buy Agency MBS ($10 billion). Swap spreads are narrowing sharply, ending the week at respectively 54, 52, 14 and -18 basis points from 75, 58, 33 and 10 basis points on Monday. The Also credit markets show signs of improvement both in EMU and US. In EMU, Commerzbank raised €5 billion (state-guaranteed), BNP sold a €1.5 billion covered bond. In the US corporate activity was brisk with GE capital ($14.75 billion); Inbev $5 billion), EIB ($4.5 billion), KfW ($5 billion) and Commonwealth Bank of Australia ($2.5 billion) the eye-catchers. Emerging sovereigns were active too: Philippines, Turkey, Brazil and Colombia tapped the market for a combined amount of $4.4 billion. Credit spreads (both investment and High yield) narrowed. In EMU, Germany, France, Ireland all tapped the market, while in the US 10-year TIPS, and 3- and 10-year nominal bonds were placed. The TIPS was a huge success, as some investors were afraid that the current fiscal and monetary policy orientation will push inflation up over time. The 3-year auction was rather disappointing, but the 10-year was an unexpected success due to aggressive dealer bidding and good albeit not aggressive buy-side interest. All-in-all, the market quite easily absorbed the increased supply, suggesting that capital preservation is still a main theme for investors.

Technically, Treasuries corrected lower in early 2009, after having rallied sharply in December to new all time highs. The correction was however modest and didn’t violate the longer term positive picture. The 2.50% in the 10-year yield and the broken top of the uptrend channel in the March Note contract offered support. However, the key 125-22 (neckline double top) resistance couldn’t be taken out sustainably on Friday. A break would have opened the way eventually for a retest of the highs at 128- 22. Only a drop below 123-02-to-122-21 would have more negative and longer lasting consequences. So technically for this week’s trading, a break above 125-22 (March Note future) would be a ST positive that may push the contract eventually to the highs. Longer-term, there is no signal that a more pronounced downward correction is in store. A re-run to the high offers a good profit taking opportunity.

Previewing this week’s trading, the eco data looks to be supportive. The December payrolls set the trend for the month. Therefore, more eco weakness and favourable inflation reports are to be expected. The technicals are a positive too. The market will start looking forward to the inauguration of Mr. Obama that will take place next Monday, but probably the most important item will be equities that will start reacting to the earnings season that kicks off today with Alcoa, who already published a profit warning. Intel reports on Wednesday, but the bulk of reports will only be published from next week onwards. Therefore, we expect all in all calm trading conditions with technicals deciding whether Treasuries (March future) will trade in the 125-22 to 128-22 range or in the 122-21 to 125-22 range. Profit taking in case of a retest of the highs and buying on dips in case returning to 122-21 is our strategy at the start of the trading week.

Supply concerns remain in the focus on the European bond market

Today, the euro zone calendar is empty, but will heat up later this week with the ECB monetary policy meeting. On Wednesday, euro zone industrial production figures are expected to show a drop of 2.1% M/M in November, but we expect to see a lower figure after the very weak German and French data last Friday. On Thursday, the ECB rate announcement and press conference afterwards will be eyed closely. The November trade balance is scheduled for release on Friday.

With regard to the ECB rate decision, we expect a finely balanced decision to leave rates unchanged at 2.5% on Thursday. Despite recent awful eco data and the drop in inflation, the ECB hasn’t clearly signalled at another rate cut for this meeting. Several governing council members even warned on the adverse effects of too low interest rates, although others favoured a pre-emptive easing to counter a potential deflation threat. Following the impressive 175 basis points of easing in Q4, the stability-oriented ECB may well decide to take some more time to assess the economic situation. Nevertheless, although markets are currently looking for another 50 basis points rate cut, the impact of such an unchanged decision may well remain fairly limited, as the ECB is likely to hint at more rate cuts to come probably as soon as in February. In a longer-term perspective, we have cut our ECB rate target from 1.5% to 1% for this year. As such, we still see any upward correction in 2-year yields as an opportunity to add to existing long positions. Later on this week, a comprehensive preview on the ECB meeting will be published.

