Markets: Fixed Income
On Friday, the first trading day of 2009, trading occurred in still very thin conditions. Several Asian markets were closed for a prolonged holiday, while in Europe and US, many traders took a day off, keeping traded volumes very low. As a consequence, we wouldn’t draw too many conclusions from the recent price action.
In these conditions, US Treasuries sold off like they did on the last trading day of 2008, driven by a rebound in equities. In Europe, where markets were closed on Wednesday, bonds ended in regular session still up, even if in after market trading, also European bonds slid in negative territory. The losses were contained though. Interestingly, the US market completely ignored the awful ISM manufacturing confidence survey. In the EMU area, the PMI fell short off expectations too, similarly weak as in the US, but pushed European bonds intra-day up towards the rally highs (Bund).
Intra-day, the Bund opened slightly lower, but largely ignoring the sell-off in the Treasury market that occurred on Wednesday when the European market was closed. However, a batch of weak and weaker-than-expected final December PMI’s generated a bid, pushing the Bund to 125.51 in early US dealings, only a whisker away from the recent contract high (125.56). US Treasuries started the session on a positive footing, as bargain hunters reacted on Wednesday’s sell-off. However, the tide turned as the market completely ignored the awful December ISM. This was the sign that the market was still exhausted and soon selling started, driven by rallying equities. In thin conditions, the sell-off continued until the close of the session, leaving US bond yields 5 to 15 basis points higher, the longer end underperforming the shorter end.
Treasury trading will start in earnest
Today, the calendar contains the November construction spending and the December car sales. Construction spending is expected down 1.4% M/M in November, while car sales are expected weaker too, at 10 million annual sales rate (December) from 10.2 million in November. Later on this week, the dataflow is abundant and interesting, as it comprises the Non-manufacturing PMI (Dec) and factory orders (Nov) on Tuesday, the ADP employment (Dec), on Wednesday, the initial claims on Thursday, but above all the December payrolls report on Friday. Following a horrendous November payrolls report that showed a net loss of 533 000 in November, the consensus estimate for December stands at a stellar 480 000 loss of jobs. The distribution of estimates is wide (400 000 to 600 000), but the story looks very much similar as in November: the labour market is falling off the cliff. If the outcome is close to consensus, the 2008 job loss will be close to 2.4 million, the largest annual decline since World War 2. December is always a tricky month to forecast the outcome of the payrolls report, but all available evidence (including claims and the Dec ISM employment index) points to another extremely weak report.
In the final two weeks of December, very few Fed governors gave speeches, but that is changing now. Over the weekend, governors Bullard, Evans, Fisher, Dudley and Yellen all spoke in San Francisco at the American Economics Association’s annual meeting. Interestingly, Governor Yellen said “the US faces a serious risk of stagnating for an extended period of time” and “it’s worth pulling out all stops on fiscal stimulus”. Yellen also highlighted the risks of deflation when she said that “it is increasingly likely that inflation will fall to undesirable low levels.” Yellen not only supported aggressive fiscal support for the economy, but said that the Fed would likely expand its raft of unconventional monetary policy measures. Governor Yellen is known for her dovish inclination towards monetary policy. However, she isn’t alone to support more fiscal action. On Saturday, Chicago Fed governor Evans already stated that “programs to support growth must be large in order to be effective and to instil badly needed confidence”.
Today, Yellen will lead a panel discussion on the Subprime crisis, while Hoenig will speak about the economic outlook on Wednesday and Lacker on financial conditions on Friday. The Fed will release the Minutes of the December 15-16 historic FOMC meeting, at which the Fed laid down the foundations of its quantitative easing policy. While the FOMC statement, released after the meeting was unusually long and straightforward, the Minutes may still reveal interesting details of the new policy.
Supply will stay a feature for the Treasury market at the start of the year. The Treasury will have to issue a mountain of debt to finance the bank bail outs, the stimulus package and offset sharply dropping tax receipts. Today, the Treasury will announce the details of the 3- and 10-year Note auctions that will take place on Wednesday and Thursday and settle on Tuesday January 15th. The amounts issued might be 28 and 16 billion dollar, which would be unchanged from December. Later on in January, a 20-year TIPS auction and 2- and 5-year Note auctions are scheduled.
