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Sunrise Market Commentary

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It is unclear whether such a decision should be expected

Wed, Nov 25 2009, 08:21 GMT
by KBC Market Research Desk

KBC Bank

Markets: Fixed Income

On Tuesday, global bonds again traded constructively during the day, while an exceptionally strong US 5-year T-Note auction triggered a rally late in the US session. US Equities were more sideways oriented, while eco data couldn’t really make the difference. Technical pictures improved for both the US T-Note future and the Bund. In a daily perspective, US yields fell between 3 and 7.7 basis points, the 5 and 7-year outperforming the 10 and 30-year. The 2-year stabilized, but only due to a benchmark change. In EMU, German yields were flat (30-year) to 2-3 basis points lower elsewhere on the curve. Intra-EMU spreads versus Germany showed a mixed picture with the stronger credits like France and the Netherlands seeing a marginal narrowing of the spread while weaker credits like Italy (+1 bp), Ireland (+2 bps) and Greece (+6 bps) showing losses. Following two days of losses due to the ECB decision on collateral, the Sep 3-month Euribor stabilized.

Intra-day, the Bund opened higher, reflecting the overnight movement of the Treasuries and equity weakness in Asia, but gradually eased slightly as European equities stabilized and later on recovered the opening losses. However, once more, the Bund losses were minimal and a retest of the 122.44 former resistance got no chance. The Bund barely reacted on the stronger IFO business confidence and traded sideways until well into the US session. Treasuries also kept a sideways trading profile and the (mixed) eco data (see news) had no lasting effect, as traders seemed hesitant to get involved ahead of the 5-year note auction. The latter went exceptionally well triggering a powerful rally that lasted until the closure. The FOMC Minutes were published during the rally, but looked neutral to us.

Today, the market calendar contains a long list of interesting US eco data, while in EMU, only second tier releases are scheduled. Other items are the German €5B OBL auction and the $32B US 7-year T-Note auction. Activity may be affected also by the upcoming Thanksgiving holiday on Thursday.

The US eco calendar contains the durable orders (October), the new home sales (October), the weekly claims, the final figure of Michigan consumer confidence (November) and the personal income and spending data (October). Initial claims are expected to stabilize near 500 000, but risks are on the downside. A surprisingly low figure could have an impact on the markets. Durable orders are notoriously difficult to forecast and we have no information to distance ourselves from consensus. Household spending should be robust in October, especially in durable goods as evidenced by the retail sales report. Car sales drove overall sales, but we expect also sales excluding cars to improve modestly. Michigan consumer sentiment fell sharply in November according to the preliminary report, but the final report may show some upward revision. The weekly ABC consumer comfort index, but also the Conference Board measure of consumer confidence showed an improvement in November. New Home sales are expected to have risen slightly in October. Existing Homes sales shot higher in October, but New Home sales also lagged the existing ones in previous months. The expiration of the first homebuyer tax credit at the end of November might have had a negative impact.

The US $42B 5-year T-Note auction was exceptionally successful: strong and aggressive demand with the buy-side prominently and dominantly present. The auction stopped at 2.175%, with 67% allocation at the high yield, well below the 2.211% bid in the WI trading at the stop. The bid/cover of 2.81 compares to last month’s 2.63 and an average of 2.27 over the past 12 auctions. Indirect bidders took down 60.9% of the auction with a very strong 72.9% hit ratio. The record Indirect bid amounted to $35B, while the Direct bid was large too at $5.2B. Also dealers posted a record bid of $77.8B, but the hit ratio was on the light side (19.5%). Today, the Treasury holds its $32B 7-year T-Note auction that concludes the three part end-of-month financing operation. Following extremely successful 2- and 5-year auctions, expectations are for a good auction. The vey low absolute yields didn’t weigh on the 5-year auction. In the past however, the 7-year Note auction sometimes got a bit more difficult going than the shorter maturities. The size of the 7-year was upped by $1B and is the highest on record. The active 7-year outperformed yesterday, dropping 7 basis points to 2.80%, near the lowest levels since May 2009. The yield is about 25 basis points lower than where the 7-year traded before the October auction. So, while there are some indications that may point to a more difficult 7-year Note auction, the success of the 5-year suggests that also the 7-year auction will go well. It seems investors are bidding as if there won’t be any auctions anymore tomorrow. In Germany, the Bundesbank auctions the 2.5% October 2014 OBL for an amount of €5B. German auctions usually don’t go very well. Yield considerations (lowest of the area) and market technical factors are responsible for this often lukewarm reception on the market. However, the issue is currently attractively priced, which might help the auction.

