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Sunrise Market Commentary

US T−Note future again above neckline double bottom

Fri, Sep 11 2009, 07:24 GMT
by KBC Market Research Desk

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Markets: Fixed Income

On Thursday, US and EMU bonds made a stellar performance, despite economic news that pointed to a further strengthening of the global recovery, a dollar under severe ongoing pressure and at least in the US higher equities. The icing on the cake was a very strong US 30-year bond re-opening that draw very good demand and aggressive bidding. It finished a three-stage issuance operation. In a daily perspective, US yields dropped between 4 and 13 basis points flattening the curve, while German bond yields fell about 5-to-6 basis points with the 2-year bond underperforming and its yield down 4 basis points.

The global bond market was well oriented from around noon European session, initially supported by weakening equities. The US data were intrinsically bond negative. Initial and continuing claims fell lower. Following some disturbing stabilization in initial claims recently, the decline was welcomed for those like us that bet on a strong recovery in the US. The unexpected widening of the trade deficit may be negative for Q3 GDP, but is in fact a very positive. Exports were sharply up, reassuring that global demand is strengthening, while surging imports show that the US economy is reviving. However, following some minor hesitation, bonds continued their ascent. The results of the US 30-year bond auction were splendid, pushing bonds still higher and towards juicy gains for the day. EMU bonds mirrored Treasuries unlike on Wednesday and succeeded in recapturing large part of the losses it endured in the previous session.

US T-Note future again above neckline double bottom

Today, the calendar contains the Italian industrial production data (July), US Michigan consumer confidence (September) and wholesale inventories (July). After declining in June, Italian industrial production is expected to increase (0.4% M/M) in July. We believe that the risks might be on the downside of expectations after the weaker than expected German and French IP data. We shouldn’t forget that the Italian economy continues to lag its EMU peers. In September, University of Michigan consumer confidence is expected to show some improvement after two consecutive declines. The headline index is forecasted to rise from 65.7 to 67.5 as the growing number of positive economic news and smaller number of job losses might have improved consumer confidence, as may have higher equities. In July, US wholesale inventories are forecasted to show the eleventh consecutive decline.

There are also again a lot of central bankers scheduled to speak today, including ECB’s governing council members Gonzalez-Paramo, Bini Smaghi and Ordonez. Yesterday, Bundesbank president Weber, known as one of the most hawkish members within the ECB governing council, said that he doesn’t expect the economic recovery in Germany to become self-supporting in the foreseeable future. Therefore, investments have to pick up, but as capacity is currently massively underutilised this may take a long time.

Yesterday, the ECB monthly bulletin downplayed the link between economic activity and inflation, as inflation may prove more resilient despite the sharp fall in output. It is possible that the current downturn has involved a decline in the supply potential, which would imply a smaller output gap and weaker disinflationary forces’. Moreover, the monthly bulletin concludes that ‘while economic slack may contribute to movements of inflate on in the short run, well-anchored inflation expectations are also a crucial determinant of the inflation process’. Given the heightened uncertainty about the inflation dynamics based on the economic analysis, we expect the ECB governing council to place more weight on the monetary assessment when they will have to decide on the timing of the exit. Recently, several governing council members have pointed to the importance of the money and credit developments at the time they decided to start tightening policy in December 2005.

Yesterday, Fed vice-president Kohn repeated that ‘with the global economy quite weak and inflation low, a large and rapid rise (in rates) seems quite improbable’. ‘As the FOMC has said, that time is not likely to come for an extended period’. He however singled out the payment of interest on reserves as a very valuable tool when the time comes to tighten the stance of monetary policy. ‘Raising the interest paid on those balances should provide substantial leverage over other shortterm market interest rates because banks generally should not be willing to lend reserves in the federal funds market at rates below what they could earn simply by holding reserve balances’. As such, it appears still very unlikely that the Fed will sell it purchased assets again in the market to drain excess liquidity, but instead will prefer to drain liquidity via other tools.

Regarding US Treasury trading, we are surprised by the strong run of Treasuries yesterday. Indeed, in the face of signs of stronger eco data, rallying equities and a weakening dollar, the rally looks a bit suspicious. Of course, the auctions went very well (also a bit surprisingly) and the Fed continues to signal its intention to keep policy easy for a prolonged period of time. However, the latter should eventually be considered as negative for the longer end. In these circumstances, we remain suspicious about the upside for the longer end of the curve. Cross checking with the technical picture, the Note future tries again to move above the 117-19, neckline of a big double bottom formation with targets more than five points higher. However, a first venture above that level wasn’t sustained. In the cash market, corresponding levels (that would paint double tops) aren’t reached either. These stand at 0.85% for the 2-year, 1.35% for the 3-year, 2.16% for the 5-year, 3.25% for the 10-year and 4.15% for the 30-year. Only a break below these levels would really unclog the market and open perspectives for more gains. While the market is currently not on our side, we keep a negative view on the longer end of the Treasury market.

Regarding European bond trading, following Thursday’s sharp correction in the Bund and the fall below the neckline of a potential double bottom formation, we become more negative on the near-term outlook for the Bund. Yesterday’s strong rebound puts this into question, as the Bund is again above the neckline at 120.84. We are however not convinced yet that much more upside is available, as the first break failed to generate much momentum. Therefore, only a sustained break above the previous reaction highs at 121.70 would suggest that a new up-leg is in the offering.

In the UK, the PPI data (August) are on the agenda. In August, both input and output prices are forecasted to have risen on a monthly basis due to increases in oil- and commodity prices. The yearly figures are forecasted to remain firmly in negative territory.

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Published on  Fri, Sep 11 2009, 07:33 GMT

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