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Sunrise Market Commentary

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Autumn forecasts to highlight worsening public finances

Tue, Nov 3 2009, 07:59 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Monday, investors reacted only moderately positive to the stronger than expected improvement in the cyclical manufacturing sector. Manufacturing data in the US, UK and China all exceeded expectations and raised hopes on a strong global recovery. Equities and commodities rebounded slightly, but recouped only part of Friday’s sharp losses, while bonds traded broadly sideways in the euro zone to slightly lower in the US. UK Gilts underperformed sharply, as the strong rise in the manufacturing CIPS raised doubts whether the Bank of England would decide to extent asset purchases above the £175 B.

In a daily perspective, US yields increased by 2 to 3.5 basis points across the yield curve, while German yields were almost unchanged, except at the longer end of the curve, where 30-year yields moved 2.2 basis points higher. In the UK, yields rose by 4.5 basis points and even by 6.1 basis points at the 5-year segment. The intra-EMU sovereign spreads stabilized, except for Greece that benefited from some bargain hunting after Public Debt Management Agency announced it is to sell a new 15-year benchmark in the near future, which was widely expected after the new government had raised the budget deficit forecast to 12.5% of GDP.

Autumn forecasts to highlight worsening public finances

Today the calendar is thin as it only contains the factory orders (September) in the US. After an unexpected decline in August, US factory orders, which include the durable orders that have been published in a separate report last week, are forecasted to have risen by 0.8% M/M in September. We have no reasons to distance ourselves from the consensus.

On the supply front, Austria will tap its 30-year benchmark 4.15% Mar2037 for an amount of €0.55B, while Spain will tap its 3-year floating rate Oct2012 for an amount between €1-2B. The positive net cash flow should support demand.

Much attention will also go out to the EU Commission Autumn Forecasts. These will highlight the adverse impact of the economic crisis on public finances. Although the growth forecasts are widely expected to be revised upwards from the spring forecast of -0.1% Y/Y in 2010, the budget deficit and debt to GDP ratios are also likely to have worsened since May of this year. In May, the euro zone budget deficit was already expected to rise from 5.3% in 2009 to 6.5% in 2010 of GDP, while the debt-to- GDP ratio was seen rising from 77.7% to 83.8%, way above the targets of 3% and 60% of GDP. The outlook for public finances will also have its implications for monetary policy. Recently, ECB governing council member Bini Smaghi already indicated that ‘the more delayed the fiscal exit, the more the monetary policy exit might have to be brought forward’.

Regarding bond trading today, trading may be quite dull after yesterday’s better than expected manufacturing surveys may have put a bottom under the correction on the equity and commodity markets. Investors may also remain cautious to set up new trades ahead of this week’s monetary policy meetings from the Fed (Wednesday), the ECB and the Bank of England (Thursday) and ahead of the key US payrolls report on Friday. This may result in more sideways trading today.

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 (today at 121.83). 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 is devoid of market moving data, but on the supply front, the DMO will issue a new 5-year benchmark 2.75% Jan 2015 for an amount of €4.75B. Demand may suffer from the uncertainty about the asset purchases by the Bank of England over which the MPC will have to decide at Thursday’s policy meeting. Yesterday, the 5-year segment underperformed.

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Published on  Tue, Nov 3 2009, 08:07 GMT