• Home ::
• Fundamental ::
• Analysis Reports ::
• Sunrise Market Commentary

• Send
• Print
• Add To
• Rss

Sunrise Market Commentary

97dc83dc-b5df-4af1-a288-dc8f118c387e

1

0

Fears about credit squeeze and details covered bond plan to dominate ECB press conference

Thu, Jul 2 2009, 07:40 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Wednesday, investors started the new quarter in a positive mood, as equi-ties and commodities gained, while government bonds struggled to make more headway. The eco data showed that global business sentiment in the manufacturing sector has continued to improve over the month of June with the worldwide manufac-turing PMI rising for the sixth consecutive month to 46.9 and the output balance breaking again above the 50 level to 50.4. The ADP employment report in the US however indicated that cautiousness is still warranted, as it showed a much larger than expected drop in employment in the private sector, although the pace in job losses is slowing. This weighed on investors’ optimism ahead of today’s official Pay-rolls report and helped bonds to recoup most of their intra-day losses, as equities closed off their intra-day highs.

In a daily perspective, the yield curve steepened both in the US and the euro zone. Short-term yields fell on the expectation that policymakers will keep interest rates low for a prolonged period of time. This expectation was reinforced by dovish comments of Fed’s Yellen who said she finds "all of this emphasis on inflation mis-placed and a misunderstanding of what the underlying situation is that we face," and that leaving the Fed funds target near zero for the several years is "not outside the realm of possibility." US 2- and 5-year yields fell by respectively 7.1 and 4.7 basis points, while 10- and 30-year yields were broadly unchanged ahead of next week’s auctions. In the euro zone, German 2-year yields fell by 1.4 basis points, while 10-year yields rose by 2.8 basis points ahead of today’s ECB meeting.

Fears about credit squeeze and details covered bond plan to dominate ECB press conference

Today’s eco calendar is again well-filled with the euro zone unemployment rate (May), US weekly claims and factory orders (May) and June payrolls report. In the euro zone, the ECB will also hold its monthly policy meeting.

In April, the euro zone unemployment rate rose to 9.2%, the highest level in almost ten years. For May, the consensus expects a further increase in unemployment to 9.4%. The sharp rise in unemployment risks to fuel protectionist measures, as gov-ernments may want to protect their own economies from the global downturn, which could in the end exacerbate the downturn. In the US, all eyes will be on the June payrolls report, this month scheduled for release on Thursday instead of Friday as markets are closed on Friday in observance of the Fourth of July. 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 raised expectations that the worst of the US recession is behind us. For June, the consensus is looking for a decline in employment by 363 000 (from -345 000 in May), but a weaker out-come is not excluded after the disappointing ADP report yesterday. In the week ended June 27, initial claims are expected to have dropped to 615 000 (from 627 000), but we believe the risks might be on the upside of expectations as more teach-ers might hit the unemployment rolls following the end of the school year. US factory orders are expected to show the second consecutive increase in May. The consen-sus is looking for an increase by 0.9% M/M, but we believe the risks are on the up-side of expectations after the unexpected increase in the durable goods orders last week.

At the July policy meeting, no new monetary policy initiatives are expected. As such, most attention will go out to the ECB’s press conference, where we look out for comments on the financing conditions in the euro zone as well as for more de-tails on the purchasing of covered bonds. Recent lending data to both households and non-financial corporations have shown that the sharp slowing in lending is con-tinuing and although it’s uncertain whether this is mainly due to supply or demand factors, it indicates that the risks for a disruptive credit squeeze shouldn’t be down-played. If tight financing conditions prevail over the coming months, this may force the ECB’s hand to bypass the banking sector (like ECB’s Weber and Gon-zalez-Paramo already suggested) and to provide direct credit to the private sec-tor, by broadening its asset purchases beyond covered bonds, in which case the focus may turn rapidly towards commercial paper and/or corporate bonds. A sus-tained high use of the ECB deposit facility may be an additional sign that banks are not ready to step up lending. Yesterday, the amount deposited at the ECB rose fur-ther, but is expected to decline today taking into account the lower amount allotted in the weekly refinancing operation. Market participants are also eagerly awaiting more details on the covered bonds purchasing plan, which will start this month. Recently, ECB’s Nowotny suggested that the purchases will be carried out mainly by the 16 na-tional central banks and that the maturities of the bonds won’t exceed five years, but no official communiqué has been published. Hence, it’s still unknown how the ECB will divide its purchases among the different member states, which may prove a yardstick for potential future purchases of other assets. For a complete pre-view of today’s ECB meeting, we refer to our ECB flash on the websit.

On the supply front, Spain will issue a new 5-year benchmark for an amount of €3.5-4.5B, while France will issue a new 10-year benchmark as well as tap its 7-year OAT for a total amount of €6-7B. In the US, the Treasury will detail next week’s auc-tions.

Regarding trading, the rebound on the bond markets halted this week, as the Bund declined in a bearish engulfing way on Tuesday, which is from a technical point of view a potential trend reversal figure. We would however be careful to draw too many conclusions out of recent sessions, as trading may have been influenced by the end of the second quarter. Nevertheless, the upside in the Bund may indeed have be-come more difficult now that the targets of the short term double bottom with neckline at 119.31 have been reached and strong resistance looms at around the 121.55 level, which is the neckline of a major double top formation on the continuation charts. Also from a fundamental point of view, we are not convinced longer-term yields should fall much lower due to the deterioration in public finances and the addi-tional capital that still may be needed to prop up the banking sector. At the short end of the curve, the expectation that the ECB will have to keep rates at very low levels for a prolonged period of time and may have to expand its ‘credit enhancement sup-port’ should keep short-term yields low.

In the UK, the eco calendar is empty, but the Bank of England will release its quarterly credit conditions survey, while several MPC members will take the stage. Recently, concerns about tight credit conditions have been moving to the forefront of policymakers, as a credit squeeze could halt the recovery despite the recent signs of improvement.

• Download Full Sunrise Market Commentary

Published on  Thu, Jul 2 2009, 08:45 GMT