The Minutes of the November FOMC meeting noted some further improvement in the economic outlook and a continued healing of financial markets, but the Committee was cautious in assessing the outlook given considerable uncertainties and regarding the inflation outlook. The Minutes nevertheless also show the Fed is preparing for the time when the exit strategy from the non-conventional policy measures needs to be implemented. FOMC participants anticipated that these tools (for exit) would be tested but they stressed that such testing would not imply that these tools would be employed for policy purposes anytime soon. On the economy, FOMC forecasts for 2009/10 growth have risen slightly. The risks surrounding growth were seen as being rather balanced than tilted to the downside, but uncertainty was still viewed as quite elevated. Interesting, the Minutes showed that “most participants anticipated that about 5 or 6 years would be needed for the economy to converge fully to a longer-run path characterized by a sustainable rate of output and by rates of inflation and unemployment consistent with their interpretations of the Fed’s objectives.” Concluding, the economy continues to recover, but only gradual with little inflation risks and broadly balanced risks surrounding growth and inflation. , week low/reaction low hourly), at It will take long to close the output gap. It is too early to implement an exit strategy, but preparations are ongoing. Treasuries did well after the publication, but they were already rallying ahead of the release (MTMA) and at k that they were broadly in line with expectations. During the day, we take a closer look on the Minutes.

ECB Provopoulos, the governor of the Greek Central Bank, said that the ECB will make “final decisions” at its next policy meeting on December 3 about withdrawing emergency support. That support would not last forever he added and that was also the reason he had advised Greek banks to become less dependant from ECB liquidity support. Interestingly, he also put the quality of the collateral accepted by the ECB in its liquidity providing operations on the table. The ECB lowered the quality of the accepted collateral during the crisis. The governor now said this was also temporary. It is the first time to our knowledge that some remarks are made about the reversal of this measure. It is unclear whether such a decision should be expected.

Regarding bond trading today, there are no eco data of interest in EMU, but in the US, the eco calendar is busy. Eco data should be mixed for bond trading, with the US 7-year Note auction again a wild card. The German 5-year BOBL auction will attract attention too. Often the auctions are sluggish, but chances for a better than usual outcome are good. However, it shouldn’t have a tremendous effect on overall trading. Position squaring ahead of Thanksgiving may be an issue in the US Treasury market. Equities look well oriented at the start of trading, but it would surprise us if the S&P or NASDAQ would set new highs, which if it happen would have negative implications for bonds. The technical pictures of the T-Note future improved as it settled above the previous high, but confirmation is needed. The Bund picture is also positive, even if the contract high at 123.04 still looms. Given the long string of (modest (daily) gains and the overbought conditions, the risks of some kind of correction are increasing. So concluding, sideways trading with some risks on correction looks most likely for US and EMU markets.

During his testimony about the inflation report BoE governor King spoke about the risks for the global outlook, the QE policy and fiscal policy. King said that the global imbalances remained a big risk for the global economy as the problem has not been tackled profoundly and the imbalances may re-appear fast as activity recovers. Secondly, he regretted that the too big to fail question in the financial sector was not resolved and could undermine confidence in the market economy. He defended once more his idea of splitting “utility” banking from other banking activities. Only the extension of QE to £200B, King downplayed both the three way split and concerns that it was stoking asset price inflation. Regarding fiscal policy, King understandably promoted the establishment of a credible plan to address the structural problems. The gilts lost temporary some modest ground, but in a daily perspective yields across the curve ended narrowly mixed. According to the press, in the afternoon King would have repeated that an extension of QE can’t be ruled out and this time adding that it may happen earlier than in February, this is new information.

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Published on  Wed, Nov 25 2009, 08:39 GMT