Markets: Fixed Income
On Wednesday, global bonds resumed their uptrend after a pause on Tuesday, as investors left risky assets for safer ones. The risk aversion trade (VIX moved above 50%, CDS indices climbed further) shifted the US curve substantially lower and made it steeper. In EMU, the gains were more modest with the 10- year sector outperforming and the 30-year sector again distancing itself from the overall movement higher. The upcoming ECB meeting may have made EMU investors a bit cautious.
The collapse in US retail sales was a shocker, even after the avalanche of bad eco news published in recent weeks. The Beige Book was sobering too, but not seen as bringing new info and thus largely ignored. Also corporate news was scaring with rumours about HSBC, Wells Fargo and BoA needing extra capital, Deutsche Bank Q4 warning and Citibank’s mess contributing to fears that Q4 will turn out to have been another disastrous quarter for financials. Expectations regarding extra capital injections for financials grew by the day.
In the EMU area, the effective downgrade of Greece and a confusing story (afterwards denied) that Ireland would look to the IMF for help together with weak production data added to the fertile ground for government bonds, but more important caused a further widening of the spread between German bonds and those of most other EMU countries
Intra-day, Bonds moved sideways with a very mild negative bias that changed as soon as US traders got involved and sentiment soured on equity markets. Equities stabilized though and lingered around the lows for the remainder of the session, leaving Treasuries hovering close to the intra-day highs.
US Treasuries rally as risk aversion mounts
Today, the calendar is well-filled with the weekly jobless claims, PPI data (December) and January NY Fed and Philly Fed. Beside these, Fed governors Evans and Lockhart will speak and Fed nominee Tarullo will testify. Importantly, earnings results of JPM (before trading) and Intel & Genentech (after trading) will be closely scrutinized, especially as recently sentiment on financials soured again.
In the week ended January 10, initial claims are expected to come out above 500 000 after two weeks of significantly lower claims. The consensus is looking for an outcome of 508 000, but a significantly higher figure is not excluded after the previous two numbers were distorted by Christmas and New Year. Continuing claims, which are reported with a one-week lag, rose to the highest level since 1982 in the week ended December 27. For the week ended January 3, an outcome of 4 620 000 is forecasted. In the last four months, cyclical manufacturing activity decelerated at an historical unprecedented fast pace. The market will be eager to know whether the pace of deterioration is slowing at the onset of January. The NY Fed and Philly Fed surveys stabilized in recent months at very low levels, suggesting the pace of slowing remained constant. We see little reasons to expect a noticeable change in January. The NY Fed is expected to come out at -25.00 (from -25.76) and the Philly Fed is forecasted at -35.0 (from -36.1). Producer prices are forecasted to have declined 2.0% M/M in December, after falling 2.2% M/M in November. A softer drop is not excluded after the less than forecasted drop in import prices. It will also be interesting to see the development in core PPI, which is expected to have risen 0.1% M/M in December.
Fed governor Plosser made some interesting remarks yesterday. Asked about the Fed’s intentions regarding the purchase of Treasury securities, he said that the decision hadn’t been made, but is discussed. We think that the Fed will buy Treasuries when the yields on these would rise substantially. As long as they stay, let’s say below 2.50/75%, we suspect the Fed will remain concentrating on credit spread narrowing by buying non-Treasury assets. However, the possibility of Fed buying should currently cap the upside. On the economy, Plosser expects a turnaround in activity in H2 of 2009 and doesn’t expect deflation. On the labour market, he said he didn’t expect the unemployment rate to rise to 10.5% which was the level reached in 1980, but added that unemployment is a lagging indicator. He also devoted quite some time on the exit strategy for the current quantitative policy, but offered little details. “The Fed must develop a well-articulated exit strategy….” Plosser is concerned about the quantitative policy, even if he supports it for now, and prefers some sort of target or anchor.
The Beige Book didn’t affect trading, as it more or less confirmed the awful eco data recently released. “Overall activity continued to weaken across almost all Federal Reserve districts since the previous period.” Activity continued to struggle in manufacturing, mining and retail and the housing market remained in eclipse, commercial real estate slipped and credit conditions stayed tight amid worries about credit quality. Wage pressures remained contained in weak labour market conditions.
