Markets: Fixed Income
On Thursday, global bonds had again a quiet run, only modestly impacted by weaker equities, stronger initial claims, ECB talk and a disappointing US 30-year bond auction. This resulted in the US yields dropping 1.6 to 3.7 basis points in a daily perspective, the belly outperforming the wings marginally. In EMU, the curve steepened further with the 2-year German yield down 1.4 basis points, while 5, 10 and 30-year yields ended up by 0.7, 1.9 and 2.5 basis points.
Intraday, The Bund opened little changed and was well bid in initial dealings as Asian equities traded weak. However, sentiment very gradual soured as European equities found their composure and stabilized around unchanged levels. ECB Bonello spoke about the exit policy in very moderate wordings. The emphasise was on gradualism and he even suggested that the ECB might still be lending banks unlimited liquidity past the end of June 2010, when $442B in euros in 12-month loans must be repaid and keeping up extra lending operations in 3 and 6 months. This was dovish and helped the curve steepen. The EU industrial production data for September were slightly disappointing, but it left understandably no traces in the markets. Following stabilization, the Bund and the US T-Note future came under renewed pressure in the US session. Re-positioning ahead of the 30-year bond auction may have been a factor, but also initial claims dropped more than expected. The latter certainly didn’t initiate the down-leg, but surely gave it more impetus. However, a bottom was found and prices hovered sideways into the US 30-year bond auction. The latter was sloppily bid (see below) and Treasuries (and Bund) spiked lower only to reverse course as speedily as it had declined, short covering kicked in and Treasuries erased most of the losses. The changes in the cash market were partly the result of the catching up with the futures that remained open during Veteran’s Day. The EU Commission report on government finances had no noticeable effect on intra-EMU government yield spreads.
Global bonds continue to linger around without much momentum
Today, the market calendar heats up. In the euro zone, the calendar contains the third quarter GDP data. In the US, the September trade balance and November Michigan consumer confidence are scheduled for release. Central bankers on duty are ECB members Paramo, Weber and Noyer and Chicago Fed Evans. The ECB members have spoken recently and thus shouldn’t be important for trading, Evans speaks in Paris on asset bubbles, which might be interesting, but probably too late scheduled to impact European markets.
Most important figure of today will be euro zone’s third quarter GDP that is expected to show an expansion after five quarters of negative growth. The consensus is looking for an expansion by 0.5% Q/Q and we have no reasons to distance ourselves from the consensus, even if the retail data and Trichet’s cautious comments last Thursday make us a bit wary about the outcome. Such an outcome would also support an upgrade of the ECB assessment of the growth outlook to be expected at the December meeting. University of Michigan consumer confidence is forecasted to show a marginal improvement in November after falling from 73.5 to 70.6 in October. It remains to be seen however how households will have been influenced by the mediatised jump in unemployment rate to 10.2% although it apparently had no impact on the ABC consumer confidence, according to the latest report. In September, the US trade balance is expected to show a widening deficit. The consensus is looking for an expansion in the deficit from $30.7B to $31.8B as exports are forecasted to show the fifth consecutive increase, but an even larger increase in imports is expected.
The $16B US 30-year bond auction did not go well. The auction stopped at 4.469%, well above the 4.437% in the WI bid. The bid/cover of 2.26 was slightly below overall average, but better than at original issue auctions. The $8.7B Indirect bid was down from the August refunding, but the 80.5% hit ratio was high keeping the Indirect takedown at a reasonable 44%. Direct bid was strong and the hit ratio high leaving the direct takedown at a high 12.1%. The dealer bid was sloppy though with a 28% hit ratio. So, overall the auction was disappointing following strong 3- and 10-year auctions earlier this week, but it was no disaster. The market may be relieved that the supply is off the table for some time.
Philadelphia Fed Plosser said in an interview that inflation is a worry for the medium to long term not for the near term. He was cautiously optimistic on the economy that he saw in a transition to a more sustainable recovery. Like other colleagues, he however stressed risks coming from the commercial real estate sector. Regarding tightening, he noted that the pace of tightening will depend on the pace at which reserves flow from banks to the economy. This got quite some coverage and some suggest it initiated the drop in Treasuries (early in the US session), but it seems to us common sense. If the excess reserves flow to the economy, it means that the transmission mechanism works again and thus the special non-conventional measures aren’t needed anymore or not to the same extent. Plosser states that no decisions are yet made on which tools to use to withdraw market support and in what order, which he consider to be an important issue. Plosser prefers raising rates on excess reserves as an important tool, but didn’t exclude that draining excess reserves may need to happen via outright sales of assets or via reverse repos.
