Markets: Fixed Income
On Wednesday, supply continued to be an important driver for the government bond markets, as the German Bund and US 3-year Note auction disappointed. As a consequence, the sharp fall in the equity and commodity markets and the very weak ADP employment report failed to provide much support and bonds closed the session generally lower. Government bonds had also to cope with an increased appetite for high-quality corporate bonds, as the decline in the credit spreads suggested that investors are switching out of low yielding government bonds towards higher yielding corporate bonds.
In the euro zone, the steepening of the yield curve continued, as the short end of the curve outperformed on the back of the equity weakness with German 2-year yields falling to new all-time lows at 1.62% ahead of next week’s ECB meeting. The first rise in German unemployment in three years and the sharp drop in the PPI figures had no immediate impact, but contributed to the sentiment that the ECB will have to cut rates much lower over the coming months. At the longer end of the curve, German 10-year yields however extended their correction higher following the weak German Bund auction (for more details see European bonds below), but traded sideways after the very weak ADP report. In a daily perspective, German 2-year yields were down 9.1 bps compared to a rise of 4.5 bps in 10-year yields. As such, the steepening continued and the spread between 2- and 10-year yields rose to a new cycle high at 155 bps.
In the US, yields rose about 5 bps across the yield curve, which should be considered as rather disappointing taking into account the significant losses on the equity markets and the very weak ADP employment report. However, most of the losses occurred in the Asian overnight session.
US Treasuries cannot profit from disconcenting employment figures
Today, the eco calendar contains the weekly claims and November consumer credit data. Last week, initial claims surprised on the downside, falling 94 000 to 492 000, while the consensus expected only a modest drop (11 000). The plunge might have been due to Christmas and many unemployment offices may have been closed or short-staffed on the Friday after Christmas. For the week ended January 3, an outcome of 545 000 is expected, but a lower figure is not excluded as the distortion might still be apparent in this week’s figures. However, we expect the labour market to weaken further in the coming weeks and months, as the ADP employment and the Challenger lay-off reports suggested yesterday. Continuing claims, which are reported with a one-week lag, are expected to have dropped to 4 483 000 (from 4 506 000). Also here, we might see the effects of a shortened Christmas week. The claims sometimes get more attention when published just before the payrolls, but seasonal adjustment uncertainties suggest one should treat the outcome with more caution than usual.
The NY Fed announced at the start of the week that they started to buy Agency MBS securities in the framework of its $500 billion purchase program. Today, the first data about these purchases will be published in the H4.1 Fed statistics.
President-elect Obama in a CNBC interview confirmed yesterday that his economic stimulus package will be worth $775 billion as it is send to Congress, where some inevitable additions will be made. Obama will make a major speech (+ Q&A) on the economy and stimulus package later today. The package would be spread over 2 years and would consist of 60% more spending and 40% tax cuts. Obama also said he wanted to avoid living in a “bubble” and would pay close attention to how financial markets react to his policies. Recent nervousness on the scale of government interventions have raised doubts about the exit strategy when the economy starts to normalise. In this respect a sell-off in Treasury papers and a crash of the dollar are the dangers.
The $30 billion 3-year Note auction didn’t go well. The auction stopped firmly above the WI bid side at the stop (1.20% versus 1.18%) and the bid/cover of 2.21 was on the light side (average 2.32). Indirect takedown of 28% fell short of the 35.3% and 36.1% at the previous auctions. Today, the $16 billion 10-year Note (3.75% Nov 2018) re-opening will raise all new cash on settlement day (Jan 15), meaning cash flows surrounding the re-opening are a negative. Its size matches last month’s record high (for a re-opening). It is also the first second opening of the 3.75% issue first issued in November. From now onwards, the 10-year issues will re-open twice. This should help, amongst other measures to successfully cope with the extraordinary financing needs, but investors probably won’t be very eager to get some pieces of this issue that is now auctioned for the third time. Re-openings are typically dealer dominated and go sloppy, if history turns out to be a good guidance. Of course, while some uncertainty remains as there are no historical precedents for a second re-opening, the odds are indeed for a sloppy auction.
Regarding trading, Treasuries had a rollercoaster session that ended with modest losses. Since the start of 2009, investors became obviously less risk averse. The typical reflationary trades were favoured. Equities did well, especially the cyclicals, as did commodities and corporate bonds. Also in the currency markets, the peripheral currencies gained, while the yen lost ground. Treasuries paid the price and the 10- year yield rose by about 50 basis points, albeit from its rock bottom lows from end 2008. The reflationary idea got hit yesterday, as the ADP showed a staggering loss of 693 000 jobs in December, oil inventories sky-rocketed and corporate news, also from the financial sector, was sobering. Treasuries couldn’t profit fully, as a sloppy 3- year Note auction, an up-coming 10-year re-opening (today) and some switching from Treasuries to corporate bonds (sustainable?) acted as headwinds. Also uncertainty about the budgetary stimulus package (and its impact on supply), Friday’s payrolls and current low yields make investors wary to buy in size. Technically, the short term picture is neutral in the 123-02 to 125-22 area. Overnight, Asian equities traded very weak, but supply concerns will probably leave Treasuries in their short term sideways range.