Besides the ECB rate decision, supply will remain an important factor, mainly at the longer end of the curve. This week, Belgium (new 10-year; 4-5B), the Netherlands (Tuesday, new 3-year; 2.5-3.5B), Germany (Wednesday, 2-year tap; 7B), Italy (Wednesday, 4-, 20- and 30-year tap; 5.5-7B) and Spain (Thursday, 15- and 30-year tap; n.a.B) are expected to tap the market. Weak demand at the auctions may keep the downside in longer-term yields limited and favour a further steepening of the European yield curve. Following Friday’s announcement of a new 10-year Belgian OLO via syndication, Belgian bonds underperformed their European peers significantly (Later today, a flash on the new OLO 55 will be published). And also Irish bonds continue to underperform following last week’s difficult issuance of the new 5- year benchmark. Austrian bonds however benefit from the rather strong demand for its new 5-year benchmark. The massive amount of supply this week will keep bond markets nervous and may lead to some more divergent trading on the European bond market.

With regard to the Bund, Friday’s session was constructive, as the Bund managed to recoup the 123.75 level. But as long as there is no sustained break above the contract high in the Bund at 125.56, we are not convinced that the Bund is ready for another significant move higher. Today, Germany will also announce more details on its second stimulus package, which may be worth €50B over a two-year period. According to the latest rumours, the new plan would also include a €100-135B ‘Germany Fund’ that would issue credit guarantees to help cash-starved businesses, as last week’s second capital injection in Commerzbank indicated that the crisis in the banking sector is not over. The new intervention of the German government in the economy signals a change in stance and may also raise concerns about the financing of the German debt.

Also in the UK, the calendar is empty today.

Currencies: Payrolls fail to give a clear signal for currency trading

On Friday, EUR/USD showed again some remarkable price action. After a ‘suspicious’ up-tick on Tuesday, the pair held close to the 1.37 area ahead of the US payrolls report as investors feared more bad news from the US labour market. The US payrolls report indeed painted a poor picture as more than 500K jobs were lost. However many investors apparently had feared an even bigger loss and markets first didn’t know what conclusion to draw from the report. The market reaction to the report was not consistent through different markets. Equity investors were not really convinced and stocks headed south and investors continued to buy save haven bonds. Currency traders did draw a different conclusion: EUR/USD tried to gain some ground immediately after the release, but the move failed and this pulled the trigger for a euro correction. So, for EUR/USD there was some kind of ‘buy the rumour, sell the fact’ reaction after the payrolls. We are a bit puzzled whether we should call this a dollar rebound as USD/JPY moved lower at the same time. Nevertheless, EUR/USD continued to cede ground throughout the remainder of the session and closed the day at 1.3476, compared to 1.3702 on Tuesday’s evening.

