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Sunrise Market Commentary

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US Treasuries go higher in a thinly traded session

Tue, Jan 13 2009, 08:29 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Monday in typical thin trading, global bonds eked out some moderate gains, extending their multi-day rally amid growing risk aversion. Besides the bonds, the dollar & yen gained too, while the risky assets like commodities, commodity currencies and equities were hit and the VIX rose to 45.84. In the US, yields fell 7-to-8.5 basis points, the 2-year sector lagging though (yield barely down). In EMU, yields dropped 1.7 to 3.1 basis points, the 30-year lagging (yield up 1.8 basis points).

No eco data of major countries were published, but the G-7 leading indicators for November fell a steep 1.5%, with Germany posting the biggest decline. While they were not influential in trading, they suggest that after a weak Q1, the weakness might be prolonged in Q2. The OECD stated that the results point to “deep slowdowns in major G7 economies as well as non-OECD countries. More important for trading were upped concerns about Q4 earnings. Alcoa reported worse than expected Q4 results, but more attention went to the financials. Citigroup shares crashed on fears of Q4 earnings, further write-downs and an eventual break-up of the company. Also BoA shares tanked on fears of more credit losses. There was some talk again about the “Treasury bubble”, maybe resulting in some early selling pressure, but soon the risk aversion theme reigned.

In EMU, S&P put Spain’s AAA rating on creditwatch negative, which caused some upheaval in the bond market. Spain doesn’t trade anymore as a AAA, but the announcement nevertheless caused a generalized spread widening (at longer maturities) inside the EMU government universe. It certainly keeps supply in the picture.

US Treasuries go higher in a thinly traded session

Today, the calendar contains the trade balance (November), the January IBD economic optimism, the December budget statement and after trading the weekly ABC consumer confidence. The November trade balance is expected to show a contracting deficit from -$57.2B to -$51.0B, after widening in October. Both imports and exports are forecasted to decline, which is typical during recessions. Much of the drop in imports should be due to the sharply lower petroleum prices. As such, the trade balance figures are no strong market mover. They allow analysts to fine-tune their Q4 growth estimates. ABC consumer confidence is expected to show a marginal improvement from -49 to -48, while the IBD economic optimism index is expected to have declined slightly in November. We have no strong opinion on both reports, but given the awful November and December payrolls, one shouldn’t count on a sustained improvement anytime soon.

Fed governor Bernanke speaks in London on the financial crisis and the policy response, probably the highlight of the day. There are some signs of a thawing in the money and credit markets. Yesterday, the 3 month Libor dropped further, even a big 10 basis points, to 1.16%, pushing the liquidity spread (3-month Libor- 3m OIS) to below 100 basis points (98), the lowest level since the Lehman demise sent the spread to above 300 basis points. Also in several credit markets, there is some improvement visible, especially in these markets that the Fed supports (CP, Agency MBS, mortgage). It will be interesting how Bernanke qualifies these improvements. Yesterday, the IIF published its capital markets monitor and concluded that recent improvements in financial markets are unlikely to be sustained in the face of deepening recession and profit deterioration. Corporate defaults and credit losses are likely to be the defining features of the financial crisis in 2009. Fed governor Kroszner announced his resignation from the Fed board of governors, effective on January 21. It wasn’t a total surprise, as it was obvious that Kroszner, whose term expired in February 2008 wouldn’t be re-nominated by Obama.

Atlanta Fed governor Lockhart suggested in a speech that the Fed might keep its rates at current very low levels for good part of 2009 or even longer. While he isn’t concerned about deflation, he says that the Fed has more ammunition to counter deflation if it becomes a threat. It could expand its balance sheet further and he suggested that the Fed might buy Treasuries. This is important as it might cap upward corrections in yields, like we saw recently. He also dismissed critique that the Fed’s policy was about picking winners and losers or that the Fed policy has veered into industrial policy. The flattening of the curve yesterday occurred simultaneously with the publication of the speech, probably no co-incidence.