Reiterating our longer term outlook, at this juncture we still see the recent losses of (longer-term) Treasuries as corrective in nature. For the 10-year T-yield, 2.50% (tested yesterday) and 2.80% offer first entry possibilities. The March Note future (CTD is May 2016) tested the broken uptrend channel (123-31+ today), but investors may wait to consider new long positions for a re-test of 123- 02/122-21+ (targets double top). A break above 125-22 (neckline double top) would re-install the short term positive outlook. We favour some sideways trading today.
German bonds suffer from weak Bund auction
The calendar is well-filled today with the European Commission confidence indicators (December), November unemployment rate, final figure of third quarter GDP and German factory orders. Economic confidence dropped last month (from 80.0 to 74.9) to a 16-year low. The worsening was due to a sharp decline in industrial and services confidence. For December, the consensus expects to see another drop in economic confidence (to 71.8). All sub-indices are forecasted to have deteriorated further led by a sharp drop in industrial confidence. The unemployment rate is expected to extend its increase, coming out at 7.7% and third quarter GDP is expected to be confirmed at -0.2% Q/Q. Both in September and in October, German factory orders showed sharp plunges. A more modest drop (-1.9% M/M) is expected in November, while the yearly figure is forecasted to come out at -20.1% Y/Y.
Over the past days, supply has become an increasingly important driver for the government bond markets. Yesterday, the disappointing German Bund auction sent longer-term yields higher, as the auction failed to attract enough bids to cover the whole issue (€6B). As such, the German Bundesbank has to retain a large amount of almost €2B for its own operations and only €4B was allotted. Weak demand for the German bond auction could be a bad sign for other government bondissuers which are expected to sell a massive amount of bonds this year. However, the decrease in the intra-EMU spreads and corporate credit spreads does suggest that the weak German bond auction could be related to a return of risk appetite as investors prefer higher yielding government and corporate bonds above low yielding German debt. In this context, it will be very interesting to see the auction results of today’s French and Spanish auctions and the success of the Irish new 5-year benchmark, which is expected to be priced at around 90 bps above mid-swap. This is very cheap and has already contributed to a further underperformance of Irish bonds compared to their European peers.
On the money market, demand at the 3- and 6 month supplementary refinancing operations collapsed, as only €9.5B was allotted in the 3-month tender and €7.6B in the 6-month tender compared to respectively €50.8B and €38B in the previous tenders. The drop adds to recent signs of improvement in money market conditions, although the amount deposited at the ECB remains very high. From the 21st of January the ECB will raise the penalty on the deposit rate from 50 to 100 bps and this may contribute to a further normalization of the money market. According to the forwards, the liquidity spread is also expected to narrow significantly over the coming months.
Regarding trading, the steepening on the European bond market continued yesterday, as 2-year yields fell to new cycle lows and 10-year yields extended their upward correction in the wake of the weak German Bund auction. But as uncertainty reigns with regard to the outcome of next week’s ECB meeting (the FT runs a highprofile article on its front-page that the ECB remains cautious about cutting rates much further) the downside in 2-year yields may become more limited for now. At the longer end of the curve, the technical picture of the Bund still points to more downward correction following the break below 123.75, but much will depend on the developments on the equity markets, which fell quite sharply in the US yesterday evening and this morning in Asia. Ahead of tomorrow’s Payrolls report, more sideways trading is therefore the most likely outcome for today. In a longer-term perspective, we look towards the December lows at 121.33 to open new long positions.
In the UK, the Bank of England will decide on rates and another aggressive rate cut can be expected, as the recession is deepening. A rate cut by at least 50 bps is expected, but recent comments do suggest that a larger cut cannot be excluded.
Currencies: Dollar rally stalls; sterling continues to trade strong ahead of the BOE decision
On Wednesday, the price action in EUR/USD was again interesting. On Tuesday, the pair swiftly dropped to the 1.3300 support area. However the level held and the pair rebounded. Yesterday, the pair was already well bid at the start of trading in Europe and the move gained momentum later in the session. The awful US ADP labour market report questioned the recent cautious market optimism and another selling wave hit the dollar after the release. EUR/USD reached an intraday high in the 1.3745 area shortly after the release. The ADP report and a series of negative corporate headlines also changed the positive sentiment on the stock markets that reigned since the start of 2009. However, this change didn’t cause any further USD losses and EUR/USD even ceded part of the earlier gains. The pair closed the session at 1.3644, compared to 1.3536 on Tuesday.
Today, the US calendar only contains the jobless claims and the consumer credit data. The European calendar is heavier as the unemployment rate, the EU confidence indicators and the German trade balance & factory orders are scheduled for release. Usually, those European data are no market movers. However, the markets are still pondering the relative economic performance between the US and the Europe and are making up their mind on the speed of the ECB reaction to a worsening in the economic situation ahead of next week’s ECB interest rate decision. In this context of uncertainty about the European economy, the European eco data might get some more weight. Later in the session, Mr. Obama will give an important speech on its policy intentions to address the economic downturn.