The November ECB report contained little new, but the results of the Survey of Professional Forecasters are worth mentioning. The longer-term inflation projection was lowered slightly to 1.92% from 1.98% previously. The GDP forecasts were revised higher to -3.9% for 2009 (from -4.5%), to 1% for 2010 (from 0.3%) and to 1.6% for 2011 (from 1.5%). This strongly suggests that also the ECB staff growth projections will be revised higher when published in December. It might also give the ECB the opportunity to invoke the better outlook when deciding to stop some of its nonconventional measures. Speeches of ECB governors Tumpel-Gugerell and Draghi didn’t contain market moving news. ECB Bonello (Malta) spoke with Reuters on the exit strategy. He said all options are still open on the unwinding of the unconventional measures. However, the unwinding should be gradual, non-disruptive in its impact and have to see to it that liquidity is absorbed in a way which counters any threat to price levels. Options include extending the policy of lending banks unlimited liquidity past the end of June 2010, when $442B in euros in 12-month loans must be repaid and keeping up extra lending operations in 3 and 6 months; He declined to comment whether the ECB would raise the cost of funds at December’s 12 month LTRO (cur- rently 1%) and as the ECB would not know how much liquidity the banks would ask for, he suggested that it would be unlikely the ECB would give a very detailed plan for its refunding operations in 2010. However, it looks like the ECB will continue with its fixed rate, full allotment procedure for re-financings in 2010, but subject to changes later on in 2010.
Portugal considers proposing ECB Constancio (Portugal’s central banker) as the next ECB vice-president. Constancio is one of the most, if not the most dovish, member of the entire ECB council. The post of vice president is however de jure not more important than the one of other members of the executive board and therefore Constancio’s eventual nomination wouldn’t have much immediate influence on the monetary policy decisions and thus shouldn’t affect markets.
Regarding trading today, Asian equities are trading mostly (moderately) negatively, but following Wall Streets steeper fall, it doesn’t give us many clues about equity trading later on. The eco data may support optimism on the near term eco outlook and thus be negative for bonds. However, consensus already points in that direction which should dampen any impact. Compared to weekly opening levels, EMU bonds are only modestly higher, too little to see pre-weekend profit taking kicking in. Some positive effect may come from US Treasuries, at least if the T-Note future succeeds in breaking the 118-28+/119-01 resistance, now under test. Overall though, we didn’t discover a clean, outspoken price pattern in recent weeks, making us cautious on setting up a strategy for the day. If equities would correct further in next sessions, we might see Treasuries and Bunds revisiting the recent highs at respectively 119-29 and 122.44/123.04.
Regarding the European bond market, re-iterating our view, the longer-term bullish technical picture of the Bund started to deteriorate after the Bund fell off the highs at around 123.00 and broke below its long-standing uptrend channel. It didn’t however come yet to a real test of the September lows at 119.85 (which if broken would violate the higher low higher high configuration), but a break through 120.51 would already be an omen that such a test might be in the cards. Earlier this week, the Bund moved further away from the support and put a bullish engulfing pattern on the chart, a short term positive, but more gains are needed to become more enthusiast. The broken uptrend at 122.09 is the first point of reference.
Regarding the US Treasury market, the technical picture of the US T-Note future is still quite similar to the Bund future, as the T-Note future has also fallen off the highs (119-29) since early October and rebounded before a test of the September lows (116-18) occurred. Last and this week, the US T-Note tested but yet failed to break above the neckline of a potential double bottom formation at 118-28+/119-01, but kept the Note future still a good distance off the crucial 116-18 support level (more than the Bund). With the refunding operation finished, supply may fade into the background for some time, making us curious whether it will be enough to lead the T-Note future break the 118-28+/119-01 resistance. A break might brighten the short term outlook and open the way for a test of 119-29 (October 2 high) level.