Today, calendar is almost empty on both sides of the Atlantic. However, this will for sure change later this week with a lot of important US eco data to be published from tomorrow on. In Europe, all eyes will be on the ECB interest rate decision on Thursday.
Since the start of the new year, we indicated that currency traders didn’t find a straightforward new trading theme yet and this was again illustrated on Friday. Should the dollar got the advantage of the doubt on the expectation that the US economy will emerge from the crisis first, supported by hefty stimulus measures? Or will the dollar suffer from the flood of liquidity and extremely low interest rates as the Fed’s shifts towards quantitative easing? Of course, within the EUR/USD balance, there is also the euro side of the story. European data are becoming awful, too. The ECB is (very) reluctant to bring interest rates to extremely low levels (or even more to make steps towards quantitative easing). This gives the euro interest rates support over the dollar, but markets obviously doubt on the adequacy of the ECB policy, too. Ahead of the ECB interest rate decision on Thursday, uncertainty on what to expect from the ECB might cause some additional euro nervousness, too. Longerterm we remain dollar skeptic, but in the current context of high market indecisiveness, we can’t but keeping a close eye on the technical chart.
From a technical point of view, EUR/USD in December broke above the previous sideways trading pattern and an important downtrend line (cf. graph). This made the MT picture for EUR/USD positive. However, the rebound lost momentum in the second half of December and in a forceful correction, EUR/USD dropped last week to the top of the previous sideways range (1.3300 area). This level held but the subsequent EUR/USD rebound had no strong legs either. At the end of last week, we suggested that the pair might had entered a short-term consolidation pattern between 1.3300 (reaction low + previous range top) and the 1.3825 area (previous low). This range is still in place, but the EUR/USD price action on Friday was far from convincing. For now, we hold on to our ST buy-on-dips approach. However, tight stop-loss protection remains warranted if the pair was to clear the area 1.3300 area.
On Friday, USD/JPY was under slight downward pressure ahead of the US payrolls report. The pair tried to gain ground immediately after the release of the report. However, the gains could not be sustained as a disappointing open on the US stock markets brought the yen again in the picture. USD/JPY declined from intraday highs in the 91.60 area and closed the session at 90.39.
This morning, Japanese (stock) markets are closed. Most other Asian markets show losses in line with the US stock markets on Friday evening.
Looking at the charts, global market stress and overall dollar weakness in the wake of the US Fed’s announcement on quantitative monetary easing hammered USD/JPY and the pair set a reaction low in the 87.15 area on December 17. Since then, the pair entered calmer waters. USD/JPY first settled in a sideways trading pattern close to the 90 mark and tried to move higher during the first trading days of 2009, supported by the ‘improvement’ in stock market sentiment. The pair tested a first resistance area around 94. The level was temporary broken, but the test was rejected. The long-term trend in the pair remains negative. In a day-to-day approach we continue to prefer a sell-on-upticks approach. A break above the 94.63 reaction high would question our ST negative bias. The downtrend might slow below 0.9000 as officials will voice concerns on the ascent of the yen if USD/JPY comes closer to the 0.8720 reaction low.

On Friday, the rebound of sterling against the euro continued. At the start of the session, EUR/GBP tried to move higher, but the move lacked power. The UK production data painted a very bleak picture on the UK economy, but that was not enough a reason to cap the rebound of the UK currency. The move even accelerated later in the session as overall pressure on the single currency left its trace on EUR/GBP, too. EUR/GBP continued to lose ground throughout most of the day and closed the session at 0.8878, compared to 0.9006 on Thursday.

Over the weekend, the NIESR GDP estimate for December declined from an estimated contraction of 1.1% to -1.5% in the three months through December. Today the UK calendar is empty.

At the start of 2009, the pressure on sterling eased and this trading pattern was extended after Thursday’s BoE interest rate decision. On top of that, on Friday, the price action in EUR/GBP mirrored not only correction/rebound in sterling, but also overall euro weakness. This theme could continue to play its role ahead of Thursday’s ECB interest rate decision and press conference. Nevertheless, we maintain our LT view that a negative interest rate differential vis-à-vis the euro, combined with ongoing negative eco news contains the risk for sterling to come under pressure again. We remain sterling skeptic as long as we don’t receive a sign that the weakness of sterling gets more weight in the BoE’s monetary policy assessment and/or unless we get a clear sign on the technical charts.

On the technical charts, the break above a series of high profile resistance levels in November/December has made the long term technical picture outright positive for EUR/GBP. Since start of 2009, EUR/GBP showed quite a forceful correction but in our view this move still didn’t change the long-term sterling negative picture yet. The drop below the 0.9000 suggests that the correction might have some further to go. Nevertheless, we still consider the current move as corrective in nature Long term, we still look to buy EUR/GBP but we’re not in a hurry and wait to see how far the current correction has to go. A sustained return below the previous high (0.8663) would question our long-standing sterling negative attitude.

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Published on  Mon, Jan 12 2009, 10:40 GMT