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Sunrise Market Commentary

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Bund still playing with the uptrend channel

Mon, Nov 2 2009, 08:17 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Friday, global bonds had a good run, as riskier asset markets like equities and commodities couldn’t sustain Thursday’s powerful rebound, but on the contrary fell prey to more profit taking. Whereas earlier last week, bonds had often difficulties to fully benefit from equity weakness, on Friday they surged higher throughout the whole session, closing at the highs of the day with lofty gains, that may turn out to be significant from a technical point of view. Besides equity weakness, month end extension buying may have played a role too. US yields fell between 8.7 basis points at the 2-year sector, 11 basis points for 10 & 30 year yields and even 13 basis points for the 5-year yield. In EMU, German yields fell 9 basis points across the curve, while the 2-year slightly underperformed (-6.8 basis points). The decrease in risk appetite also resulted in a widening of the intra-EMU sovereign spreads with Greece and Italy underperforming.

Intra-day, the Bund opened little changed, but soon moved very gradually higher, despite equities trading in a sideways range. The EMU HICP and unemployment data were in line with expectations, while German retail sales were weak and much weaker-than-expected. However, they didn’t impact trading, as they are not very reliable and thus have no status as market mover. We suspect that short covering/ bottom fishing following Thursday’s sell-off might have played a positive role. During the US session, Treasuries rose following the early day releases, Personal Income & Expenditures and the Employment Cost Index, who were bang in line with expectations. This already suggested that sentiment was bullish with also here bottom fishing and month end extension buying presumably behind the movement. The Chicago PMI was unexpectedly strong and Michigan consumer sentiment also topped expectations. Bonds pulled back for some minutes, but as the downside was protected, buyers showed up, triggering a nice rally, helped fully this time around by tanking equities. The bond rally continued into the close.

Bund still playing with the uptrend channel

Today, the US calendar is well-filled with the manufacturing ISM (October) and pending home sales (September). After a slight decline in September, the manufacturing ISM is forecasted to show a marginal improvement in October. The consensus is looking for an increase from 52.6 to 53.0, but we have no clear view on the risks as the regional indicators came out mixed. In September, US pending home sales are expected to show the eighth consecutive increase, but the pace of increase might have slowed (0.4% M/M from 6.4% M/M). We believe the risks might be on the downside of expectations due to the expiration of the stimulus coming closer. Later this week, all eyes will be on the payrolls report, published on Friday. Last month, the payrolls report disappointed showing a decline in employment by 263 000, while markets had hoped for a drop by 175 000. For this month, the consensus is again looking for a decline by 175 000. We believe that a better than expected outcome is not excluded after the positive development in the claims recently. Nevertheless, the ADP report on Wednesday might give us a better indication.

In the euro zone, the final figure of the manufacturing PMI is forecasted to confirm the first outcome of 50.7. On Thursday, the September retail sales are expected to show a slight increase, the first since April. After the disappointing German figure however, we believe the risks might be on the downside of expectations.

With regard to monetary policy, the Fed, the ECB and the Bank of England will hold their monetary policy meetings this week on respectively Wednesday and Thursday. No change in interest rates is expected, but the focus will be on the exit strategy of the unconventional policy measures. Last week, the Fed ended its Treasury purchases, as the target of $300B has been reached. The purchases of MBS will however continue until the end of the first quarter of 2010. At Wednesday’s meeting, no increase in the Treasury purchases is expected, while it will be crucial whether the Fed will repeat that the Fed funds rate is likely to remain ‘at exceptionally low levels for an extended period’. In the euro zone, ECB president Trichet is likely to call current interest rates still ‘appropriate’, which would suggest that no change should be expected anytime soon. Markets will however be looking for details on the exit strategy of the ECB’s enhanced credit support framework, as the governing council will have to decide before year end whether the additional longer-term refinancing operations will continue and whether the refinancing operations will continue at a fixed rate and with full allotment. Comments of ECB’s Weber last week suggested that the ECB may start its exit strategy by stopping its 12-month tenders from next year on, but that the full allotment and fixed rate system was likely to be maintained for now. In the UK, the Bank of England is also expected to keep rates unchanged, but the MPC will have to decide whether to increase its asset purchase facility again, as it has reached the target of £175B last week. The market is split between unchanged, a £25B or £50B increase.

On the supply front, there are no auctions scheduled in the US, but the Treasury will announce the amounts of next week’s 3-, 10- and 30-year auctions on Wednesday. In the euro zone, Slovakia, Spain and France will tap the market. The net cash flow will be positive for the second week, given the redemption of an Italian BTP for an amount of €22B and several coupon payments in Italy. This should support demand at this week’s auctions, although investors’ appetite for the peripherals may have waned following last week’s downgrading of the outlook for Greece and Portugal by Moody’s.

Regarding bond trading today, Asian equities are down this morning, with the exception of China, where the manufacturing PMI rose to an 18-month high. The decline on the Asian equity markets shouldn’t surprise after Friday’s dismal performance of the US equity markets. This morning, there is much ado about the collapse of the commercial lender CIT in the US, but the impact on the equity and bond markets looks limited for now, as the US equity futures are higher, while the US Treasury futures are slightly lower. Nevertheless, Friday’s sharp correction on the US equity markets suggests that a test of the previous lows (1019 in S&P) is becoming more likely. This would also support the bond markets, although we wouldn’t expect much more gains unless equities would break decisively lower.

Regarding the European bond market, the longer-term bullish technical picture of the Bund started to deteriorate after the Bund fell off the highs at around 123.00 and broke below its long-standing uptrend channel. It didn’t however come to a real test of the September lows at 119.85 and on Friday the Bund even recouped the uptrend channel. If confirmed, this suggests that the downside on the bond markets is still rather well protected and that the market is not yet ready for a sharper correction.

Regarding the US Treasury market, the technical picture of the US T-Note future is very similar to the Bund future, as the T-Note future has also fallen off the highs (119- 29) since early October and rebounded before a test of the September lows (116-18) occurred. The rebound has now brought the US T-Note close to the neckline of a potential double bottom formation at 118-27. A break above would bring the highs again in the picture, in which case we would offload long positions.

In the UK, the calendar contains the manufacturing PMI (October). After deteriorating in the previous two months, the consensus is looking for a marginal improvement in October. A figure of 50.0 is expected, but we see the risks on the upside of expectations after the better than expected euro zone PMI’s.

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Published on  Mon, Nov 2 2009, 12:44 GMT