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Bund confirms break above downtrend channel

Mon, Jun 29 2009, 07:02 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Friday, global bonds gained further ground supported by month end duration extension buying and weaker equities. The data had little immediate impact, although French consumer confidence, US personal income and Michigan consumer confidence all came out better than expected. Overall, this weren’t the most important data, as investors are still looking for hard evidence of an economic recovery.

In a daily perspective, US yields were slightly lower (0 to 3 basis points) across the curve, while there was a bull flattening of the German yield curve. 2-year yields stayed unchanged compared to a decline by 2 basis points in 5-year yields and 3.5 basis points in 10-year yields.

Bund confirms break above downtrend channel

Today, the euro zone calendar contains the European Commission confidence indicators (June). In the US, no important data are scheduled for release. In May, economic confidence showed its second consecutive improvement, after reaching an all-time low in March. The consensus is looking for another, slight improvement (70.8 from 69.3) in the headline index due to increases in consumer and industrial confidence. We have no reasons to distance ourselves from this estimate, as the confidence indicators tend to lag the PMI surveys.

Later this week, the calendar is well-filled both in the euro zone and in the US. In the euro zone, the first estimate of June CPI, M3 data and retail sales will attract most attention. In the US, all eyes will be on the June manufacturing ISM and payrolls. On Friday, German CPI surprised on the downside of expectations as the yearly figure stayed unchanged at 0.0% Y/Y, while the consensus was looking for a negative inflation figure. Belgian CPI, on the contrary, dropped further into negative territory. Tomorrow, euro zone CPI is forecasted to fall into negative territory (-0.2% Y/Y), but the risks might be on the upside of expectations after the German inflation data. In April, M3 money supply slowed less than expected, but for May a further slowdown is forecasted (4.6% Y/Y from 4.9% Y/Y). The ECB will also keep a close eye on the lending data to see whether the unconventional measures are effective. On Friday, retail sales are expected to decline again in May after rising for the first time in seven months in April. The consensus is looking for a decline by 0.2% M/M. In the US, the manufacturing ISM is forecasted to show its sixth consecutive improvement in June. The headline index is expected to rise from 42.8 to 44.0 after some earlier released regional business confidence indicators came out mixed. We therefore believe than a marginal deterioration is not excluded. This month, the payrolls are scheduled for release on Thursday instead of Friday due to the long July 4th weekend. In the previous two months, US payrolls came out significantly better than expected, indicating that the sharp decline in employment is slowing. In May, the official employment report showed also an improvement in temporary help agencies, which also raised expectations that the worst of the US recession is behind us. For June, the consensus is looking for a decline in employment by 375 000 (after -345 000 in May). We believe that a sharper decline in employment is not excluded, but the ADP report on Wednesday might give us a better indication.

On the supply front, there are no auctions scheduled in the US this week, but in the euro zone, Germany, France and Spain will tap the market. Germany will tap its 10-year Bund for an amount of €6B, while France and Spain will issue respectively a new 10-year and 5-year benchmark. France will also tap its 7-year OAT. In the US, the announcement of the 3-year note, 10-year note reopening, 30-year bond reopening and 10-year TIPS auctions, that will ensue the long weekend, will also attract some attention.

On Thursday, the ECB will hold its monthly ECB policy meeting. Recent council members’ comments have indicated that the ECB is currently firmly on hold, as they called interest rates ‘appropriate’. At the same time, they will await the impact of the recent measures taken. In this context, the impact of last week’s first 12-month refinancing operation will be closely monitored. In a first response, money market rates have dropped to new historical lows, but the main question remains whether banks will step up lending or will park the excess liquidity at the deposit facility at the ECB. On Thursday, banks deposited €143.4B at the ECB and it will be important to see this amount declining again over the coming weeks. Otherwise, pressure will mount to bypass the banking sector. Indeed last week, ECB’s Weber already warned that the ECB may circumvent the banking sector if they do not step up lending, which suggests that the ECB may broaden its asset purchases beyond covered bonds towards other private securities, as government bonds do still look no option.

Regarding trading, government bonds have rebounded quite strongly over the past two weeks, as investors turned more cautious about the economic recovery and want too see more hard evidence of improving economic conditions. The change in sentiment occurred after US 10-year yields tested the 4% level. The more cautious mood was also reflected on the equity markets, as most European and US indices failed to break above the year highs in a sustainable manner and turned south. From a technical point of view, the Bund is currently under the positive influence of a double bottom formation with the neckline at 119.31 (targets at 121.11/16) and has also broken above its downtrend channel. In the US, the improvement of the technical picture has been more gradual, but on Friday, the T-Note future also confirmed the break above a double bottom formation at 115-25. Hence, the technical picture has improved, but much will depend on the data and the developments on the equity markets this week. Regarding the Bund, strong resistance is seen at 121.55 (neckline major double top continuation charts), where some partial profit-taking on the recent rally can be considered.

In the UK, the May lending data are scheduled for release. These have become ever more important as several MPC members have shown fears that too tight lending conditions might quell the economic recovery. Today, the Bank of England will also hold a reverse auction for an amount of £3.5B.

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Published on  Mon, Jun 29 2009, 07:17 GMT