Markets: Fixed Income
On Thursday, global bonds rallied for the second consecutive day, as the profit taking on the riskier assets like equities and commodities continued. The trigger was the disappointing US Existing Home sales. Worth mentioning, the US 7- year T-Note auction went very well, while the German Debt Agency trimmed the planned issuance in Q4 by €4 B, especially in the 5-year sector, that outperformed on the day. In a daily perspective, US yields fell between 2.5 and 4 basis points, the belly outperforming. In EMU, German yields fell between 5 and 8 basis points, also the belly outperforming.
Intra-day, the Bund opened strongly, catching up with the post-FOMC developments in the US Treasury market. There was even an attempt to develop more upside momentum, but when European equities turned north following a weak opening, the Bund topped out and subsequently fell gradually and slowly lower. US Treasuries traded little changed ahead of the initial claims, but briefly dropped when the claims came out lower than expected. However, the absence of any follow through selling encouraged bottom pickers to appear, as it was the sign that the post FOMC buying wasn’t over. Indeed, later on Treasuries (and Bunds) gained further ground. An initial small uptick in equities following the release of lower than expected initial claims ran into resistance, which turned out a good pointer for the sell-off that followed the publication of weaker Existing Home sales. While also here the report as such wasn’t terrible important (see news) it was the trigger for some follow-up profit taking. The sharp sell-off was quickly finished and equities settled in a sideways range until the end of the session. Treasuries too settled near the highs and remained close to these until in the close. The 7-year T-Note auction went very well, but couldn’t push the Treasuries sustainably higher anymore, leaving Treasuries with moderate gains in a daily perspective. EMU eked out more robust gains as they had to do some post- FOMC catching up.
Bonds move higher in the range
Today, the market calendar is rather thin, but contains a few interesting features, like in the EMU, the August M3 money supply and credit growth figures and in the US the August durable goods and New Home sales and the final September Michigan consumer confidence. Regarding events, there are speeches of Fed Warsh, ECB Orphanides and SNB Hildebrand at the Chicago Fed’s banking conference and a brief appearance of Bernanke. Tentatively, we suspect little market-moving news from these appearances. The G-20 meets in Pittsburg with the economy (rebalancing), global warming, the IMF (vote changes) and the financial sector (reforms and bonuses) at the forefront of the debates.
With regard to EMU money supply growth, a further slowing is expected from 3.0% Y/Y in July to new lows at 2.7% Y/Y in August. The sharp slowing indicates that also on a medium-term basis inflationary pressures are likely to remain muted. A lot of attention will also be focused on the credit growth data given the fears about a credit crunch in the euro zone. Recent surveys from the ECB have however suggested that most of the slowdown is mainly due to demand factors instead of supply factors. In the US, the New Home sales will get attention after yesterday’s “disappointing” Existing Home sales. Sales were up in the past four months. New Home sales, for statistical technical reasons, are timelier than Existing Home sales. US durable orders are expected to stabilize (0.4% M/M) following a steep 5.1% M/M gain. Usually a strong monthly reading is followed by a weaker one (consensus), but given the developments in the car sector, the risk may be on the upside of consensus. The final Michigan consumer sentiment survey should show some modest further improvement.
Yesterday, the Fed scaled back two liquidity facilities. One day after the FOMC meeting the Fed announced that it reduces the amounts to be offered under the TAF and TSLF facilities, but the Fed keeps the option to expand its liquidity operations if needed. Perhaps the Fed thinks of the end-of-year period when liquidities conditions often tighten. In August the Fed already reduced amounts once, but given the improvements in markets, banks demand already fell below those reduced amounts. Therefore, the Fed saw the possibility to reduce them further. The announcement is consistent with the FOMC statement on Wednesday where the FOMC committed itself to use a wide range of tools (previously it spoke of using all available tools). The ECB announced that it will stop its 3-month auctions of dollar liquidity after the October 6 operation, while it will continue to offer 7 day liquidity at least until the start of January. Also here the decision is following the situation on the markets as in the previous auction there was no demand for 3-month money.
Today’s bond markets. The eco data may be at the margin bond unfriendly as risks for US data are on the upside, but as in recent days the eco data as such are not so important. They may however play the role of trigger that may bring the underlying sentiment to the forefront (See the reaction of markets on the initial claims/Existing Home sales yesterday). In the past two sessions, profit taking in riskier markets was the theme, which allowed US and EMU bonds to gain ground and move away from key support levels that were under test. So, the question for today (and early next week) is whether the correction in these riskier markets is over. For the S&P supports at 1039 and 991 may play their role. A loss of the latter would seriously question the correction hypothesis. We suspect they hold. If not, bonds would have the chance to break above the top of the sideways ranges located at 121.74 (Bund) and 118-16+ (T-Note future).
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 Treasuries. We were quite well served last week as a correction occurred. However, the correction 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 technical 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 (unchanged). 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 convinced the market to look again to the upside and the Bund settled 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 offering, 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 correction. While the current picture is one of indecisiveness, there are some prevailing risks on the downside for bonds though, which are however now pushed (temporarily?) to the background.
