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Sunrise Market Commentary

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Sharp rebound brings Bund again close to lost uptrend channel

Wed, Oct 28 2009, 07:58 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Tuesday, global bonds had a strong run underpinned by weak US and EMU eco data, and a strong US 2-year Note auction against a background of still weak equities and oversold conditions. The rally may have finished the correction that took place in recent weeks. US yields dropped between 9 and 11.5 basis points, the belly slightly outperforming the wings, while German yields fell between 6.7 and 9 basis points, also here the belly outperformed. 

Intra-day, the Bund opened slightly lower but soon crept very gradually higher. Equities were initially a bit lower again and the M3 money supply figures were weak. However, the market had become oversold as the Bund steadily declined in recent weeks and Monday’s price action offered hope that the downtrend was ready for a correction. The real boost to bonds happened in the US session though, but only following a small pullback on the stronger-than-expected S&P house price data. Both US consumer confidence and the Richmond Fed survey printed weaker, raising fears about the strength of the recovery. Coming on the heels of a pronounced correction, re-positioning took place and investors favoured again bonds over more risky assets pushing bonds further up into the 2-year Note auction. The latter saw incredible strong and reasonable aggressive bidding from both investors and dealers, giving Treasuries a final push going into the close. The intra-EMU spreads widened very slightly yesterday, as risk aversion increased.

Sharp rebound brings Bund again close to lost uptrend channel

Today, the calendar contains the US durable goods orders (September), new home sales (September), the first estimate of German CPI inflation (October) and Belgian third quarter GDP. In August, US durable goods orders dropped by 2.4% M/M due to a sharp decline in civilian aircraft orders. For September, the consensus is looking for an increase by 1.0% M/M, but we have no clear view on the risks due to conflicting signs from the transportation sector. US new home sales are forecasted to show the sixth consecutive increase in September. The consensus is looking for an increase by 2.6% M/M to a total number of 440 000 as homebuyers might have hurried to make a purchase before the (first-time) tax credit expires at the end of November. In Germany, the first estimate of CPI inflation is forecasted to show an increase from -0.5% Y/Y to -0.1% Y/Y in October, partially due to the waning of the energy price base effects. Also on a monthly basis, a slight increase is expected.

On the supply front, the US Treasury will issue a new 5-year Note for an amount of €41B, another record size, upped by $1B compared to the September’s auction. Yesterday, the $44B 2-year T-Note auction went very well. The auction stopped at 1.02%, well below the 1.045% bid in the WI trade at the moment of the stop. The bid/cover of 3.63, the highest in more than 2-years, compares to an average of 2.69 over the past year, despite the increased size of the auction. Both the buy-side and the dealers showed a strong appetite for the issue with a $103.9B dealer bid and a $40.5B indirect and $14.9B direct bid. The bidding of the buy-side was reasonable aggressive too. The 5-year Note auction will raise all new cash upon settlement next Monday. 5-year yields have backed up recently, which is a positive and the results for the 2-year auction yesterday are encouraging, even if these auctions don’t always correlate well, as was partially the case last month when demand was strong, but the bidding not aggressively resulting in a stop slightly above where the issue traded in the WI trading. However, we nevertheless are optimistic about the reception of today’s 5-year Note auction.

In the euro zone, Germany will tap its 5-year Bobl as well as its 10-year inflationlinked Bund for an amount of respectively €5B and 2B. Yesterday, the Netherlands sold €1.05B of three off-the-runs, which was in the middle of the pre-announced range. Demand at today’s German auctions may suffer a bit from the new governments’ higher than expected budget deficit forecasts, which will almost double the net borrowing requirement from 47.6B this to €86.1B next year. On the other hand, this week’s positive net cash flows due to the redemption and coupon payments from France should ensure a smooth sale.

