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Sunrise Market Commentary

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Curve steepening again the name of the game

Thu, Nov 5 2009, 08:26 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Wednesday, the US yield curve steepened after the Fed reaffirmed its commitment to keep the Fed funds rate at ‘exceptionally low levels’ ‘for an extended period’. For a complete review of the Fed interest rate decision, we re-fer to our flash: FOMC, steady as they go."

Earlier on the day, global bonds were already under some downward pressure, as equities rebounded sharply. US equities however lost almost all their gains in the closing, keeping the losses at the longer end of the curve limited, while the short end closed moderately higher in the US. The data didn’t play a major role, but the services PMI were better than expected in the UK and the euro zone, while the nonmanufacturing ISM and ADP employment report disappointed slightly in the US. The refunding announcement offered no surprises and had no immediate impact on trading. The US Treasury announced that next week’s $81.0B refunding will consist of a $40B 3-year note, a $25B 10-year note and a $16.0B 30-year bond.

In a daily perspective, US 2-year yields fell by 1.6 basis points, while 10- and 30-year yields rose by respectively 5.8 and 7 basis points. In the euro zone, the German yield curve steepened too, as 2-year yields rose by 2.7 basis points, but 10- and 30-year yields were up by around 5.5 basis points. The intra-EMU sovereign spreads ignored the rating downgrade of Ireland by Fitch from AA+ to AA- (outlook raised to stable) and narrowed slightly, reflecting the improvement in risk appetite.

Curve steepening again the name of the game

Today the eco calendar contains the US weekly claims and euro zone retail sales. In the week ended October 31, initial claims are forecasted to extend their downtrend. The consensus is looking for a decline by 8 000 to 522 000. Continuing claims, which are reported with an extra week lag, are expected to drop by 47 000 (to 5 750 000) after falling significantly in the previous week. In September, euro zone retail sales are expected to show the first increase in five months. The consensus is looking for an increase by 0.2% M/M, but the risks might be on the downside of expectations after the disappointing German data.

After the Federal Reserve, the ECB and Bank of England will hold their monetary policy meetings today. As no changes in interest rates are expected, markets will focus on the fate of the unconventional measures taken to combat the financial crisis.

With respect to the ECB, several emergency liquidity measures will expire by the end of this year, if the governing council does not decide otherwise. So, the ECB governing council will have to decide before year end whether to continue their supplementary longer-term refinancing operations and their procedure of meeting all demand at fixed interest rates next year. Although ECB president Trichet is likely to delay the final decision until the December meeting, Bundesbank president and ECB governing council member Weber has already suggested that the full allotment will have to remain in place for a longer period of time than the additional longer-term refinancing operations. This suggests that the next 1-year refinancing tender scheduled for December will be the last one, but that the ECB will continue to provide banks with as much liquidity as needed in their (shorter-term) refinancing operations next year as long as they have collateral available. The scaling back in longer-term refinancing operations should enable the governing council to withdraw the excess liquidity in the money markets over a shorter period of time and provide scope to begin raising rates when the time is appropriate. Most probably it will take at least until the first massive 1-year tender, in which €442B was allotted, has expired in June 2010 before rates may be increased. This would also correspond with the end of the ‘covered bond’ purchases, planned for the end of June.

With regard to the Bank of England, the MPC will have to decide whether to halt or to extend their asset purchase facility, as the target of £175B has been reached last week. Currently, the market is split between a pause, a £25B extension and a £50B extension. We also have no strong opinion on the outcome.

On the supply front, France will tap 4-year longer-term OATs for an amount of €6.5- 8B, while Spain tap its 5-year Bono 3.3% Oct2014 for an amount between €2.5-3.5B. The positive net cash flows should support demand.

Regarding bond trading today, the steepening of the US yield curve on the FOMC decision to reaffirm its commitment to keep the Fed funds rate low for an extended period may be an example for today’s trading too, as the ECB is also expected to call current interest rates ‘appropriate’. This implies that no change in interest rates should be expected anytime soon. Yesterday’s failure of the US equity markets (S&P) to recoup the uptrend channel suggests that the downward correction on the equity markets might not be over. The decline in the Asian equity markets this morning does point to a significant lower opening of the European equity markets today. This would support the bond markets. However, as long as the S&P doesn’t fall below its previous low at 1019 in a sustained manner, which would put the longer-term uptrend on the equity markets into question, the upward support should remain limited.

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. This suggests that the upside is limited and a new test of the lows may be looming, in case the downward correction on the equity markets doesn’t go much further.

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- 729) since early October and rebounded before a test of the September lows (116- 18) occurred. On Tuesday, the US T-Note 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, the eco calendar contains the September industrial production data. After a significant decline in August, UK industrial production is forecasted to have risen by 1.2% M/M in September. An upward surprise is not excluded as a lot of factories closed in August for the summer, which is rather unusual in the UK.

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Published on  Thu, Nov 5 2009, 09:48 GMT