Markets: Fixed Income
On Tuesday, global bonds posted a strong rebound, as equities retreated from the highs and the US eco data came out bond friendly. As such, investors ignored another string of strong Q3 earnings from Apple, Texas Instruments, Caterpillar, but focused on the weaker than expected US housing starts and permits and the larger than expected decline in the PPI. This helped bonds to extend their rebound after the test of key support levels in both the Bund and the US T-Note future failed recently. The intra-EMU spreads narrowed slightly in response to a strong Irish bond auction.
Intra-day, bonds opened the day lower, as sentiment on the Asian equity market was still bullish. European equity markets however soon failed to hold on to their opening gains on profit-taking in part due to reports that the Qatar Investment Authority was unloading its position in Barclays. The reports raised concerns that the recent rally on the equity markets had gone far enough, and offered support to the bond markets. Equities however recouped their losses in the run-up to earnings results of Caterpillar, which again topped analysts’ expectations, but equities failed to build out the gains afterwards. As such, bonds traded almost unchanged when the US data were released. The US housing data came out weaker than expected pushing equities lower and bonds higher. In the euro zone, German yields were up between 5-6.5 basis points compared to 3-5.5 basis points in the US, with the belly of the curve hit the hardest.
Uptrend channel Bund remains intact
Both in the US and euro zone, the eco calendar is boring today with no market moving eco data scheduled for release. Therefore, most attention is likely to be focused on the Fed speeches from Lacker, Tarullo and Rosengren and the Beige book ahead of the next Fed meeting on the 4th of November. The Fed will also buy Treasuries in the 08/26 to 08/39 sector in the framework of its Treasury purchase program.
Yesterday, Treasury Secretary Geithner said the Obama administration will shutter programs of the TARP plan, but remain focussed on supporting the economy. The Treasury will start to wind down some programs and focus on programs directed at areas where there is still weakness in access to credit. He announced three programs to be shut down by year-end, but no decision has been made about the overall bailout plan. The Capital Purchase Program, the Capital Assistance Program and the Targeted Investment Program are singled out to stop at the end of the year.
Regarding Fed speakers, yesterday Fed governor Warsh moderated at the San Francisco Fed conference on Asia and the financial crisis. Warsh spoke recently very hawkish by saying that interest rates may need to rise more rapidly and ‘with greater force’ than it has in the past to keep inflation in check. However in San Francisco he was less outspoken and wondered whether the steep rise in Asian and US equities signal a return to normalcy after a wrenching crisis or raise the prospect for asset bubbles. Because there will be more crises and turmoil in the future, he said policymakers need to be prepared and develop new tools to fight the next crisis. At the same Conference, San Francisco Fed governor Yellen, traditionally a dove inside the FOMC, showed herself once more dovish by saying that she doesn’t expect the Fed to raise rates or start unwinding the liquidity injected into the economy in the next few months. She referred to the “extension period” phrase in the FOMC statement following the September FOMC meeting. Yellen said the Fed had not yet made up its mind which tools to use and when to exit its QE policy. In other comments, she also said that a deposit facility, a new tool to drain liquidity, is ready to be used, but will only be put to use once the time to tighten is right. If Yellen’s words (given in an interview) are correctly interpreted it would mean that we will be sure the tightening has started the day the deposit facility is effectively running. In a speech at the Stanford University, Philly Fed governor Plosser suggested the Fed should strike a deal with the Treasury to allow the Fed to swap its non-Treasury securities for US Treasuries. He also wanted that an authority other than the Fed should be in charge of winding down troubled financial “too big to fail” financial firms. Plosser is clearly concerned about the Fed’s independence that might be at stake because of its unorthodox policy (MBS asset purchases) it was obliged to conduct because of the crisis. In the same vein, former Fed governor Mishkin, now professor, said the Fed’s large and growing holdings of MBS securities pose a ”real dangers” for the future. More than its size it is the composition the Fed’s balance sheet that is disturbing, because being a big player in that market it is not clear how the Fed is going to get out of its asset holdings. All these comments show that the Fed hasn’t finished its thinking on the how and when of its exit policy.
Today, there are speeches of Fed governors Lacker, Tarullo and Rosengren. However, they may be less interesting. Lacker speaks on “Economics made easy” to journalists and Rosengren gives some welcome remarks at a conference. The subject of Tarullo’s speech is not specified. Given the recent somewhat more mixed eco data releases, the market will closely look to the Beige Book, a preparatory document of the November FOMC meeting that describes the economy via anecdotal evidence collected by the Regional Fed banks. Usually though, it is close to the published data.
The Fed will conduct another round of purchases of US Treasury securities. The Fed targets today the 08/2026 to 08/2039 sector of the curve. The Fed purchased already $297B of Treasuries, almost finishing its $300B program. With two auctions to go and $3B to buy, the amounts are really small and therefore the impact should be modest too.
Regarding trading today, Asian equities trade narrowly mixed, giving little signals about trading in the European session. Further out, unless some Fed governors surprise, it might be the earnings season and equities that are the most important input for bond trading. Yesterday, above consensus earnings report couldn’t help equities eke out additional gains. Equities look toppish, but in recent days there was no sign of a sustained correction. Equities limited losses and closed well above intra-day lows. Yahoo earnings surprised positively overnight, but caused little positive momentum in post-closure trading. So, despite the still strong posture of equities, the prospect of a correction should be taken seriously. Recently, bonds reacted asymmetrical to equity moves. They lost relatively little ground when equities boomed, but gained ground on some, temporary equity weakness. A similar reaction to eco data: Strong eco data are well digested, but weak ones are a reason to rally. Will this pattern hold? However following the rally of the past days, bonds might need a breather and unless equities tank, bonds may hold their recent ranges today.
Regarding European bond market, the longer-term bullish technical picture of the Bund started to deteriorate last week after it fell below 121.74. This is a first warning signal that the underlying sentiment is deteriorating. However, the correction stopped at 121.12 (neckline LT double bottom) and subsequently moved higher to about 122, signalling that the market might not be ready to push the Bun substantially lower. In German 10-year yields, the move corresponded with a rebound above 3.25%. This potentially opens the way to a re-test of the highs, difficult to break through and therefore a good level to trim long positions or short the market
Regarding the US Treasury market, early October Treasuries broke key resistance levels, suggesting that another up-leg was in store. However, recent price action has been disappointing and the confirmed drop below the previous high at 118-17+ (TNote future) only confirmed the corrective move. In the cash markets, the re-break above 3.30% (10-year) and 4.15% (30-year) confirmed the technical picture of the futures. However in previous days the bonds try to regain the lost ground. The jury is still out though, even if we admit that a potential correction in equities might once more drive Treasuries to recent highs (119-29 for the Note future). We would take such a move as offering longs the possibility to trim or close their position.
In the UK, the calendar contains the CBI industrial trends survey (October) and Bank of England Minutes. Last month, the CBI industrial trends survey showed a slight increase in total orders (-48 from -54). For September, another improvement is expected, but total orders are forecasted to stay in negative territory for the 16th consecutive month. On the 8th of October, the Bank of England decided to leave rates unchanged at 0.5% and added that its £175B asset purchase facility would take one more month before it is completed. We expect a unanimous decision as the MPC will have preferred to await the next quarterly inflation report in November before deciding on a further expansion of its facility.