With regard to monetary policy, the ECB will publish its quarterly bank lending survey. The survey should provide further insight in the debate between supply and demand factors contributing to the sharp slowing in lending growth. Yesterday, annual lending growth to the private sector fell for the first time into negative territory from 0.1% in August to -0.3% in September. This was however mainly due to a further sharp slowing in loans to non-financial corporations, while loans to households appeared to stabilize. This shouldn’t be too worrying, as loans to household lead loans to non-financial corporations by a few quarters. An unexpected sharp net tightening of lending standards would however raise new fears about a credit crunch in the euro zone, which may hamper any economic recovery.

Outside the euro zone, the Norwegian central bank is widely expected to raise rates for the first time this cycle. A rate hike by 25 basis points from 1.25% to 1.50% is anticipated, but most attention is likely to be focused on the bank’s new forecasts for the economy and interest rates. In the euro zone, several ECB governing council members have however indicated that it’s still too early to start withdrawing monetary policy stimulus, as they sounded still very cautious on the economic recovery. Over the coming months, the ECB governing council will nevertheless have to decide on their emergency measures (additional longer-term tenders, full allotment, fixed rate) in the money market, as these will normally expire at the end of 2009. Yesterday, the oneweek refinancing operation showed the amount allotted fell somewhat further compared to the previous week when the amount already fell to a 6-year low. At the same time the number of banks participating declined too, which suggests that money market conditions in the euro zone are normalizing and that the need for central bank funding is decreasing. This may persuade the ECB not to prolong their longer-term tenders, maybe after the December 12-month tender, in which case the eonia rates may start to move closer towards the 1% policy rate. Later on, it may back off its full allotment and fixed rate modalities in a further step towards normalization.

Regarding bond trading today, equities might be a positive. Asia is trading weak, but also US equities may still have to correct a bit further, albeit not necessarily today. The Bund auction might be a small hurdle in early dealings, while we look in a neutral way to German CPI and Italian business sentiment. Inflation is not yet an item, at least not from a short term data perspective. The Norges rate decision might remind markets that very gradually monetary policy is turning towards a more restrictive stance and thus a slight negative, even if the US and EMU are still a safe distance from a tightening of policy. Therefore, the impact should at most be temporary and small. While we have no strong views on the outcome of the US data, the market might look asymmetrical to the results, favouring a bearish interpretation. The technical pictures show tentative signs of improvement. So, all in all we might see bonds trade positively, but given the sharp sell-off of recent, more is needed to improve sentiment more sustainable.

Regarding the European bond market, the longer-term bullish technical picture of the Bund started to deteriorate two weeks ago when the bund fell below a previous reaction high at 121.74. This was a first warning signal that the underlying sentiment was deteriorating. Last week, the Bund also fell below its long-standing uptrend channel, which could now lead to a test of the September lows at 119.85 (KEY). However, only a fall below the September lows would put an end to the higher high, higher low pattern and suggest that a substantial downward correction is looming. Yesterday’s up-move brought the Bund again close to the uptrendline (121.62), but sustained trade above 121.74 is needed to call off the alert.

Regarding the US Treasury market, early October, Treasuries broke above key resistance levels, suggesting that another up-leg was in store. However, recent price action has been disappointing and the drop below 118-17+ (prev. high) and 117-20+ (Oct 16 low) (T-Note future) only confirmed the deterioration of the technical picture to neutral from positive. Next key support stands at 116-18 (Sep 9 low/ uptrendline). A break of this level would turn the picture bearish. Yesterday’s price action was constructive and might indicate a medium term bottom has been reached. However, there is no reason to become overly optimistic. We would again advice to consider taking profits on longs in case the rebound would bring us closer to the top. In the cash markets, the re-break above 3.30% (10-year) and 4.15% (30-year) confirmed the technical picture of the futures, while the 10-year yield tested resistance at 3.53/60% (neckline inverted Head & Shoulder/Aug 24 high). A loss of this level would be a major negative that might point to a retest of the year highs around 4%, but the test failed at least yesterday, but nervousness in the market may be prolonged into next week (FOMC/payrolls).

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Published on  Wed, Oct 28 2009, 08:14 GMT