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Sunrise Market Commentary

US Treasuries stabilize in volatile trading

Fri, Jan 16 2009, 08:33 GMT
by KBC Market Research Desk

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Markets: Fixed Income

On Thursday, global bonds had a rollercoaster ride that left US Treasuries little changed and EMU with some modest gains in the close. Markets were influ-enced by equities and risk appetite/aversion on the one hand and the ECB rate decision on the other hand, while the US eco releases played a secondary role.

The US eco news was mixed but with slight positive bias (versus expectations). Initial claims were higher-than-expected, but continuing claims lower. The PPI was near expectations, but the NY Fed and Philly Fed manufacturing headline indices were better. The Philly survey showed also some improvement in its details. That put the Treasuries under pressure at the start of the US session. In EMU, the ECB cut rates by 50 basis points, which was largely discounted, but the subsequent press confer-ence showed president Trichet less hawkish than one might have feared. He sug-gested further rate cuts were likely as he said that rates could fall below 2% (histori-cal low) and pointed to March as the next important rendezvous. The short end (euri-bor futures and 2-year) reacted negatively on the suggestion that no change in policy should be expected for February. However, we would consider this as an insignificant buy the rumour, sell the fact reaction. Equities remained at first under pressure due to concerns about the financials (Citi, BoA) and expectations for more losses and sub-sequent capital injections. However, later on equities rebounded putting bonds again under pressure.

Overnight, a return of risk appetite is dominating markets, supporting equities, commodities, the euro, while bonds, the dollar and yen are under some pressure. The rescue operation of BoA is the driver.

US Treasuries stabilize in volatile trading

The calendar is again well filled today with the December CPI, Industrial production figures, January Michigan consumer confidence and Net Long-term TIC flows (No-vember). 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. CPI is forecasted to have dropped 0.2% Y/Y in December, but a softer drop is not excluded after import prices and PPI, released earlier this week, surprised on the upside. Industrial production is forecasted to have dropped 1.0% M/M in December after falling 0.6% M/M in November. We see the risks on the downside of expectations after the very weak November factory orders and durables and auto plant shutdowns. In December, University of Michigan consumer confi-dence showed an unexpected rebound, but a slight decline is expected in January. The headline figure is forecasted to come out at 59.0 (from 60.1) as massive job cuts higher oil prices might have had a negative impact on consumer confidence.

Yesterday, there were more signs that the improvement on ST funding markets had stalled. The Fed reported that outstanding CP shrank in the most recent week by $45.8 B following an encouraging increase by a hefty $83.1 B in the previous week. Libor rates were marginally higher and Swap spread widened. Corporate spreads narrowed, but high yield widened.

Regarding trading, yesterday, Treasuries closed little changed. Treasuries tried to move higher amongst ongoing risk aversion, but failed to sustain, which was a disap-pointment and lost the intra-day gains were equities rebounded later in the session. Overnight, the governor rescued Bank of America via a $20B capital injection and a backstop on losses on a pool of $118B toxic assets. We see a lessening of risk aver-sion overnight on the back of the government support for BoA. Today, BoA and Citi will report on Q4 and year result, ahead of the schedule. While these may renew pressure on financials, we have the impression that after the latest government measures, investors might be more resilient against bad news. In a short term per-spective, the recovery late in the session yesterday, following a test of the downside, was encouraging. It is still early days, but it might have set the stage for at least some short term, albeit probably weak rally. This would of course be bad news for Treasur-ies, where on the chart a doji-like candlestick (potential ST trend reversal) appeared. The configuration should be confirmed, but it makes us cautious and together with the long weekend points to profit taking. The longer-term outlook remains positive, but longs may consider taking some chips off the table. Pronounced corrections are still buying opportunities. The eco data are interesting, but as we have no distinct dif-ferent views from consensus, they may be Treasury-neutral, unless steep deviations from consensus would occur, which we doubt.

ECB cuts rates and Trichet hints at further easing

Today, the eco calendar contains only the euro zone trade balance and the French business sentiment for December. In October, the trade balance showed a signifi-cant narrowing in the trade deficit (from -4.4B to -1.3B), but the deficit is expected have widened again in November. The consensus expects an outcome of -4.8B. As traditional for periods of recession, both imports and exports are forecasted to have declined. French business sentiment dropped sharply in recent months and also for December, a decline, albeit smaller than in previous months, is expected. Given the earlier publication of similar sentiment surveys, the report shouldn’t affect the mar-kets.

The ECB cut its main refi-rate by 50 basis points to 2%, matching its historical low. It was the fourth consecutive monthly decline in rates that cumulatively amounts to 225 basis points. In his press conference, Trichet sounded less hawkish than might have been feared and even hinted at further easing, probably at the March meeting. We see three main reasons that may explain his less hawkish than expected stance. Firstly, the dramatic scale of deterioration of activity in the euro area. Secondly, con-cern that any signal that rates were unlikely to fall further could cause problems for fi-nancial markets that are very nervous and fragile. Thirdly, the recent evidence that the downturn in activity was being felt more acutely in Germany of late, as this proba-bly weakened the resistance of the traditional hawkish wing that includes Stark and Weber. The ECB still sees economic risks on the downside, even after the cut. Trichet hinted that 2% was not the limit even as he also said that the ECB was de-termined not to get caught in a liquidity trap, suggesting that they would follow the US and Japan towards virtual zero rates. While we thought before the decision that the ECB might have preferred to cut rates in February instead of January for purely tacti-cal reasons, we still think that the ECB will be forced to cut rates a good deal further in the next months, bringing the refinancing rate to 1% in June.

On the supply front, Spain tapped its 15- and 30-year benchmarks. The auction didn’t go exceptionally well, but was no disaster either. The Treasury sold €2.6B of its 4.8% Jan 2024 at an average yield of 4.471%. The tail was 2.9 basis points and the bid/cover 1.24. The issuance of the 4.9% July 2040 was better bid with an average yield at 4.847% and a tail of 1.1 basis points and a bid/cover of 1.7. The bid/cover amounted to 1.24. Following the auction, selling pressures mounted and Spanish bonds underperformed all other EMU government bonds. Greece and Portuguese bonds traded very weak too, while Italy’s and Belgium’s underperformance was more modest.

Regarding trading, German bonds ended the session mixed, the short end under-performing the longer end of the curve. The short end was hit by a buy the rumour, sell the fact reaction during the ECB press conference, when Trichet said that the next rendezvous was in March, suggesting strongly that they wouldn’t change rates in February. The market had discounted the ECB move fully or even more, leaving little scope for a positive reaction. The longer end did gain more ground, but more on risk aversion factors, as financials remained under severe pressure. The Stoxx 600 finan-cial sub-index tested its cycle lows (and even closed slightly lower). However over-night, BoA was rescued via a $138B package, including $20B capital and $118B guarantees. Anglo Irish was nationalized and the UK Treasury is working on a new banking plan that might be finalized in the week-end. The US equities tested impor-tant levels but couldn’t sustain, leaving some potential trend reversal signs on the charts. Today’s earning results of Citi and BoA is of course still a hurdle, as is next week’s flurry of company results, but the possibility on an eventual temporary reced-ing of risk aversion is growing. Therefore, we should take a more cautious atti-tude. The chart of the Bund shows a doji (potential trend reversal) that if con-firmed today might be the precursor of a more pronounced profit taking move. The Bund set a new high yesterday at 126.53, but closed near opening levels at 126.17. From a longer term perspective the picture remains bullish with 122.54 first key support level (buy-on-dips).

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Published on  Fri, Jan 16 2009, 08:39 GMT

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