Markets: Fixed Income
On Wednesday, global bonds eked out some gains as the FOMC reconfirmed that rates may stay at the exceptionally low levels for an extended period and didn’t say a word about the modelling, implementing or timing of its exit strat-egy. Earlier, a mixed 5-year T-Note auction has sent US bonds lower. In a daily per-spective, the US yield curve bull steepened with yields down by about 5 basis points at the shorter end to flat for the very long end. The EMU cash market was already closed at the time the FOMC statement was published. German yields fell a couple of basis points. Please note that the benchmark change of the US 2- and German 5-year Notes resulted in a rise of yields in the daily tables.
Intra-day, the Bund opened little changed and hovered sideways in a tight range be-low the previous closing level during the European morning session. The German BOBL auction was plain vanilla, while the EMU PMI’s showed an improvement in September, but one that fell short to expectations. Also the details weren’t unequivo-cal positive. However, EMU bonds ignored both of them. In early US session, bonds strengthened somewhat, but a mixed 5-year US T-Note auction pushed bonds sharply lower ahead of the FOMC decision. The Note future again approached the 116-18 support level, already tested a few times in recent sessions. The move, un-derstandably just ahead of the FOMC meeting, stalled though and was followed by a jump higher after the FOMC rendered its verdict. No change in policy, nothing sub-stantial on the exit strategy and a “promise” to keep rates low for an extended period.
Bonds to move higher in the range
Today, the calendar contains the initial claims and existing home sales in the US, as well as the German IFO indicator in the euro zone. In the US a $29 B 7-year Note auction is scheduled while the G-20 meeting in Pittsburgh starts.
After the slightly disappointing German PMI surveys yesterday, the risks are on the downside compared to the market consensus for a rise from 90.5 in August to 92.0 in September. A more gradual improvement in the business confidence surveys may underscore the message from policy makers and central bankers, who have been expecting a very slow recovery. Yesterday, ECB’s Nowotny said that ‘instead of a V-shaped recovery, we will see an L-shaped one, sharply down and then very slowly up’. He also warned not to draw too much comfort from the recent improvement in fi-nancial markets. ‘Financial markets are doing well at present, but that could be of temporary nature; a depression could still follow’, he added. This evening, ECB’s Stark is scheduled to give the opening speech at an exhibition ‘Die Sprache des Geldes’. Overall, we think the ECB would be quite happy with a rather gradual improvement in the economic outlook, as this would give them the time to withdraw monetary policy stimulus in an orderly way and at the same time re-duce the risks on new asset price bubbles.
The Fed played it safe yesterday and didn’t do anything that might have upset markets. No change in rates, an unchanged inflation outlook and only modest changes in its assessment of economic activity. Very importantly, the FOMC state-ment repeats 2 phrases which it has used since the Lehman debacle. Firstly, the Fed will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. Secondly it continues to anticipate that economic conditions are likely to warrant exceptionally low levels of Fed Funds rate for an extended pe-riod. Concerning its purchases of agency MBS and Agency debt, the FOMC confirms the amounts of $1.25 T and $ 200 B respectively, while it announce a slowing of the pace of these purchases to promote a smooth transition in markets. The program should be completed at the end of Q1 2010 instead of Q4 2009. There were no refer-ences made to an eventual redrawing of liquidity (exit strategy).
The US 5-year Note auction yesterday gave some mixed results. The stop was well above the WI bid at the time of the stop, but the bid/cover and buy-side participation was decent. However, the market sold off on the publication of the results, an indica-tion that supply remains a factor. The size of today’s 7-year Note auction has been upped by $1B to a record $29B. It raises all new cash at settlement. Last month’s auction went very well as did Tuesday’s 2-year auction. However, yesterday’s results of the 5-year inject some uncertainty about the reception of today’s 7-year Note auc-tion. On the positive side though, the FOMC meeting is out of the way and the state-ment is moderately positive for bonds, even if more for the short than for the longer end.
In the UK, the data calendar is empty, but BoE’s chief economist Dale will speak at the Exeter Chamber of Commerce. Yesterday, the Minutes of the Sep-tember meeting as well as the speech of BoE’s Barker indicated that the MPC is still very cautious on the longer-term outlook for the UK economy, despite recent better eco data and is still some distance away from an exit policy. Indeed, the Minutes re-vealed that governor King and Miles do feel that a further extension of the asset pur-chase facility may still be needed, while Barker warned that monetary policy should be careful not to initiate a ‘too rapid adjustment in private sector balance sheets. This could ‘keep domestic demand growth below trend’, in which case, ‘the inflation rate would be expected to remain below target, as the large output gap at present would be sustained’.
Today, the eco data may be at the margin bond friendly with risks for the IFO to dis-appoint and claims somewhat higher. The G-20 is interesting with the rebalancing apparently the main theme. We doubt however there will be an agreement on the subject. So it should be neutral for bonds. The US 7-year Note auction may on the contrary act as a negative ahead of the auction, but if it successful the market may be relieved that the monthly refunding is out of the way. Equities corrected yesterday. Will that continue? It may be as the S&P chart shows a bearish engulfing pattern. However, recently we saw that corrections were rapidly met by renewed buying. The underlying fundamentals stay positive for equities. The US and EMU bonds tested extensively the downside recently, but it held suggesting that in a short term perspec- tive the bottom is better protected. So we might see bonds moving somewhat higher in the recent sideways range.
Regarding US Treasury trading (unchanged), we were surprised by the strong run of Treasuries in August and early September in the face of stronger eco data, rallying equities and a weakening dollar and advocated a defensive attitude vis-à-vis Treasur-ies. We were quite well served last week as a correction occurred. However, the cor-rection has technically no meaningful significance, even if it brought the Note future near first support levels. These levels seem to have been rejected following the FOMC decision. While we remain moderately negative for Treasuries further out, Treasuries may climb higher in the range, especially should equities show some further correction. So we would sell Treasuries on upticks, if possible closer to the recent high at 118-16+ (10-year T-Note future). However, should Treasuries decisively drop below 116-18 we would jump the bandwagon. Should we be wrong and a powerful rally takes off, one needs to survey, in the cash market, the key tech-nical support levels (that would paint double tops if broken) that stand at 0.85% for the 2-year, 1.35% for the 3-year, 2.16% for the 5-year, 3.25% for the 10-year and 4.15% for the 30-year. Only a break below these levels would really unclog the market and open perspectives for more gains. However, this looks unlikely.
Regarding European bond trading, During the week, the Bund tested extensively support levels (120.17) with a new ST intra-day low at 119.85. Earlier, the technical break higher above the necklines of two double top formations at respectively 120.84 and 121.12 failed to generate additional upward momentum. The failed test of key support may now convince the market to look again to the upside and the Bund may settle higher in the range. However, only a sustained, but unlikely break above the previous reaction highs at 121.70/74 would suggest that a new up-leg is in the offer-ing, as this would also correspond with a break below the recent lows in 10-year yields at 3.20%. As such, we see the current move higher as an occasion to install new short positions and prefer a sell on up-ticks strategy at around the highs. On the downside, only a confirmed break below 120.17 (now neckline potential double top) would suggest that the upside is rejected and open the door for more downward cor-rection. While the current picture is one of indecisiveness, there are some pre-vailing risks on the downside for bonds though, which are however now pushed (temporarily) to the background.
