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Sunrise Market Commentary

The $40B US 3−year T−Note auction went extremely well

Tue, Nov 10 2009, 10:27 GMT
by KBC Market Research Desk

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Next report should be on Thursday 12 November, 2009

Markets: Fixed Income

On Monday, Global bonds withstood an iron-strong equity rally and closed little changed in the US to moderately higher in EMU. We are a bit surprised by the resilience of bonds in the face of strong advances in equities, EUR/USD, commodities including gold and narrowing corporate spreads. So the overall reflationary trade didn’t hurt global bonds yesterday. The G-20 confirming that it is too early to start the exit strategy on the back of a similar message of the Fed last week has been supportive for risky assets. The strong EMU activity data were largely ignored, while a very strong 3-year US T-Note auction couldn’t push the overall market sustainably higher. At the end of dealings, US yields were virtually unchanged, while German yields dropped by 3 to 5 basis points, the belly of the curve slightly outperforming the wings.

Intra-day, the Bund opened the week little changed from last week closing level. The trade surplus was slightly smaller in September than expected, but the unexpected rebound of both imports and exports confirmed that the recovery is ongoing. Similarly, French business sentiment index improved more than expected in October and has now recouped a big chunk of the crisis-generated losses, while German production surged in September, suggesting the economy entered Q4 at a reasonable strong pace. However, the Bund largely ignored all these data, as well as stronger equities and hovered broadly sideways, well into the US session. Early in the US session, the Bund and to a lesser extent US Treasuries too made a step higher, when equities paused. There was little news behind the move and as also EUR/USD moved sideways at that time, it is difficult to attribute the outperformance of the Bund to euro strength. However, the euro might become more of a theme for the Bund market than previously.

Today, the US calendar is thin with only some less important sentiment indicators like the weekly ABC consumer confidence. In the euro zone, the eco calendar is more interesting, but probably not enough to have a lasting impact on markets as the German ZEW (November) and the production data for France and Italy (September) are scheduled for release. Last month, the German ZEW showed an unexpected decline, while the IFO and PMI’s extended their rebound. But the index has already reached a high level of 57.7 which has to be compared with peak values of 70 to 80 in previous cycles and therefore the correction shouldn’t be taken too serious. For this month, the consensus is looking for another slight decline (55.0 from 56.0). It will be interesting whether French and Italian production data will be evenly strong as the German one, published yesterday (see news). If so, one might see Q3 GDP forecasts been raised. More important for trading might be the US 10-year T-Note auction and central bank speeches, including four Fed governors, an ECB governor and a BoE governor.

The $40B US 3-year T-Note auction went extremely well. Massive demand (largest bid/cover of 3.33) with record bid sizes for all three categories (dealers, Direct and Indirect bidders). Indirect bidders took down a record 68.3% of the auction. Bidding was aggressively too with the stop at 1.404%, well below the 1.434% bid in the WI at the moment of the stop. Today, the refunding continues with a $25B 10-year Note auction. The size was upped $2B from the August refunding and it will raise all new cash. For the entire refunding package and taking the redemptions and the coupon interest payments into account, the Treasury will roughly raise $25.2B in fresh money, one of the most unsupportive amounts in recent years, but still better than the cash flows surrounding the monthly re-openings. The huge success of the 3-year Note auction yesterday is a positive for today’s 10-year, but success is not guaranteed. The curve steepened quite a lot and inflation expectations increased since the FOMC decision to keep rates low for an extended period. This might make investors somewhat reticent to bid massively. However, after all the odds are not bad for the 10-year Note auction.

