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Sunrise Market Commentary

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The issue traded strong after the publication of the results

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

KBC Bank

Markets: Fixed Income

On Wednesday, global bonds traded for most of the session sideways to lower on stronger-than-expected eco data and technicals, but another exceptional strong US auction late in the US session, propelled the bond futures higher and into positive territory. This was not yet reflected in the daily results for the EMU cash market. In yield terms, US 2- and 5-year yields were up about 2 basis points, still the result of the benchmark changes and early trading in the new issues. The 7-year yield (old issue) and the 10- and 30-year yields fell by respectively 5, 3.3 and 1.3 basis points. In EMU, German yields rose by 1-to-3 basis points, the wings underperforming the belly. The intra-EMU yield spreads versus Germany narrowed marginally for most credits, but the weaker credits Ireland and Greece saw their spread widen again by respectively 4 and 6 basis points. Ireland is hit by street protest against the austerity measures, while Greece is hit by concerns about its banks.

Intra-day, the Bund opened little changed, but immediately faced selling pressures that push it to 122.60 from 122.80. However, as soon as it became obvious that equities couldn’t hold onto their opening gains, the Bund turned north and rallied towards the intra-day highs of 122.89 around noon. There were no eco data of importance higher, but the well bid OBL auction was a small positive. Bunds and Treasuries stabilized in early US dealings. The early US data, especially claims were stronger than expected. However as was the case in previous sessions, it couldn’t really push bonds sustainably lower. So, Treasuries and Bunds traded at about unchanged levels when the next set of US data was published. New Home sales and Personal Consumption spending were again stronger than expected, but the negative reaction was even smaller than was the case earlier in the session. Bonds stabilized again before losing some modest ground ahead of the 7-year Note auction. The latter was outstanding and triggered a rally that continued into the close.

Today, bond trading will kick into a lower gear, as US markets are closed for Thanksgiving. As a consequence, the US eco calendar is empty. In the euro zone, the M3 money supply and credit growth data (October) and first estimate of German CPI (November) are on the agenda. The M3 money supply data are expected to show a further, significant slowing in M3 from 1.8% Y/Y to 0.8% Y/Y. In recent months, the lending data showed a monthly increase in household lending. This is interesting as household lending usually bottoms at the same time as the economy, contrary to corporate lending that lags the cycle by three quarters. Therefore, another increase would be an encouraging sign for the economy that wouldn’t go unnoticed in Frankfurt. In November, German CPI inflation is forecasted to return to positive territory after four months of negative inflation. The consensus is looking for an increase from -0.1% Y/Y to 0.5% Y/Y as last November’s 0.5% M/M decline in CPI falls out of the inflation calculation. Nevertheless, while inflation is forecasted to edge further up in the coming months, due to energy-linked price effects, underlying inflation will remain subdued as growth is forecasted to resume rather slowly. ECB Weber speaks twice, ones on the covered bond market and once on stabilizing the financial system, but one week before the ECB meeting, he shouldn’t elaborate on monetary policy matters.

Yesterday, the $32B 7-year US T-Note auction went extremely well, mirroring a similar strong 5-year auction on Tuesday. Demand was lofty and bidding from Indirect bidders aggressive. The auction stopped at 2.835%, well below the 2.867% at the stop with 88% allocation at the high yield. The bid/cover of 2.76 was above the 2.53 average, despite the steady increase in the size of the auctions. The Indirect bid of $25.8B was a record high one with a solid 77.6% hit ratio and a 62.5% takedown, which is average. The Direct bid was strong too at $4.7B and aggressive, resulting in a record 9.6% takedown. The Dealer bid on the contrary was smaller than previously and not aggressive, resulting in a record low 27.9% takedown. Overall, the end-ofmonth financing operation went extremely when, showing a still strong investor appetite for Treasury paper. The strength surprises us a bit, given the very low yields, but may be partially the result of end-of-year balance sheet considerations and of course the Fed’s “guarantee” that official rates will be low for an extended period of time.

The German €5B 2.5% Oct 2014 OBL was a success. It was met by reasonable strong demand that resulted in a bid/cover of 1.7 above the recent 1.6 average. There was a small tail of 0.2 basis points and The Bundesbank retained €0895B of the issue for its open market operations, slightly less than average too. The issue traded strong after the publication of the results.

Regarding bond trading today, the environment is intrinsically bond positive. Asian equities are sliding on a weaker dollar and more news items about a recapitalisation of its banks. Also the announcement of Dubai that state-owned Dubai World places a 6 month standstill on it’s debt as default risk soars is a positive. The stellar US 7-year Note auction is supporting Treasury buying in Asia. Dollar weakness/euro strength is a positive for the euro, as it may soften the ECB stance regarding the exit strategy, but at least until now this was not reflected in the price action (see graph US-German 10-year yield spread). The EMU eco data, while interesting, shouldn’t have a major impact on trading. Of course today’s trading will be heavily influenced by Thanksgiving holiday in US, which might keep many investors/traders sidelined in Europe too. Whether this will result in listless sideways trading or exacerbate the volatility is difficult to say in advance. The Bund opens about 10 ticks higher compared to the levels in the after-market trading yesterday. This is disappointing, given the 10/32 advance of the T-Note future.

The technical Bund picture is also positive, even if the contract high at 123.04 still looms. The Bund is again in its uptrend channel and above 122.44 that marks the neckline of a double bottom formation. We were a bit sceptical about the upside potential of the Bund and should stick to that. Of course, one should not go against the flow and install short positions. However, we still think that profit taking on long positions, eventually partially, remains a good idea. We remain as usual open-minded and will re-assess our view early next week when US trading has resumed in earnest and when the outcome of the test of the 123.04 contract high becomes clearer.

In the UK, the quarterly CBI distributive trades report is scheduled for release. Yesterday, gilts outperformed Bunds on the back of a disappointing revision of Q3 GDP. It was revised higher, but only to -0.3% Q/Q, which kept the economy in recession for six quarters. A stronger revision was expected, also by BoE. The BoE also purchased £1.7B of Gilt issues (March 2013 to September 2019). The offer to cover was 4.44, above the 3.27 average for this maturity bucket.

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Published on  Thu, Nov 26 2009, 09:08 GMT