Markets: Fixed Income
On Thursday, government bond markets had a better run than recently, but once more the picture showed quite some variations both geographically and curve-wise. In EMU, yields fell across the curve by 5 to 7 basis points; the 2- year yield continues to set new all time lows (1.58%). In the US the belly of the curve performed strongly, as yields dropped 8 and 5.5 basis points for 5- and 10-year, but the wings saw their yields go 1 basis point higher.
In the euro zone, the eco data were awful. German exports dropped more than 10% in November (also in other parts of the world like Asia and LatAm) confirming that international trade fell off the cliff and the recession is global in nature. Disconcerting German factory orders (-6% M/M) and plunging confidence across the board in the EU Commission December survey completed the dismal picture of the EMU economy. The French and Spanish auctions went difficult, but hadn’t a lasting effect on trading. Interestingly, the rally of the Bund occurred ahead of the US session after which the Bund stabilized ignoring a good performance of the 10-year T-Note. The presence of strong resistance at 123.75 might be the explanation. The rate cut of the BoE to the lowest level since 1694 (and the Bank of Korea overnight) reminds markets that monetary policy is still in an aggressive easing mode throughout the world, which might have positively affected thinking about the outlook for lower ECB rates.
In the US, an earnings warning of Wal-Mart and the subsequent reaction in equities pushed Treasuries higher on the onset of trading, but lower claims and a rebound in equities pushed Treasuries temporary down. Later on, they re-found their composure and went up again, helped later on by a surprisingly strong 10-year re-opening. Equities struggled up again, but its effect on the belly at least was modestly.
US Treasuries up ahead of payrolls
Today, all eyes will be on the December payrolls report. The November payrolls report showed an extreme plunge in employment, the sharpest drop since December 1974. The story looks very much similar in December with the consensus expecting another horrendous figure (-510 000). December is always a tricky month to forecast the outcome of the payrolls report, which is also illustrated by the wide distribution in estimates (-350 000 to -750 000). But all available evidence and especially the ADP report, points to another extremely weak report. If the outcome is close to expectations, the 2008 job loss will be close to 2.4 million, the largest annual decline since World War 2. A considerably weaker (stronger) report is expected to have a positive (negative) impact on the market. The unemployment rate is expected to have risen from 6.7% in November to 7.0% in December.
President-elect Obama didn’t unveil new information about the details of his stimulus package during a key-note speech, but said that bold action was needed to avoid the US from sliding into a very long (years) recession. Interestingly, it seems that some opposition against the tax cut part of his plan is growing inside the group of House democrats. Boston Fed Rosengren, a prominent dove inside the FOMC, said that the recession looked to be longer and more severe than originally thought, but he nevertheless added that there are signs the economy will improve in H2 of 2009. In the Q&A session, Rosengren said that the ballooning Fed balance sheet need not necessarily lead to inflation down the road and that concerns about deflation and an extended period of eco weakness were greater. He said that some improvement in the functioning of short term credit market was seen and expected it to continue. In this respect, 3 month Libor rates dropped further yesterday to 1.35% from 1.39% on Wednesday driving the liquidity spread (Libor compared to OIS) to a new low of 116 basis points. Also swap spreads continued to narrow. 2 year swap spread narrowed, the lowest level since the crisis started in mid-2007.
Contrary to our and market’s expectations, the $16 billion 10-year Note (3.75% Nov 2018) re-opening went well. The auction stopped at 2.419%, well below the 2.458% in the WI at the time of the stop. The bid/cover of 2.59 exceeded the average of 2.20 (last 12 auctions). Indirect bidders took away 17.5% of the auction, which is slightly better than average (for re-openings) that stands at 16.5%. The buy-side did bid in good size, but didn’t bid aggressively.
Regarding trading, Treasuries corrected lower in the second half of December after reaching all-time lows. The correction ran into resistance early this week and yesterday Treasuries went up again. However, at the same time, we see some signs investors are more risk-minded at the start of the year, even, if some reality check occurred on Wednesday (oil dropped sharply lower/equities fell hard). Today’s payrolls report will give us a better clue about how the markets will evolve in early 2009. Will the extreme risk aversion, the main attitude in 2008, continue to dominate or will it be replaced by a longer lasting risk-minded mentality? We have no strong view on the December payrolls, always difficult to forecast. It should be bad, of course, but whether it is minus 350 000 or minus 700 000 is unclear to us. More interesting than the figure, will be the market reaction. We suspect an asymmetrical reaction may occur. A very weak payrolls report (-600 000 or more) will have a less positive impact on Treasuries than “strong” report (- 400 000 or better) will have a negative reaction. The market should be ready for a very weak report, also after the release of the ADP report. The market might currently be in a mood that it wants to see the glass half full instead of half empty. If at the close of trading, the March Note contract is well above 125-22, the road is open for a re-test of the highs. Otherwise, the correction lower might resume.
