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Sunrise Market Commentary

Bund still close to the highs

Wed, Sep 30 2009, 07:25 GMT
by KBC Market Research Desk

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Markets: Fixed Income

On Tuesday, global bonds ended mixed with the curve again flatter. The movements had however little significance from a longer term perspective. The market reacted to various impetuses including the US eco data, EMU/US supply and maybe some month-end extension buying. Hawkish comments of Fed Fisher may be responsible for the ongoing, albeit modest, flattening. At the end of trading, US yields were up 2.4 basis points at the 2-year maturity, flat to 1 basis point higher in the belly and down 1.5 basis points in the 30-year sector. In EMU, German yields were up 2.6 basis points, but down between 1 and 4 basis points further out.

Intra-day, the Bund opened the session unchanged, but immediately lost some modest ground. The market awaited fresh Italian supply, a negative, while ECB Liikanen’s remarks were ignored as in line with the current views of Trichet and the board. The losses were very modest though and when the Italian auction was concluded successfully, the Bund erased the losses and hovered sideways at opening levels until the US trading started. US Treasuries and Bunds came under renewed pressure by the combination of stronger-than-expected S&P house prices and fresh $5B FDIC guaranteed supply from Citi in the 2-3 year sector. However, the market found soon a bottom and following some sideways trading at these lows, a weakerthan- expected consumer confidence report send prices back higher, helped by equities for which the report didn’t go unnoticed either. Some support may have come too from the Fed purchases of Treasuries (mostly in the 09/12 issue) and from month end extension buying. While the latter factor may have been the driver for the flattening, also hawkish comments of Fed Fisher qualify as a potential driver. Fisher said that when time is ripe, the Fed will tighten with equal speed and intensity as it had done in its easing process. In EMU, today’s Schatz auction may have been behind the underperformance of the short end.

Bund still close to the highs

Today, the market calendar becomes really interesting, as the US ADP employment/ the Chicago PMI reports and the EMU September HICP inflation data/German unemployment figures are published. Other eye-catchers are the ECB 1-year liquidity tender, the German 2-year Schatz auction and a number of Central Bankers speeches.

Regarding the data, the US ADP employment report is a reasonable good pointer for the outcome of the all-important payrolls report that will be published on Friday. The market is looking for a decline of private employment by 200 000, which compares to a decline by 298 000 in the previous month. Any substantial deviation might be good for a market reaction, even if markets won’t forget that the ADP report is not always a good pointer for the payrolls. The Chicago PMI is traditionally used as a tool to forecast the ISM which is published tomorrow. However that relationship broke largely down in recent years. Following somewhat mixed, disappointing, NY and Richmond Fed surveys on manufacturing (especially the underlying figures), another disappointment would suggest that the ISM report for September could show a stabilization instead of further progress. The EMU HICP inflation flash estimate is expected at -0.2% Y/Y in September, unchanged from August. Following the German, Spanish and Belgian inflation reports, the odds are for a decline of 0.3% Y/Y or even 0.4% Y/Y. The German unemployment figures were surprisingly good in previous months. In July and August the number of unemployed actually declined slightly. Big part of the explanation is the use of subsidized Kurzarbeit to prevent unemployment. We suspect gradually higher unemployment, but maybe not yet in September.