In the final days of 2008, the Fed announced some more details about its programme to buy $500 billion in Agency MBS securities. It selected four private investment managers to help implement the programme. The purchases will start in early January and the $500 billion will be purchased by the end of the second quarter of 2009 (before it was stated that purchases would take place over several quarters). Only fixed-rate Agency MBS securities guaranteed by Fannie, Freddie and Ginnie Mae are eligible. The programme includes, but is not limited to, 30-year, 20-year and 15-year securities. To limit risk, the investment managers will employ a passive buy and hold strategy. The objective of the programme is to support the house and mortgage markets via lower mortgage rates. These indeed fell quite sharply since the announcement at the end of November. As a result mortgage applications, especially for refinancing, surged higher, but it remains to be seen how much applications will result in effective refinancing. Applications for home purchases reacted only mildly, probably as households are afraid to buy amid job fears and as they may wait for still lower house prices.
Regarding trading, Treasuries corrected quite sharply on Wednesday and Friday, after a number of sessions of sideways trading near the all-time highs. The thinness of the market doesn’t allow us to draw firm conclusions. Positioning surrounding endof- year might have been the driver of the price action. However, the technical picture deteriorated to some extent. The March Note contract fell through the medium term moving average and below the December 24 low painting a bearish double top on the charts. The potential targets of the configuration stand more than 2 full big figures below current levels. While the fundamental picture is still Treasury bullish, the technicals suggest cautiousness.
Regarding the fundamentals, the ISM (and earlier in December the housing data) suggests that the economy is still on a steep downward path without signs that a bottoming might by nearby. We suspect that economists will continue to slash their growth expectations and in a similar vein, corporate earnings will have to be revised lower. Inflation is clearly receding and deflation is ever more coming into focus. Equities rallied on Friday and even broke above a first meaningful resistance level (919). While also here low volumes ask for cautiousness in interpretation, it might be that investors put some money at work in the equity market on the premise that following a ink black 2008, one of the worst years for equities ever, 2009 can only be better. This might be a reasonable expectation and a driver for equities in early 2009, but we think that there are too many uncertainties left to expect it to be the rally that ends the bear market. Regarding still the fundamentals, the quantitative easing policy put into place by the Fed should limit the upside for yields for many months to come. The market will soon be confronted with the Fed buying Agency MBS. Also Fed talk, like we heard over the weekend (see higher), is still Treasury-friendly. In this respect, it might be a Treasury buy-on-dips environment, whereby losses on eventual equity strength open entry possibilities for longs. For the 10-year yields, levels around 2.50% (previous low/broken downtrendline) might be a first such interesting entry level.
European bonds open lower today
Today, trading will heat up, as many market participants were still absent last Friday, the official first trading day of 2009. In the euro zone, the eco calendar looks thin today, although the Italian and Spanish inflation data are likely to attract some attention ahead of tomorrow’s euro zone flash CPI.
Over the past months, euro zone headline inflation has dropped significantly lower raising concerns that the euro zone economy is facing a deflation threat. Until now, the ECB has continued to downplay this threat and has stressed the difference between disinflation and deflation. Nevertheless, the diminishing of upside inflationary has led to a dramatic reduction of interest rates by 175 bps to 2.5%. Regarding the January meeting, the ECB has left all options open, although some members of the governing council showed some preference to leave rates unchanged. In a similar vein, ECB’s Vice-President Papademos warned that any rate cut ‘to low levels must be judged with special care because of its longer-term implications for price stability’. The cautiousness of the ECB to cut rates much lower conflicts with the aggressive easing seen in the US, UK and other central banks around the globe and has sent the euro trade-weighted to new highs at the end of the year.
Any further appreciation of the euro risks to deal another blow to the European economy and diminishes the impact of the recent easing in monetary policy. As such, the ECB may be obliged to cut rates further if it doesn’t want the euro to go through the roof. Last Friday’s awful Manufacturing PMI data indicated that the negative spiral hasn’t halted yet. Currently, markets are looking for a 25/50 bps rate cut at the January meeting. Although this is not a done deal, we think that the risks for an upward correction in 2-year yields is rather limited, as we still expect the ECB cut rates further in the course of the year to at least 1.5%.
At the longer end of the curve, the risk on an upward correction in yields is much larger due to the enormous increase in government bond supply and the increased risk aversion of investors. This week, Germany, Spain and France are planning to tap the market. The centre of supply will be at the 10-year segment, as both Germany and France will tap their 10-year benchmark. Hence, although we look to the European bond market from a bullish point of view, we are rather cautious to go long at current levels and would wait on more correction from the recent highs. Demand at this week’s auctions may already be a good pointer with regard to investor’s appetite for European government bonds.
In the UK, the calendar is empty today in spite of a mini-tender auction today. Later on this week, the Bank of England will decide on rates and in contrast to the ECB, the BoE has already signalled its willingness to cut rates again. A rate cut of at least 50 bps is currently expected.
Currencies: Currency markets looking for a new trading theme?