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% (failed test earlier this week) and 2.80% offer entry possibilities. The March Note future (CTD is May 2016) tested the broken uptrend channel (124- 03+ 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.
European bonds gain on weak eco data
Today, the euro zone calendar contains the November retail sales and German and French industrial production figures (November). In October, euro zone retail sales surprised on the downside, as sales dropped 0.8% M/M instead of an expected decline of 0.4% M/M. An outcome of 0.0% M/M is forecasted for November. Both in France and in Germany, October industrial production figures surprised on the downside recently. German industrial production dropped 2.1% M/M and French industrial production plunged 2.7% M/M in October. For November, French industrial production is expected to show a more modest decline (-0.8% M/M), while German industrial production is forecasted to continue its sharp decline (-2.0% M/M). These figures should give us first indication of the euro zone industrial production figures released next week.
Unsurprisingly, following recent weak eco data ECB’s Weber yesterday evening suggested that the Bundesbank might have to revise down its growth forecasts for this year. ‘The final quarter of 2008 may have been worse than we expected. This would weigh on our growth projections for the current year’. Looking ahead, Weber however warned against all too pessimistic growth forecasts. ‘Furthermore, globally expansive monetary and fiscal policies this year will help. Both give reason to hope for a pick-up in economic growth next year’. Weber declined to comment specifically on the interest outlook, as the black out period has started ahead of next week’s ECB meeting. There is still much uncertainty with regard to the rate decision at the meeting, as there has been no clear signal from the ECB that rates will be cut again. A high-profile front-page article in the FT yesterday morning even suggested that the ECB might leave rates unchanged next week and caused some upward correction in 2-year yields. This proved however very short-lived, as the collapse in the EU confidence indicators and the German exports and factory orders pushed 2-year yields again lower to new all-time lows. This signals that the room for an upward correction in short-term yields remains very limited. Indeed, even if the ECB leaves rates unchanged next week, one shouldn’t expect a sharp rebound, as theECB then is likely to signal a rate cut at is February meeting. We now expect ECB rates to fall to 1% in the course of the year, which isn’t yet completely discounted in the market.
At the longer end of the curve, the recent downward correction in the Bund brusquely halted yesterday. On Wednesday, the upcoming flurry of supply still weighed on the longer end of the curve, as the German Bund auction disappointed. But despite yesterday’s weak demand at the French and Spanish auctions, bond markets now appeared relieved that the auctions had passed. However, as long as the Bund hasn’t recouped the 123.75 level in a sustainable manner, we’re not convinced yet that the market is ready for a substantial move higher and first look for more downward correction towards the December lows at 121.33 before opening new long positions. Today’s market reaction to the US Payrolls report will be very important in this context. In the coming weeks, supply will remain a concern too, as much more issuance is still expected. Regarding the intra-EMU spreads, there has however been some easing recently, but this should be more related to the very weak eco data coming out of Germany, the expected new German fiscal stimulus plan and yesterday’s bail out of Commerzbank than an overall improvement in sentiment. Indeed, these issues all indicate that Germany isn’t spared in the current crisis and may lead to a further substantial increase in German supply too. A noticeable exception to the recent easing in spreads is Ireland that underperformed following the very cheap pricing of its new 5-year benchmark at 90 bps above asset swap. Ireland however sold €6B of the issue, double the amount originally intended, which should provide some buffer against a further spread widening.
In the UK, the calendar contains the December PPI figures and November industrial production data. The PPI data are expected to show another significant drop in inflation. The consensus is seeking for a 0.6% M/M drop in output PPI, but a sharper decline is not excluded. Industrial production is expected to show the seventh consecutive monthly decline, falling 0.5% M/M.
Yesterday, the Bank of England cut its benchmark rate by 50 bps to a record low of 1.5%. Gilts in first instance lost on the rate decision, as many had expected a larger rate cut. Later on during the session, Gilts however recouped the losses. The statement of the Bank of England sounded very downbeat, as it stated that ‘business surveys suggest that the pace of contraction in activity increased during the fourth quarter of 2008 and that output is likely to continue to fall sharply during the first part of the year’. This leaves the door open for more easing in the course of the year. At the same time, the Bank called for more action to restore lending activity. ‘The availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non-financial sector’.
