Markets: Fixed Income
On Monday, global bonds had a strong run despite surging equities &, commodities, declining corporate spreads and plunging swap spreads, all typically reflationary trades. Bonds did already well from the start of trading, but received a boost following the speech of Bernanke, in which he sounded very cautious, even a bit pessimistic on the outlook for the economy (see lower). The chairman backed up his cautious tone by repeating that rates could stay exceptionally low for an extended time. The US eco data were a bit mixed versus consensus. Retail sales were encouraging, but the pullback of the NY Fed manufacturing index was deeper than expected. It had little impact though. The curves flattened in both the US and EMU, as previous steepening had brought the curve near its steepest for the cycle. Contrary to what one should expect, intra-EMU yield spreads continued to widen both yesterday and early today, with especially Greek credit in the focus.
Overnight, Fed vice chairman Kohn gave a very interesting speech in which he said that there is currently no bubble in the asset markets brewing, contrary to the opinion of some vocal analysts. He even admitted that one of the desired effects of the current low rate policy is higher asset prices. Eventual bubbles should be addressed by micro- and macro-prudential oversight and regulation and not by monetary policy that should remain focussed on the dual objective of maximum employment and stable prices. While Asian equities are trading modestly lower today, it is a longer term positive for risky assets classes. US equities set new highs yesterday, which if confirmed, would be a major development. Potentially it is negative for bonds, but given the Fed assurance that policy rates will stay low it shouldn’t have too much negative impact. On the contrary, bonds might stay firm. The curve should theoretically steepen on Kohn’s remarks, but given that short rates have fallen again to very low levels and the curve is very steep, the recent flattening may have further to go.
Today, the eco calendar contains the euro zone trade balance (September), US industrial production (October), NAHB housing market index (November) and PPI data (October). In August, the euro zone trade surplus dropped to its lowest level since April as exports dropped more than imports. For September, the seasonally adjusted trade surplus is forecasted to contract further as imports are forecasted to have grown faster than exports. In the US, industrial production is forecasted to show the fourth consecutive increase in October (by 0.4% M/M). Nevertheless, we believe that the risks might be on the downside of expectations as the production was very strong in September and some payback may kick in. In October, the NAHB housing market index showed an unexpected worsening in home builders’ confidence which might have been due to the expiring of the tax credit on sales. For November, the consensus is looking for an increase from 18 to 19 due to the expectation that the first-time home-buyer tax credit might be renewed. An increase in energy and food prices is forecasted to push PPI inflation up in October. On a monthly basis, producer prices are forecasted to have risen by 0.5% M/M, while core PPI is expected to show an increase by 0.1% M/M.
There are also a lot of central bank appearances today. Regarding the ECB, Chairman Trichet speaks at the European Banker of the Year award, while Executive Board members Stark and Tumpel-Gugerell speak in Germany on financial stability and 10 years euro respectively. We don’t expect new info from these speeches, as both spoke only days ago. Yesterday, various central bankers (Quaden, Orphanides, Nowotny, Wellink, Weber, Liikanen) repeated that the unwinding of nonconventional measures will occur in a very gradual way. Looked from another angle, it is also an invitation to the financial sector to be prepared for such a withdrawal. The end of existence of the 1-year LTRO (long term repo operation) seems a done thing (after December’s final tender). Points of discussion remain the introduction of a spread over the main policy rate for the December 1-year LTRO and a potential reduction in the pace of other LTROs (3-6 month) in H1 of 2010. ECB Quaden stressed that these measures should not be considered as a monetary tightening, but an invitation for banks to restructure their portfolios and to resume their market-based funding activities. According to news agencies, ECB Orphanides would have said that the removal of all these operations would constitute monetary tightening and thus their removal should also be considered in the light of the usual yardsticks for monetary policy (inflation/deflation).
In the US, regional Fed governors Yellen, Lacker and Pianalto take the stage today. Yellen, an outspoken dove in the FOMC, recently said that the risks of deflation remained high. Pianalto, a more centrist figure, who last spoke in early October, most likely will keep close to the Bernanke party line in her comments. Atlanta Fed Lacker on the contrary is a hawk on policy, but he did nothing to underline his hawkish credentials when he last gave an interview on November 10. He sounded quite relaxed by the current policy stance and by the progress in the economy, while he didn’t see inflation as a near term problem. He declined to speculate when rates could be raised and even said that it could take longer than 2010, the date the interviewer suggested.
