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Sunrise Market Commentary

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Bund still trying to regain the lost uptrend channel

Thu, Oct 29 2009, 08:10 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Friday, global bonds started the week with an outstanding performance, surfing on the waves of renewed risk aversion. Indeed, the rejection by the Obama administration of the carmakers restructuring plans and the bail out of the Spanish regional saving bank, Caja Castilla la Mancha, convinced equity investors to take profit on the strong rally of previous weeks.

In EMU, the eco data were dismal. Spanish building permits slumped 62% Y/Y and inflation dropped in negative territory (-0.1% Y/Y) for the first time in decades. This illustrates the enormous challenges for the Spanish economy hit by a busting real estate market. The EMU economic confidence index dropped in March to new historical low, contrasting with the slight uptick in the PMI sentiment reported last week. The US eco calendar was devoid of eco reports.

Intra-day, the price action was clear-cut. US Treasuries moved higher in the Asian session on weakening equities and the move up continued in early EMU dealings on the same factor. Afterwards the market slid in a sideways range near the intra-day highs where the EMU bonds lingered for the remainder of the day. In the US session, the price action was more volatile and the correlation with equities loosened, as the longer end was sold after the Fed bought only a small amount of very long Treasury securities in its third operation of Treasury purchases. The belly of the curve outperformed the wings in EMU, the opposite of Friday’s move. Yields fell between 3 and 7.7 basis points. In the US, the curve steepened in a bullish way with yields 8 to 1.4 basis points lower.

Intra-EMU yield spreads widened substantially on the risk aversion theme, even before S&P cut Ireland’s AAA rating to AA+ and held its negative outlook, which actually was announced after the cash market closed.

Bund still trying to regain the lost uptrend channel

Today, all eyes will be on the third quarter US GDP data, but the calendar contains also the weekly claims, European Commission confidence indicators (October), German unemployment data (October) and Belgian and Spanish CPI inflation data (October). After four consecutive quarters of negative growth, the US economy is expected to have climbed out of recession in the third quarter. The consensus is looking for an annualized growth figure of 3.2% Q/Q dominated by strength in consumer spending, net exports and a slower pace of inventory liquidation. Last week, the initial claims surprised on the upside of expectations, but the four-week average is still declining. Last week’s figures might also have been distorted by the Columbus Day Holiday. For the week ended October 24, the consensus is looking for a drop by 6 000 in initial claims (525 000). After the upward surprise in the German IFO and PMI’s, also the European Commission confidence indicators are forecasted to show an improvement in October. Economic confidence is expected to have risen from 82.8 to 84.4, with all sub-indices showing an increase.

With regard to monetary policy, yesterday’s ECB bank lending survey indicated that the ECB’s enhanced credit support mechanism is having a favourable impact on the European banks’ lending behaviour. According to the survey, the net tightening of credit standards both to non-financial corporations as well as households declined considerably in the third quarter. For the fourth quarter of 2009, banks even expect a slight net easing of credit standards for loans to enterprises. An important factor behind the improvement was related to supply-side factors, as banks indicated that their access to market financing and their liquidity position improved. This supports the ECB’s view that the sharp slowing in lending growth mainly reflects a decline in demand for loans instead of a credit crunch. Today, Bundesbank president Weber will speak in Berlin on ‘Germany in a year of election and crisis – perspectives for politics, economy and society’. Last week, ECB’s Weber signalled that it’s too early to start withdrawing monetary policy stimulus, as he saw no inflation risks and called the recovery ‘fragile’. Ahead of next week’s ECB monetary policy meeting, we don’t expect him to break new ground, although he may criticize the new German government preference to focus on growth instead of deficit reduction. Last week, ECB’s Weber still warned governments to implement their fiscal exit strategy ‘as soon as the recovery has firmed up, which means no later than 2011’. The timing of the fiscal exit strategy will also have implications for monetary policy, like Bini Smaghi suggested earlier when he said that ‘the more delayed the fiscal exit, the more the monetary policy exit might have to be brought forward’.

On the supply front, the US Treasury will issue a new 7-year Note for an amount of €41B, another record size, upped by $1B compared to the September’s auction. Yesterday’s 5-year T-Note auction was mixed as the auction stopped above the WI bid, but overall demand was very strong and Indirect takedown solid. The auction stopped at 2.38% versus 2.388% in the WI at the stop. The bid/cover of 2.63 compares to last month’s 2.40 and an average of 2.25. It was the highest cover/cover in 2 years. So, overall, the 5-year auction was not outstanding like the 2-year on Tuesday, but nevertheless solid. The record $31 B 7-year Note auction completes this week funding package. The size of the auction was increased $2 B compared to last month. Last month, the 7-year Note auction was very strong, despite following a sloppier 5-year. Will history repeat itself today? In the past days, there was very strong demand and aggressive bidding for the 5-year TIPS and the 2-year Note auctions and strong demand but sloppier bidding in the 5-year Note auction. So we bet on a strong 7-year Note auction.

In the euro zone, Italy will tap two BTPs in the 3- and 10-year sector and one 7-year CCT for a total amount between €5.5-7.5B. Yesterday, the German Bobl and Bundei auctions went very well, despite the focus of the new government on growth instead of deficit reduction. This week’s positive net cash flows should also support today’s Italian auctions.

Regarding bond trading today, Asian equities are sharply down, but the intra-day profile is flat, meaning that it simply reflects Wall Street’s dismal performance yesterday. The S&P showed a near Marabodzu, which might point to some short-term relief action, especially as the correction amounts now to slightly more than 5%, which already qualifies as a good correction. However, it shouldn’t surprise us should the S&P (now 1042) would retest the 1019 support level. The US GDP might be the key for trading. We have no opinion on the risks that surround the 3.2% consensus estimate. In case of a disappointing figure (2% or lower) the correction in equities might continue and bonds may profit on both sides of the Atlantic. Sentiment on bond markets is still shaky as yesterday’s absence of strong follow through buying showed. We would like to see more constructive action and a break of the Bund decisively above the bottom of the uptrend channel and the previous high at 121.68/74. For the T-Note future we put forward the 118-16+/27 area, as important to re-install a more positive sentiment.

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. This week’s up-move brought the Bund again close to the uptrendline (121.67 today), 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. Tuesday’s price action was constructive and might indicate a medium term bottom has been reached. However, there is no reason to become overly optimistic, especially not after yesterday’s all in all disappointing price action. 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. A renewed drop below these levels is needed to become more enthusiastic short term.

In the UK, the calendar contains the mortgage approvals (September). UK mortgage approvals are expected to extend their uptrend in September (53.6K from 52.3K). Although the mortgage approvals have almost doubled since its low reached in November 2008, they remain significantly below the long-term average. Overall, the lending data will be closely monitored, as there are concerns that too tight lending conditions may hamper the economic recovery, in which case the MPC may feel the need to raise their asset purchase facility again in November.

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Published on  Thu, Oct 29 2009, 08:21 GMT