Regarding trading, yesterday, Treasuries gained big on increased risk aversion (cf. above) linked to the situation in the financial sector and the expectations of an ever deeper recession. With the Fed Fund rate effectively zero, such a context leads to a flattening of the curve. Today, the eco data, especially Philly and NY manufacturing surveys, should again be weak, but we haven’t many indications to put the risks on the downside of expectations. PPI is expected to drop sharply, but here we even put the risks on the upside of consensus, even if we think that such an eventual result shouldn’t affect Treasuries negative. We expect the Fed speeches to have only a minor impact on trading, but the Q4 earnings results of JPM and other corporate might be of greater interest for trading. Risk aversion is fully back in town, following some hopes at the start of the years that equities would do well in 2009. The latter may still be true, we’ll see, but at least for now the prospect of a re-test of the cycle lows has increased: a drop below 837 (now 542) would indeed make the attraction of the lows at 742 too strong to resist.
We were too conservative yesterday as we thought the equity market would take a pause ahead of the bulk of Q4 earning results that will be published from next week onwards. Nevertheless we don’t change tack now and keep focussing on the 122-22 to 128-22+ range, of course within still a long term bullish framework.
Summarizing, the March Note future broke above 125-22, neckline of a previous double top, re-installing a bullish ST picture, which might eventually lead to a re-test of the contract highs at 128-22+. Should equities threaten to go for a test of the cycle lows, Treasuries may get another boost. If not, the upside should be limited to the cycle highs at best (128-22+ for March contract; 2.03% fort 10-year yield). We play the 122-22 to 128-22+ range (March Note future) with a positive inclination as long as above 125-02+/124-25+ (LTMA /channel top).
Bund sets new high on eve of an all-important ECB meeting
Today, the calendar contains the December euro zone CPI, but all eyes will be on the ECB rate decision. Last week, the December CPI estimate surprised on the downside coming out at 1.6% Y/Y from 2.1% Y/Y in the month before. The final figure is expected to confirm the first estimate of 1.6% Y/Y. It will be interesting to see whether core CPI, excluding food and energy, will show its first decline after staying unchanged at 1.9% Y/Y in the previous four months.
With regard to the ECB rate decision, the market is looking for a 50 basis points rate cut to 2%. Although we expect the ECB to be forced to cut rates to 1% by the summer, we are not that certain whether the ECB will already deliver a 50 basis points rate cut today. The next meeting is only three weeks away and until now the ECB has given no clear signal that another rate cut is to be expected at this meeting. Following the 175 basis points of easing during the fourth quarter, it may well be that some council members want to see a confirmation of a further step-down in activity before cutting rates for the fourth month in a row, as eco data can be fairly volatile around the turn of the year. At the same time, it was also fairly clear that some council members were uncomfortable with the unprecedented 75 basis points reduction in December. It is also the case that the substantial policy easing implemented in October, November and December has not had any time to feed through into the economy. Allied to this consideration are the problems in the money market, which despite some improvement, are still preventing a normal functioning of the market. Hence, some may argue that it might be appropriate to ensure the proper working of the money market before making another move. As such, we see a real risk for disappointment on the ECB rate decision today. A downward correction in the Schatz should however be seen as an opportunity to install new long positions.
On the supply front, Spain will tap its 15- and 30-year benchmarks for a total amount of between €1.8-2.8 B. The auction will constitute a huge test for the appetite for longer-term Spanish bonds, following the credit warning of S&P and yesterday’s rating downgrading of Greece from A to A-. Ahead of the auction, Spanish bonds have already underperformed strongly, as the spread compared to Germany in the 30-year sector widened from around 70 basis points on Friday to more than 100 basis points yesterday. Overall, the widening of the intra-EMU spreads continues unabatedly. The various bond auctions fared rather well yesterday. The Bundesbank successfully sold €7B of 2.25% December 2010 Schatze, covered 1.6 times with Bundesbank retaining 20%. Belgium priceD its €4B new 10-year OLO 55 at midswaps +50 basis points. There was beforehand quite some scepticism about the success of Italy’s auction, but it went okay as it sold €4B of new 3.75% Dec 2013 (cover 1.493), €1.5B of 5.25% Nov 2029 (cover 1.552) and €1.45B of Aug 2039 (cover 1.49).
Regarding trading, German bonds benefited from the sell-off on the equity markets and the Bund broke above the contract high at 125.56. The break higher in the Bund isn’t however yet confirmed by a break lower in German 10-year yields. A sustained break below the lows at 2.88 would open the way towards the targets of the major double top formation at 2.70%. A disappointment from the ECB could however first lead to a downward correction in the Bund too. Given our tactical inspired expectation that a disappointment is possible, short term players may consider profit taking with the idea of stepping in again after correction.
In the UK, the eco calendar is empty today, but on the supply front the DMO will tap a long-term inflation-linked Gilt.