ECB Liikanen didn’t deviate from the well-known ECB script in a speech he gave yesterday. There is no need to rush to exit from monetary stimulus he said pointing further out that the expected weak growth will keep the already sizeable output gap growing for some time and thus maintaining inflation under control. ECB Constancio, the leading dove inside the ECB showed himself indeed dovish in his comments. While he repeated that the ECB is not pre-committed in its rate policy, he especially stressed his concern about a too rapid redrawal of monetary and fiscal stimuli. It is premature to speak about the end of the crisis. Today, a number of ECB members including Trichet, Weber and Papademos will speak on regulation at a financial forum in Sweden. In the US, Fed governors Kohn and Lockhart will speak respectively about exit policies and the economy. Overnight, Philly Fed governor Plosser showed himself moderately optimistic about the economic outlook. However, his comments on inflation were of more importance. While he expects inflation to remain subdued in the near term, he is more concerned about higher inflation in the intermediate to long term, essentially for two reasons. Firstly, because he believes monetary policy is extremely accommodative. Secondly, because he doesn’t belief that the measure of economic slack is a reliable predictor of inflation. In this respect, he points to the experience of the great inflation of the seventies (when stagflation occurred), when inflation expectations became unanchored. Therefore, he concludes that “just as the Fed has taken aggressive steps in flooding the financial markets with liquidity during this crisis to prevent the possibility of a Second Great Depression, it will have to take the necessary steps to prevent a Second Great Inflation.” This will need courage, he added, because the Fed will need to act well before unemployment rates and other measures of resource utilization have returned to acceptable levels. Yesterday, also Fisher sounded hawkish. Both Fisher and Plosser, regional Fed governors, are members of the hawkish wing inside the Fed. They voted several times against easing (or for less aggressive easing during the previous easing cycle. It seems that they started campaigning for a tighter policy somewhere down the road.

On the supply front, Germany will tap its 2-year Schatz for an amount of €5B. Yesterday, Italy’s supply was well digested. We expect the Schatz auction to go well too given the outlook for ECB rates to remain very low and the abundant liquidity policy. Today, the ECB will hold its second 1-year liquidity tender at a fixed rate of 1%. In the first tender, a record amount of €442B was allotted, but now an amount of around 200B would already be a huge success. Such an amount would bring the total amount of liquidity injected in the euro zone financial system again towards the highs of December and June. The ECB has already planned another 1-year tender in December, but it’s very uncertain whether the terms will be again as favourable.

Today’s bond markets: Asian markets trade mixed, as Wall Street’s close couldn’t give much direction. The French plan to cut taxes, especially for firms, may help European markets at the start of trading. Month end extension buying may still play some minor positive role, while the 1-year ECB liquidity tender and the Schatz auction are no negatives either. Recently, the market gets again sensible to eco US data with disappointments having a bigger impact than positive surprises. This might be important when the ADP and possibly also the Chicago PMI are published. The EMU data might be bond-friendly but probably won’t have too much lasting impact. Technicals show that the Bund is again near key resistance levels and also the US Note future approaches such levels, but the markets are overbought. The balance between positive and negative factors might be marginally in favour of the bond friendly ones. Nevertheless, given the technical position and the upcoming ISM and especially the payrolls report, we think that bonds may trade sideways to slightly lower today.

Regarding US Treasury trading (unchanged), since the start of September, Treasuries are in a sideways range, digesting the gains eked out since the turnaround on June 10. At the onset of trading this week, Treasuries are again at the top of this sideways range (118-16+ T-Note Future) and thus markets are pondering whether another up-leg is in the offering. We don’t think such an up-leg is likely, because of our above consensus economic growth outlook. Of course, the accommodative Fed stance is still supportive, but it should be clear that the Fed is slowly coming closer to implementing its exit strategy. The remarks of Fed Fisher, Plosser and before Warsh are a reminder of this. If a break would occur, we would look to build back existing long positions. In the cash market, the key technical support levels (that would paint double tops if broken) 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, which happened for the 30-year, would really unclog the market.

Regarding European bond trading, last week, the Bund extensively tested the downside (120.17) with a new ST intra-day low at 119.85, but no sustained break occurred. The reversal on the equity markets accompanied by a decline in risk appetite helped the Bund to move again to the topside of the sideways range at 121.74, which was tested on Monday morning, when a new ST intra-day high at 121.91 was reached. For now, we don’t anticipate a sustained break higher and do expect recent sideways trading to continue. In case we are wrong and a break rekindles the rally, we would consider taking profit on existing long positions.

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Published on  Wed, Sep 30 2009, 09:41 GMT

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