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Sunrise Market Commentary

US Treasuries end session mixed, but no Obama effect

Wed, Jan 21 2009, 08:45 GMT
by KBC Market Research Desk

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Markets: Fixed Income

On Tuesday, global bonds ended the session mixed, the curve steeper. There were two main drivers, notably ongoing concerns about supply and crumbling equities. While in EMU, German yield changes were limited (-3 basis points for the 3-year and +2 basis points for the 10-year), the changes were more substantial in the US (-2 basis points for the 2-year yield, but +10 basis points for the 30-year).

From a technical point of view, the Bund (and Treasuries) put in a new high last Thursday, but couldn’t sustain, leaving a doji (trend reversal) configuration on the charts. This convinced technical inspired traders to book profits. However, the correction is still nothing more than a correction and giving the worsening equity climate, the correction may be nearing its end.

Regarding eco data; a better than expected ZEW eco sentiment survey had little impact on trading and the inauguration of Obama as president of the US, at least in the equity markets, didn’t cause a boost of optimism.

Intra-day, the Bund opened little changed, but tried shyly the downside in mid morning session. A second test of the downside was triggered early in the US session when supply concerns intensified, but was followed by a rally when equities tanked.

US Treasuries end session mixed, but no Obama effect

The calendar is again nearly empty with only the weekly retail sales and mortgage applications for release besides the January NAHB survey on homebuilders’ sentiment. The latter stabilized recently at the rock bottom value of 9 and no change is expected this month. Levels of 50 are considered as neutral levels according to the NAHB methodology.

Last week, the FDIC said that it would propose rule changes to its temporary Liquidity Guarantee Program (TLGP) to extend the maturity of the guarantee from 3 to up to 10 years. Currently, banks already issued $258B in debt under the program. Now, it becomes clear that this extension will be done under certain conditions, notably supporting new consumer lending, backed by collateral (covered bonds?) and paying a fee. These conditions may of course temper the banks enthusiasm and lead to a less frequent use as the guarantee of the shorter debt maturities.

Regarding trading, yesterday, Treasuries ended the session mixed with the long end sharply hit. The longer end seems to be the victim of supply concerns that increase alongside signs that a new, the final? phase in the banking crisis is ongoing that will oblige the government to spend much more money to safe the system. Crumbling equities helped Treasuries recoup all or part of the losses later in the session. The S&P sub-index fell 16.7% on the day and is off 35.8% since the start of the week. So the transfer of power from Bush to Obama hasn’t caused a turn in sentiment. On the contrary, the S&P is now again threatening the 2002 and the current cycle lows (768/742). A sustained break of these would be highly relevant and point to a market discounting a depression instead of a deep recession. Of course, a retest of these levels has always been in the cards and therefore it is now testing times. If the bottom holds, the worst may be over for stocks, but if not, all odds are open. The situation of the Dow (below 8000) and the NASDAQ is broadly similar.

The Obama administration is now immediately challenged by a crisis and will formulate a response. Also in previous sell-offs, the government came with a plan to address the lack of confidence. Talk is now of an aggregator bank that would take charge of all toxic assets on the financial sector balance sheet in an extension of partial similar solutions put in place in the case of Citi and BoA (also sharply down again yesterday). While supply may remain an issue for the longer end, we think that the room for correction is limited by the Fed’s quantitative policy and our expectation that in case of a further sell off at some point the Fed will start buying longer-term Treasuries. The calendar is unattractive with regard to eco releases, but the testimony of Geithner is worth listening to. However, it will be the general themes of the banking sector and government measures that will dominate trading, aside of the earnings results of Blackrock, eBay, United Technology and Apple.

Is Bund correction over?

Today, the EMU calendar remains wafer-thin with German PPI for December and Italian trade balance for November. None of these is a market mover. More interesting might be the speech of ECB president Trichet who speaks before parliament and ECB board member Bini Smaghi speaks in Strassbourg.

We will closely listen to the remarks of Bini Smaghi, an influential Frankfurt-based ECB board governor, who in the past more than once offered some interesting longer-term views from within the ECB. President Trichet’s press conference last Thursday offered some intriguing, but not very clear comments. He warned that the ECB didn’t want to fall into the liquidity trap, suggesting that they wouldn’t follow the Fed and BOJ towards zero rates, but otherwise also hinted that the ECB was using its balance sheet to help ease strains in the funding markets. This sounds like a kind of unofficial quantitative policy. How does this relate to their re-financing rate and the eonia? The latter traded in recent months unusually far below the re-fi rate. So, markets will be eager to get more insights in these comments of Trichet. Will Bini Smaghi tell us something more?

The book building of the Greek new 5-year syndicated bond seem to go smoothly with a rumoured €6B of orders with a spread of 260-280 versus Bunds. Today, we expect the pricing of the issue.

Regarding trading, German bonds were in correction mode at the end of last week and continued moderately at least at the longer end of the curve also yesterday. However, the general theme of risk aversion came back with revenge during the session, as equities tanked and especially the financials are hard hit. Both US and European equity indices are now close to the cycle lows and it wouldn’t surprise if no serious test would occur today or in the next sessions. A sustained drop below would be of major importance and would create more talk about the economy sliding in a long and protracted recession or let’s give it another name: depression. Needless to say that this is a fertile soil for government bonds. Of course, the 2-year yield at 1.45% might still fall a bit further, but given that the market expectation for the bottom of the rate cycle at 1.1% is close to our 1% target, there isn’t much room to fall anymore unless ECB rate expectations drop below 1%. This might ultimately happen, but with the ECB absolutely convinced it should try to avoid a liquidity trap, market rate expectations might have difficulties to drop below 1%. The space to move up and down from current yields at longer maturities is of course larger. While we have a bullish bias for the longer end, we recently played the upward correction for 10- year yields around 3-2.9%. The most recent correction, if it would end here was however small and smaller than the previous two ones. This raises the odds for a break lower, eventually to 2.6%, the target of a double top formation where profit taking is likely. So while we still prefer opening long positions on upward corrections, we wouldn’t consider anymore to book profits when reaching 2.90- 3%, but speculate on a break lower. In Bund future terms, that would need a break above the contract high at 126.53.

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Published on  Wed, Jan 21 2009, 08:52 GMT

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