Yesterday, Fed chairman Bernanke outlined the challenges of the US economy to recovery. On the contrary, he said nothing new about the exit policy, sticking to the phrase that economic conditions including low rates of resource utilization, subdued inflation trends and stable inflation expectations are likely to warrant exceptionally low levels of the federal funds rate. He was very cautious about the economic outlook, as growth would be constraint by a difficult credit environment for households and small businesses and a weak job market. He also mentioned, as did colleagues before him, the distressed commercial real estate market as a downside risk. Regarding the job market, he was quite pessimistic arguing that “the best thing about the labour market right now was that it may be getting worse more slowly”, while even questioning the possibility of a jobless recovery. The chairman expects inflation to remain subdued for some time pointing to the resource slack on the one side and high commodities and weaker dollar on the other side.
In a remarkable speech, Fed vice chairman Kohn defended the Fed doctrine on asset prices and bubbles that has come under heavy critique following the financial crisis. He says that monetary policy is a too blunt tool to use for fighting financial instabilities and bubbles. If the Fed would use it and thus include financial stability as objective of policy besides maximum employment and stable prices, it would cause greater volatility in inflation and economic growth, even without being sure it would obtain financial stability. So over the cycles it would lead to lower/higher growth and lower/higher inflation. He proposes to use micro- and macro-prudential oversight to make the financial system more resilient to the inevitable cycles in asset prices. He applies these insights to the current situation. Some, he said, point to current strong rises in asset prices as a bubble. Should the Fed hike rates? It would derail an already fragile recovery and might bring deflation. Kohn concludes that the current uptrend in asset prices probably is no bubble and even states that monetary policy aims at pushing asset prices higher. “Another important factor has been the very low level of policy interest rates in the United States and in most other industrialized economies. Indeed, one of the purposes of these policies is to induce investors to shift into riskier and longer-term assets in order to lower the cost and increase the availability of capital to households and businesses. The more accommodative financial conditions, in turn, are intended to induce an increase in spending at a time when the level of output is expected to remain depressed for some time relative to the capacity of the economy to produce.” Kohn consciously or unconsciously gives investors the green light to speculate on further asset price gains by saying:” At present, however, the prices of assets in US financial markets do not appear to be clearly out of line with the outlook for the economy and business prospects as well as the level of risk-free interest rates.”
The Irish Debt Agency taps the 4% Jun 2014 and the Oct 2019 for a small amount of €0.74 to 1B.
Regarding trading, Asian equities traded mostly with negative bias overnight and also European equities opened slightly negative. This might be profit taking following a robust run yesterday. Fed’s Kohn’s remarks overnight look as an invitation to buy equities, we think and if the S&P may confirm yesterday’s break higher, we might have to change our view that equities will trade more sideways in the next months in favour of a more optimistic outlook. European bonds opened slightly down.
Regarding the European bond market, 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 to a real test of the September lows at 119.85 (which if broken would violate the higher low higher high configuration). The Bund managed to move away from these lows and a constructive session yesterday lifted it to 112.12. The broken uptrend at 122.19 is still the first point of reference. The longer end of the bond market seems to be in a wait-andsee period from which we don’t see it exit in the near future. Sideways trading in the 120.51/119.85 to 122.44 range is still likely, but if the 122.44 resistance is broken, it would open the road for a retest of the 123.04 contract high.
Regarding the US Treasury market, the technical picture of the US T-Note future improved yesterday as Bernanke’s comments pushed the contract to a 119-23 high, only 6 ticks from the contract high. A bullish inverted Head and shoulder formation with neckline at 118-28+ is now reigning and has final targets around 120-30). The short term picture is now bullish, but we have still some second thoughts about the upside. We wouldn’t jump on the bandwagon, but use eventual retests of the contract highs to offload long positions.
In the UK, the calendar contains the CPI inflation data. September is forecasted to have marked the trough in British inflation. In October, UK inflation is expected to have risen from 1.1% Y/Y to 1.4% Y/Y and also core CPI is expected to show a slight uptick.