At the end of last year and during the first trading day of the new year EUR/USD basically held a sideways trading pattern in the 1.40 area. The first sets of eco data on both sides of the Atlantic (PMI/ISM in Europe and the US) continued to paint a bleak picture on the economy but had no lasting impact on the (currency) market. Stocks did rather well at the first trading day of the new year but also this was not able to give EUR/USD a clear direction. The euro failed to make any sustainable gains on the cautious return of risk appetite on the stock markets and EUR/USD closed the first trading day of the year at 1.3921. However, with a lot of traders not yet at their desks it is too early to draw any firm conclusion from Friday’s price action.
Today, the US eco calendar is thin and this is also the case for Europe.
Mid-December, the Fed shifting its policy into the direction of quantitative easing while the ECB showed highly reluctant to take further aggressive steps in their monetary policy hammered the dollar and propelled the EUR/USD pair to a new recovery high in the 1.47120 area. Later in the month the pressure on the dollar eased as markets entered a remarkable end of year calm.
Going forward, the key question is what will be the next theme the currency markets will play. Will monetary policy remain the key driver for EUR/USD trading? If that would be the case, the euro might still be favoured over the dollar. Or will the markets gradually focus/anticipate on the potential positive impact from the stimulus measures that were already put in place and that will be announced with Obama entering the White House. If the markets would give more weight on this theme, the picture could become more dollar positive.
Since mid November we had a USD negative approach. At the start of this new year we turn more neutral on EUR/USD. The US payrolls and the market reaction to this report will be a first pointer on market thinking/behaviour. We still tend to think that it’s a bit too early to front-run on a sustained economic rebound. The ECB assessment on monetary policy (to cut or not to cut in January) will be another factor of importance. We start the week with a neutral bias on EUR/USD. As we are cautious on a quick improvement in the eco data, we maintain our long-term dollar skeptic attitude.
From a technical point of view, EUR/USD in December broke above the previous sideways trading pattern and an important downtrend line (cf graph). This makes the LT picture for EUR/USD positive. However, the rebound lost momentum in the second half of December. The short-term picture for EUR/USD is neutral. If the pair drops below the 1.3840/22 area, this could be an indication that the dollar correction/ rebound has some further to go short-term.
During the last to weeks of 2008, tensions also eased in USD/JPY. After setting lows below the 90-mark mid December, the relative calm in most other markets also filtered through in USD/JPY trading and the pair settled in the 90 area. The positive start of the new year on Wall Street on Friday helped USD/JPY to close the first trading day with a decent gain at 91.83.
This morning, Asian/Japanese stock markets are also mostly in positive territory and this helps USD/JPY to maintain Friday’s gains. Short-term, the gyrations in the stock markets will continue to be the main driver for USD/JPY trading. Japanese authorities recently continued to warn on the potential negative consequences of the strong yen for the Japanese economy (BOJ’s Shirakawa on Sunday). However, we don’t have the impression that interventions are around the corner at this stage.
Looking at the charts, global market stress and overall dollar weakness in the wake of the US Fed moving ever more in the direction of quantitative monetary easing hammered USD/JPY and the pair set a reaction low in the 87.20 area on December 17. Since then, the pair entered calmer waters and settled in a sideways trading pattern close to the 90 mark. Before the holiday break, we had USD/JPY negative bias. In a short-term perspective, the picture for USD/JPY turned more neutral again. If stocks remain positively oriented, the rebound in USD/JPY can go still somewhat further short-term. The long-term trend in the pair remains negative.
While there was some easing of tensions in some other major cross rates in the second half of December, this was hardly visible in EUR/GBP. Sterling remained under pressure and EUR/GBP set new highs in the 0.98 area during the last trading week of 2008. A limited correction occurred on Wednesday last week, but at least for now, the sterling continues to fight an uphill battle.
Today, only the construction PMI is scheduled for release. Later this week, there are some interesting data series, but the Thursday’s BOE interest rate decision will be the first important test for sterling. A 50 basis point rate cut is more or less expected by the markets. A more bold rate cut or more dovish talk probably won’t be a help for sterling. It will also be interesting to see whether (and if so how much) weight the BOE will to sterling weakness in its policy assessment.
On the technical charts, the break above a series of high profile resistance levels in November/December has made the long term technical picture outright positive for EUR/GBP. We maintain our view that a negative interest rate differential vis-à-vis the euro, combined with ongoing negative eco news contains the risk for additional sterling losses over time. We are well aware that a lot of negative news is already priced in for sterling at the current levels. However, as long as we don’t receive a sign that the weakness of sterling gets more weight in the BoE’s monetary policy assessment and/or unless we get a clear sign on the technical charts, we hold on to our sterling skeptic attitude.