Over the previous days there was a lot of debate in the market on which factors should get the overhand to guide the price action in EUR/USD. Some investors and analysts tended to give the dollar the benefit of the doubt as they saw the US economy in pole position to take advantage from a gradual improvement in the global economic situation in the second half of the year. Europe was seen lagging in this process. The dollar skeptics conclude that it’s too early to turn positive on the US economy and fear the negative impact from quantitative easing on the US currency. The jury is still out in this debate, but yesterday’s data/events supported the thesis of the dollar skeptics. This debate won’t be decided in the near future and one might expect choppier trading in EUR/USD, mirroring the swings in sentiment following the new data that come available on both sides of the Atlantic. In this environment, we continue to take a close look at the technical charts. The US payrolls on Friday are the next key eco release that might help markets to make up their mind.
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 made the LT picture for EUR/USD positive. However, the rebound lost momentum in the second half of December and in a forceful correction, EUR/USD came close to the top of the previous sideways range (1.3300 area) on Tuesday. If this level holds, it might be an indication that the easiest part of the current dollar rebound might be behind us. We don’t speak too loud as there is no clear trading theme yet to guide currency trading. However, we continue to take a close look at the 1.33 support area. If a next test is again rejected, we are inclined to buy EUR/USD on dips. However, tight stop-loss protection is warranted if the pair was to clear this area.
Yesterday, USD/JPY traded as one could expect in a context of deteriorating investor sentiment. Stocks lost the positive momentum that reigned trading since the start of the 2009. So USD/JPY was already downward oriented from the start of trading in Europe. The steep job losses as showed by the US ADP labour market report caused an additional wave of USD/JPY selling. The ongoing slide on the US stock markets later in US trading kept USD/JPY under pressure. The pair closed the session at 92.65, al loss of 1 yen compared to the close on Tuesday.
This morning, Asian/Japanese stock markets joined the negative trend in the US yesterday evening and this continues to support the yen. BOJ governor Shirkawa admitted that the BOJ could still do more to improve financing conditions. Next to the buying of CP (already in execution) the bank might consider ways to bring down long-term corporate financing costs. However, for an excess country like Japan, these kinds of measures of quantitative easing are of less importance for the currency.
Looking at the charts, global market stress and overall dollar weakness in the wake of the US Fed’s announcement on quantitative monetary easing hammered USD/JPY and the pair set a reaction low in the 87.15 area on December 17. Since then, the pair entered calmer waters. USD/JPY first settled in a sideways trading pattern close to the 90 mark and tried to move higher during the first trading days of 2009, making the short-term technical picture more neutral. Supported by the ‘improvement’ in stock market sentiment, USD/JPY over the previous days tested a first resistance area around 94. The level was temporary broken, but the test was rejected. The long-term trend in the pair remains negative. After yesterday’s correction, the topside in this pair might become better protected. In a day-to-day approach we prefer a sell-on-upticks approach.
Yesterday, EUR/GBP again showed some quite remarkable swings. The euro started the European trading session on a strong footing and EUR/GBP initially joined that euro positive trend. So, EUR/GBP rebounded from the 0.9020/30 area and reached intraday highs in the 0.9170 area around noon. However, at the start of US trading, cable clearly outperformed EUR/USD. Cable broke above the 1.50 barrier already before the publication of the US ADP report and this break attracted additional (stop-loss) sterling buying interest, causing EUR/GBP to return to the early morning levels around 0.9020. A temporary break of this level even sent the pair to 0.8960. However, the sterling rebound stalled as global investors turned again more risk avers later in the session and EUR/GBP closed the day at 0.9035 compared to 0.9070 on Wednesday. Sterling trading over the previous days was very much order driven. It is nevertheless remarkable for the sterling to show such resilience in the run-up to today’s BoE interest rate decision.
Regarding today’s interest rate decision, the market expects the Bank to cut rates by 50 basis points. A larger cut might again reverse some of this week’s improvement in sterling sentiment. A lot will depend on the BoE communication after the decision. Do they open the way for additional rate cuts or for additional (less conventional) measures? Will the bank again mention the decline of sterling as a factor that prevented a bigger rate cut?
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 sterling to come under pressure again. We remain sterling skeptic 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.
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. Since start of this week, EUR/GBP showed quite a forceful correction but in our view this move still didn’t change the long-term sterling negative picture yet and we consider it as a correction on the steep sterling losses last month. Long term, we still look to buy EUR/GBP on dips but we’re not in a hurry and wait to see how far the current correction has to go. A sustained drop below the 0.90 area would indicate that the correction gains momentum. In this respect it will be interesting to see how sterling behaves in case of a 50 basis point rate cut. Will this ‘minimal’ rate cut be enough for sterling to extend its current correction? A sustained return below the previous high (0.8663) would question our long-standing sterling negative attitude.