Currencies: Dollar cedes ground
On Thursday morning, the EUR/USD pair showed again an indecisive trading pattern. At the start of trading in Europe, the pair dropped from the 1.3650 area to the 1.3550 area. However, a series of poor Euro-zone eco data caused no additional euro losses, even as European yields dived sharply lower upon the release of these data. Sentiment changed again as soon as US traders got involved. Growing investor nervousness (among others due to Wal-Mart profit warning?) gradually brought the dollar under pressure. This move accelerated after US data showed a steep rise in US continuing claims. EUR/USD spiked to the 1.3800area. We don’t give too much weight to this reaction, but it at least shows that the dollar is not immune to bad economic news. At this stage, investors apparently are not really impressed by the safe haven characteristics of the US currency anymore. Global investor sentiment deteriorated over previous two days, but the damage on the US stock markets remains rather limited after all and this also helped to limit the damage for the US currency yesterday evening. EUR/USD closed the session at 1.3700 compared to 1.3644 on Wednesday. The speech of Mr. Obama on the economy didn’t bring much new info to the markets.
Today, calendar contains quite a long series of eco data releases but the only release that really matters for the markets is the US payrolls. Recently published data already brought a lot of bad news on the US labour market. The consensus expects a job loss of about 525K. The December payrolls figure is affected by a large number of statistical uncertainties. This includes to risk of unexpected swings, to the upside as well as to the downside. Nevertheless, we assume that a number of job losses of well over 500K would be no good news for the US currency.
Over the previous days, we indicated that markets were looking for a new theme to guide the price action on the currency markets in general and on EUR/USD in particular. During the first trading session of the new year, investors tended to favour the dollar on hopes that the US would be the first to emerge from the current economic downturn. However, the first eco data available in 2009 suggested that it might be a bit too early to front-run such an improvement and this questions the ST attractiveness of the US dollar. We hold on to our view that choppier trading in EUR/USD, mirroring the swings in sentiment following the new data that come available on both sides of the Atlantic will dominate. The US payrolls are the next key eco release. As long as uncertainty persists on the growth outlook, we continue to take a close look at the technical charts.
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 MT 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. This level held and we see it as indication that the easiest part of the current dollar rebound might be behind us. The pair might now enter a short-term consolidation pattern between 1.3300 (reaction low + previous range top) and the 1.3825 area (previous low). Within this range, we prefer as ST buy-on-dips approach. However, tight stop-loss protection is warranted if the pair was to clear the area 1.3300 area.
On Thursday, USD/JPY extended the decline that started on Wednesday. A less positive stock market sentiment and a growing dollar uncertainty (reinforced yesterday by the poor US continuing claims) kept the USD/JPY pair under pressure throughout most of yesterday’s trading session. However, US stock markets managed to undo most of the earlier losses and this also eased the pressure in USD/JPY. The pair closed the session at 91.20, compared to 92.65 on Wednesday evening.
This morning, Asian/Japanese stock markets trade mixed and don’t show a clear trend. USD/JPY is still trading close to the levels recorded at the close yesterday evening.
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. In a day-to-day approach we continue to prefer a sell-on-upticks approach. A break above the 94.63 reaction high would question our ST negative bias.
Yesterday, the BOE interest rate decision was the key factor for EUR/GBP trading. Over the previous sessions, sterling performed rather well. The UK currency even managed to recoup part of the steep December losses, despite the uncertainty ahead of the BoE meeting. The Bank, as more or less expected, cut its key interest rate by 50 basis points to a record low level of 1.50%. In its communiqué the Bank didn’t bring any high profile new insights to the market but still sounded very downbeat on the economy. Nevertheless, sterling spiked higher immediately after the decision. Some players apparently had expected/feared even more bold action from the BoE. EUR/GBP briefly dipped to the 0.8900 area, but the gains evaporated soon and EUR/GBP closed the session at 0.9006 compared to 0.9035 on Wednesday.
Today, the calendar contains the UK PPI data and the (manufacturing/industrial) production data. The consensus expects a further decline in activity. We assume these data to have only intra-day importance fro trading.
Over the previous sessions, the pressure on sterling eased and this trading pattern was also visible after yesterday’s BoE interest rate decision. Nevertheless, 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. 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. The 0.90 area is still under test and a sustained drop below the 0.90 area would indicate that the correction gains momentum. It is still early days, but we have the impression that the easiest part of the sterling rebound might be behind us. We look out whether the pair will still be able to set another correction low today. If not, this could signal a ST bottoming out process. A sustained return below the previous high (0.8663) would question our long-standing sterling negative attitude.
