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Sunrise Market Commentary

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Banks deposit excess liquidity at the ECB

Tue, Jun 30 2009, 06:55 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Monday, global bonds ignored the better sentiment on the equity markets and moved again higher, albeit in very thin trading conditions. Technical buying and month end/quarter end duration extension buying offered support to the bond markets, especially at the longer end of the curve. The data and events hadn’t much impact, as the EU Commission Confidence Indicators showed a larger than expected improvement, but the BIS annual report painted a very gloomy economic outlook as long as the banks’ balance sheets aren’t repaired. The report stated that ‘even though governments have taken on large commitments, they continue to be unwilling or unable to fully address the impaired assets on bank balance sheets’. The report warned that ‘a healthy financial system is a precondition for the effectiveness of expansionary policies and for stable long-run real growth’.

In a daily perspective, the yield curve flattened both in the US as well as in the euro zone. In the US, yields were down 1.6 basis points in the 2-year sector compared to 5.9 basis points in the 10-year sector. In the euro zone, German yields were higher at the short end with 2-year yields up by 4 basis points, while 10- and 30-year yields were down by respectively 2.2 and 1.3 basis points.

Banks deposit excess liquidity at the ECB

Today, 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 money supply and credit growth data and German employment data are on the agenda. Euro zone CPI inflation is forecasted to fall into negative territory in June. The consensus is looking for a drop by 0.2% Y/Y, but the risks might be on the upside of expectations after the higher than expected Spanish and German inflation data. In the coming months, inflation is expected to decline further, but is unlikely to fall as deep as previously estimated as oil prices have rebounded. 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 in supporting the flow of credit to the real economy. In Germany, unemployment is expected to have risen by 45 000 in June, after staying almost flat in May.

In the US, the Chicago PMI (June), consumer confidence (June) and S&P Case Shiller house prices (April) are scheduled for release. In May, the Chicago PMI dropped from 40.1 to 34.9, while the consensus was looking for a slight improvement. For June, a rebound to 39 is forecasted and we have no reasons to distance ourselves from the consensus. Conference Board’s consumer confidence is expected to show a marginal improvement (55.2 from 54.9) in June after rising sharply in May. We believe the risks are on the downside of expectations after the latest deterioration in ABC consumer confidence. S&P Case Shiller house prices are forecasted to have dropped by 18.83% Y/Y in April (from -18.7% Y/Y).

On the money market, the fall in the Euro Libor rates in the wake of the ECB’s 12- month refinancing operation continued. The question however remains to what extent these lower interest rates will filter through into the real economy and whether banks will step up lending again. It will therefore be interesting to see whether the record amount of liquidity injected in the banking system with the 12-month refinancing operation will be used to step up lending or will be deposited again at the ECB. On Friday, the amount deposited at the ECB rose from €143.4B to 236.2B. If this doesn’t decline again over the coming weeks, 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. Although we don’t expect a decision on this issue until after the summer, comments on Thursday’s ECB policy meeting about a credit squeeze in the euro zone need to be closely monitored. A complete preview on the upcoming ECB policy meeting will be published today.

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 picture of the Bund has improved following the break above the neckline of a short-term double bottom at 119.31 and on Friday also above its downtrend channel. Yesterday, the targets of the short-term double bottom formation were reached. Next 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, longer-term Gilts outperformed yesterday after weak lending figures and M4 money supply growth data raised speculation that the BoE may need to extend its QE programme beyond the current amount of £125B. The long end of the curve extended its outperformance in the wake of the £3.5B 10-/25-yr Gilt reverse auction, which registered a record low offer to cover ratio of 1.22

This morning, the Nationwide house price index came out again better than expected showing an unexpected rise in UK house prices in June. Nationwide however added that until we see a more robust recovery in house purchase activity, it’s too early to be confident about a full-scale recovery of prices. Further out today, the calendar is thin as it only contains the final figure of first quarter GDP. A slight downward revision from -1.9% Q/Q to -2.1% Q/Q is forecasted.

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Published on  Tue, Jun 30 2009, 07:04 GMT