Late yesterday, the Kansas Fed published its Financial stress indicator for October, which should a further, albeit very modest, improvement in financial market conditions. The index is now for the third month below its previous (Oct 1998) peak, but still higher than when the crisis started in July 2007. The Fed announced that 9 out of the 10 banks that were obliged to raise capital following the stress test (SCAP) done earlier this year have now fulfilled their obligation. The 10th, GMAC, is still working on a strengthening of its capital base. About $71B of various capital operations and sales has been executed. The Fed’s Senior Loan Officer Survey revealed further improvement in loan conditions. Banks continued to tighten standards and terms on all major categories of loans to business and households, but the percentages of banks tightening continued to decline. The improvement was more outspoken for loans to firms than for loans to households. Concluding, these reports and announcement show that the healing of financial markets continues, but obviously hasn’t been completed yet. The Central Banks are sensitive to health of the financial markets and the banking sector.

Yesterday, ECB board member Stark said the ECB is not committed to removing support in a certain order, but will start the review of the refi operations at the December meeting. He confirmed the ECB has an exit strategy in place, is able to start its exit at any time and will do so based on when the banking sector improves and when inflation risks rise. Stark said that if money market conditions improve before inflation risks emerge, the enhanced credit support can be gradually redrawn before changing policy rates. In this respect, the ECB will review the typology and modalities of its refi-operations in December Stark said. He also said the ECB would not necessarily wait until all liquidity measures are rolled back before it would start raising rates. In other comments, he showed concern about the risk of keeping these measures for too long as it would lead to distortions, misallocation of capital and make banks dependant of the ECB. He also spoke of bubbles, saying that the ECB’s two pillar system was well equipped to deal with. In case of a bubble, evidenced via galloping credit growth, is building, the ECB could lean against the wind of exuberance and raise rates even if other inflationary risks were still absent. Concluding, Stark laid down the ECB strategy, but kept his cards close to his chest ahead of the December meeting at which the issue of the non-conventional measures is on the agenda. Nevertheless, it is clear that he is sensitive to the risk of keeping the liquidity measures in place too long. We listen to eventual comments of ECB Gonzalez-Paramo, but don’t expect him to voice much divergent opinions from Trichet’s and Stark’s recent ones. In will be interesting to hear the views of Fed Yellen, Rosengren and Lockhart, all regional Fed governors following the FOMC meeting of last week. On Sunday, Fed Bullard showed he is again rather hawkish as he warned that waiting too long may cause again some bubbles. Therefore, once the recovery was well established and solid, the Fed should start removing accommodation. As a first step, he preferred the sale of the bonds purchased by the Fed. Other governors certainly have other ideas about timing of and means of tightening, Yellen, a dove, spoke of paying interest on excess reserves as mean to tighten policy and is probably more relaxed about the timing of the tightening.

Regarding trading today, Asian equities are trading with an intra-day downward pulse and also other riskier assets are hit by some mild profit taking. However, bonds cannot (yet) profit and this isn’t surprising, as they didn’t lose yesterday of surging risky assets. While yesterday’s price action was surprisingly positive, it didn’t really change the picture. Bonds are still in a broad sideways range. We don’t see many changes today. The eco calendar is not so interesting, the US Note auction is held after EMU closure and the Veteran Day holiday in a number of countries will thin trading already today. So, unless equities surprise, we see more subdued technical oriented trading.

Regarding the European bond market, re-iterating our view, 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 yet to a real test of the September lows at 119.85 (which if broken would violate the higher low higher high configuration), but a break through 120.51 would already be an omen that such a test might be in the cards. Yesterday, the Bund moved further away from the support and put a bullish engulfing pattern on the chart, a short term positive, but more gains are needed to become more enthusiast. The broken uptrend at 121.95 is the first point of reference.

Regarding the US Treasury market, the technical picture of the US T-Note future is still quite 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. Last week, the US T-Note tested but failed to break above the neckline of a potential double bottom formation at 118-28+, which is a bearish signal, but kept the Note future still a good distance off the crucial 116-18 support level (more than the Bund). We suspect supply to weigh on the longer end of the curve at least today and Thursday, even if the 3-year Note auction went extremely well, but a sustained, if unexpected, break above 118-28+ might brighten the outlook and open the way for a test of 119-29 (October 2 high) level.

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Published on  Tue, Nov 10 2009, 11:50 GMT

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