Regarding trading, Treasuries eked out more gains in a quiet, low volume trading session devoid of eco data. The curve flattened (short end lagged) on the back of Lockhart’s comments and the technicals. Indeed, the March Note future broke above 125-22, neckline of a previous double top, re-installing a bullish ST picture, which might eventually lead to a re-test of the contract highs at 128-22+. Whether this is in the cards in the next sessions is difficult to predict and will probably depend on the fate of risk aversion theme remaining intact. Earnings results are still few this week, but some warnings may occur. Should equities threaten to go for a test of the cycle lows, Treasuries may get another boost. If not, the upside should be limited to the cycle highs at best (128-22+ for March contract; 2.03% fort 10-year yield). The eco data today aren’t of major importance. We are moderately optimistic, but see little reasons to be ebullient. We would play the 122-22 to 128-22+ range (March Note future) with a positive inclination as long as above 125-22/124-17+/13+ (LTMA/channel top).

Credit warnings drive sovereign yield spreads wider

Today, the euro zone data calendar is again empty, but on the supply front the Netherlands is expected to issue a new 3-year benchmark 2.5% Jan 2012 for an amount of €2.5-3.5B and Belgium is expected to price its new 10-year benchmark. Supply and credit issues are becoming an ever important factor on the European bond market following the credit warnings from S&P on Greece and Ireland on Friday and Spain yesterday. Greece and Spain were put on negative watch, which suggests their credit rating may soon be downgraded, while Ireland was put on negative outlook.

The credit warnings underline the challenges the governments are currently facing, as they are taking action to protect their economies from the global downturn. These may drive up their financing costs and hence weaken their capabilities to support the economy any further. In response to the credit warnings, the intra- EMU government yield spreads widened significantly, especially at the longer maturities. The spread between German and Greek, Irish, Portuguese, Spanish and Belgian 10-year yields all widened to new cycle highs yesterday at respectively 235, 155, 107, 90 and 89 basis points. Ahead of today’s Dutch auction, the spread between German and Dutch 10-year yields widened too, but remains at rather low levels at around 60 basis points. This mainly reflects the healthy public finances of the Netherlands and suggests today’s auction shouldn’t be a major hurdle. The pricing of the new Belgian 10-year benchmark may therefore be more interesting, as Belgian bonds have underperformed their European peers quite significantly since the announcement of the issuance. A spread of more than 100 basis points above the German Bund would be an additional sign that the widening of the spreads isn’t over yet, despite the deteriorating outlook for German public finances. Indeed, the agreement on the second stimulus package for an amount of €50B over two years may push the deficit to above 6% of GDP this year, according the budget spokesman for Chancellor Merkel’s Christian Democrats.

Later this week, Germany (2-year sector, 7B), Italy (4-, 20- and 30-year sector, 5.5-7B) and Spain (15- and 30-year sector) are still expected to tap the market. Especially, the auctions of the latter two will require close monitoring, as they plan to tap the longer end of the curve and given their rather weak public finances.

Regarding trading, German bonds performed strongly yesterday, as the increased risk aversion drove investors again to the safe haven of government bonds. German 2-year yields fell to new all-time lows, while 10-year yields fell again below the psychological 3% level. Hence, the Bund is again approaching the contract highs at 125.56. A break higher would suggest that a new up-leg is in the making. This would bring the targets of the major double top formation with the neckline at 3.70% into the picture at 2.70%.

In the UK, the calendar contains the November trade balance. The trade deficit is expected to have shrunken in November, from -£3 867 to -£3 700 due to a decline in both imports and exports.

Overnight, the RICS house price survey and BRC retail sales monitor indicated that the UK recession is still deepening, as the number of home and retail sales collapsed. Today, the DMO will auction its 10-year Gilt 4.5% 2019. Also in the UK, investor’s appetite for government debt needs to be monitored closely given the rapid deteriorating outlook for public finances.

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Published on  Tue, Jan 13 2009, 08:36 GMT