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Sunrise Market Commentary

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Technical bearish signal on bond markets

Wed, Nov 4 2009, 08:35 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Tuesday, global bonds ended a volatile session moderately lower, as equi-ties rebounded throughout the session and the S&P managed to close slightly higher in the US. The calendar was devoid of market moving data, but investors re-acted nervously on the restructuring plans of the UK financial sector and disappoint-ing earnings from UBS as well as to the uncertainty related to the central bank meet-ings in the US, euro zone and UK. Yesterday’s session also saw gold reaching a new record high amid warnings for new asset price bubbles by the IMF and the World Bank.

The sharp outperformance of the short end of the yield curve in the US, Germany and the UK does suggest that no big changes are expected and that central banks will reaffirm their intention to keep interest rates low for a prolonged period of time. Overall, 2-year yields were unchanged in the US, while 5-year yields were up by 2.3 basis points, 10-year yields by 5.1 basis points and 30-year yields even 6.9 basis points. In Germany, 2-year yields declined 1.4 basis points, while 30-year yields rose by 3.1 basis points. And in the UK, 2-year yields fell by 1.6 basis points, but 30-year yields rose by 6.6 basis points. The intra-EMU sovereign spreads stabilized yester-day, although the EU Commission Autumn forecasts showed a further significant de-terioration of the outlook for public finances despite the upward revision of the growth outlook.

Technical bearish signal on bond markets

Today, the eco calendar is attractive in the US with the ADP employment report (Oc-tober) and non-manufacturing ISM (October). In the euro zone, the final figure of Oc-tober services PMI is scheduled for release. In the evening, the Fed will also an-nounce its interest rate decision.

Last month, both the ADP and payrolls report disappointed. According to the official payrolls report, employment dropped by 263 000, while the consensus was looking decline by 175 000. For October, the consensus is again looking for a decline by 175 000 in the official report, while the ADP report is forecasted to show a fall in em-ployment by 200 000. After the positive development in both the initial and continuing claims, we believe a positive surprise is not excluded. Also the manufacturing ISM supports our view as the employment sub-index climbed above the benchmark level of 50. In September, the US non-manufacturing ISM climbed into expansionary ter-ritory for the first time in a year. For this month, the consensus is looking for a further improvement to 51.5, but the risks might be on the upside of expectations after the significant increase in the manufacturing ISM. In the euro zone, the final figure of Oc-tober services PMI is forecasted to confirm the first estimate of 52.3.

With regard to the Fed meeting, we don’t think that the language about the stance of policy will change materially at this meeting, but if it will, markets would react sharply.Time is simply not ripe to announce a near time change in policy orientation. Unem-ployment is still rising and the economy only grows one quarter, while downside risks still abounded. If the economy were to grow for let say three quarters and unemploy-ment starts to stabilize, the policy requirements would surely change. This is some distance away. In the meantime, the FOMC should continue thinking about how to create more flexibility to act when it wants to. So, we stick to our view that the Fed won’t do anything to rock the markets and thus expect only marginal changes to the statement. On balance, a fundamental change in the statement might seem to make more sense at the beginning of 2010 when the January meeting is followed by the semi-annual testimony of Mr. Bernanke before congress.

Today, the US Treasury will also announce the details of the Q4 refunding operation. On Monday, the quarterly borrowing requirements have already been revised for Q4 to $276 B with a December cash balance of $85B versus initial estimates of $486B and $270B respectively. For Q1 2010, the Treasury projects $478B borrowing with a March cash balance of $45B. Technical issues (Treasury decision to redeem CMB’s) were behind the revision. Supply is clearly in the focus, even if the market has until now well digested the ever bigger auctions. The size of the 3, 10 and 30-year T-Note/bond refunding auctions will probably again be increased to respectively $40B, $24B and $16B. There are $38B maturing issues and interest payments of approx. $21B, which means that the Treasury will have to attract $21B of fresh cash. Contrary to recent refunding announcements, for nominal Treasuries, there are no further changes in the auction schedule expected, but the 20-year TIPS will probably be re-placed by 30-year TIPS starting next year. The Treasury desires to lengthen the av-erage maturity (now 53 months) in the next years, by shrinking the amount of bills is-suance. So in 2010 we might see at first an expansion of issuance at the longer end coupled with stable issuances at the shorter end. All things equal this should give the curve a steepening tendency. Of course, should the Fed start its tightening cycle, this will lead to a flatter curve despite more issuance at the longer end of the curve.

Regarding bond trading today, the positive performance of the US equity markets yesterday evening and the gains on the Asian equity markets this morning suggests that the downward correction is running out of steam. As long as we remain above the 1019 level (previous low) in the S&P, our basis scenario of a correction in a longer-term uptrend remains valid, even though several European equity indices have fallen below similar support levels and show a double top formation. Today’s trading may however be rather dull ahead of this evening’s Fed statement, where we don’t expect major changes.

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 the Bund tried to recoup its lost uptrend channel, which failed for now. Yesterday’s session provided a new bearish signal, which sug-gests that the upside is blocked for now and a new test of the lows may be looming.

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. Yesterday, the US T-Note however tested but failed to break above the neckline of a potential double top formation at 118-27, which is a bearish signal.

In the UK, services PMI is forecasted to show a marginal improvement in October. The headline index is expected to rise from 55.3 to 55.5, but we believe that the risks might be on the upside of expectations after the better than expected manufacturing PMI.

On the supply front, the DMO will tap its 25-year Gilt 4.5% 2034 for an amount of £2B. The recent underperformance of the longer end of the curve suggests that in-vestors’ appetite for longer-term bonds suffers from the uncertainty related to the Bank of England’s decision on the asset purchase facility.

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Published on  Wed, Nov 4 2009, 13:47 GMT