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Sunrise Market Commentary

The BoE will continue to be active in the corporate credit market

Fri, Feb 5 2010, 08:41 GMT
by KBC Market Research Desk

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Markets: Fixed Income

On Thursday, US and German bonds profited from a pronounced flight-to-quality as a number of equity-negative developments conspired. In the euro area, tensions about the government finances increased with now clearly a con-tagion from Greece towards especially Portugal and Spain. The eco data were mixed. However, the sharp drop in German new orders send shivers throughout the analyst community. Taken at face value, it shows that the recovery has in recent months quite some momentum, just at a timer in the cycle one expects the opposite. On top of that, everybody counts on Germany to pull the euro area out of the dire economic situation. Indeed, tellingly, German new orders coming for the other EMU countries fared the worst. In the US, the eco data were mixed with the claims dis-appointing, but factory orders, monthly retailers’ results and productivity growth strong. So, we wouldn’t explain Wall Street’s sell off by pointing to the (volatile) claims, even if there was a noticeable price move at the time of release (see graph). There may have been some contagion from the EMU fiscal woes towards the US. Didn’t Trichet point out at his press conference, subtly, that the EMU fiscal deficit is far lower than the US one. Interestingly, the 5-year CDS prices of sovereigns mounted across the board, but certainly also for the US (57 bps, up 10 bps) (see graph). A third element that shouldn’t be underestimated in the equity sell-off is a sign that the US might turn more protectionist. Indeed, president Obama, not only will visit the Dalai Lama and sell weapons to Taiwan, two hot items in its relationship with China, but he vowed to get tough with China (and others) on trade and ex-change rates. China reacted with anti-dumping measures against the import of US chicken. So the list of concerns has risen considerably in recent days causing investors to cash in of past juicy equity gains. In a daily perspective, US yields fell by 7 to 10.4 basis points, the belly outperforming, while German yields rose by 5 to 7.8 basis points, steepening the curve, something one should expect in case of a flight to quality.

In the intra-EMU bond universe, tensions increased further with the focus shifting to Portugal and especially Spain. The Greek market stabilized in recent days (at high spread levels) after the EU Commission accepted the Greek stability program. Trichet welcomed, if not whole enthusiastically, the Greek program. There are new doubts about the ability of the above mentioned countries to rein in their deficits and stabilize their debt ratio in a context of a very weak growth outlook. Late in the eve-ning, the Portuguese government lost a parliamentary Commission vote on a re-gional financing bill that risk raising the 2010 deficit. He appealed to the parliament to block the bill in today’s vote. In the current context, if the bill passes it would hit the credibility of the minority budgetary plans. The Portuguese 10-year yield spread wid-ened another 12 basis points to 159 basis points. However, also the Spanish 10-year yield spread rose 8 basis points to 96 basis points despite a strong 3-ear Bono auc-tion. The Spanish stability plan that was sent to the EU Commission looked quite credible to us. It would bring the deficit down to 3% of GDP in 2013 from 10.4% of GDP in 2009. The plan shows a 2.4%-point structural tightening in 2010 with the fo-cus on tax increases. However, the efforts swing towards expenditure measures in consequent years. The discussion points are still the deficits of the regions and the pension reforms. Beside Spain and Portugal, the yield spreads of Italy (+5bps to 90 bps), Ireland (+4 bps to 166 bps), also the Belgian (+3 bps to 57 bps) and France (+1 bps to 26 bps) widened.

Today, all eyes will be on the US payrolls report (January). Besides the payrolls, the calendar contains also the German industrial production data (December).

Last month, the payrolls disappointed showing a decline in employment by 85 000, while the consensus was looking for a flat outcome. For January, markets are looking for an increase in payrolls by 15 000. This year, the 2010 census will create some ex-tra jobs, based on the previous census, it might boost January payrolls by 20 000, which is not included in the ADP report as the ADP report includes only private pay-rolls. We believe that the risks might be on the upside of expectations due to the cen-sus, but also weather conditions might put the risks on the upside. In December, bad weather conditions depressed the payrolls. In January weather was still relatively cold, but materially less than in December, and therefore, the swing between De-cember and January might be employment friendly. The January report also includes the annual benchmark revisions and based on the preliminary benchmark revision, the level of March 2009 payrolls appears to be 824 000 less than earlier estimated. In Germany, industrial production is forecasted to have risen by 0.7% M/M. Following disappointing new orders, reported yesterday and given uncertainty about Q4 GDP growth, the production figures may give some more insight into Q4 GDP growth.

Regarding the ECB meeting and press conference, it went largely uneventful and not without cause. Indeed, given the tensions in especially the European bond markets, the recently approved Greek stability program and the promise at the January meet-ing that the ECB would discuss liquidity withdrawal measures in March, it was clearly the intention of ECB and Trichet to be dull in both the statement and the Q&A session afterwards. Disappointing German order figures earlier in the day and the well-known difficulties in the peripheral countries were an additional reason for the ECB to be cautious on growth and wait on the March staff projections before taking position on a number of issues. The cautiousness of the ECB and upped doubts about the eco-nomic recovery together with the fragility of the peripheral countries convinced the market to push further out rate hike expectations to well into 2011.

Despite the doubts about the Spanish financial situation, the sale of its 3-year Bono went well, as €2.5B of paper was placed at an average yield of 2.63. Demand was solid (bid/cover of 1.85) and while it came after the recent cheapening of Span-ish bonds, it shows the country can issue debt, which was recently less clear for Greece and Portugal. The French OAT auction went reasonable well, but not excep-tionally. France sold €7.869B of bonds, near the high of the target range. It issued a new 10-year OAT and tapped its 6- and 30-year OAT’s. Of the new 3.5% Apr 2020 €4.71B was raised with a 1.68 bid/cover, not terrific. The Portuguese debt agency said gross bond issuance would amount to €18B this year, up from €16B last year. It will launch two new benchmarks via syndication, with maturities and dates to be an-nounced later. Importantly, it wants to raise between €5.5 and 6.5B in Q1, of which already €1B has been raised.

Regarding trading, the key question is whether the carnage in the equity markets will continue. Developments in the intra-EMU market and the US payrolls will be key today. Yesterday, US and German bonds surged on risk aversion pushing the Bund above the contract high, while the March US T-Note future touched, but not broke through the 118-14 resistance level. The German Schatz is testing today the high on the continuation chart (108.75). The intra-EMU tension won’t dissipate in the morning, but the payrolls may bring some respite ahead of the weekend, if the report is very strong though. Our strategic view that German and US bonds were toppish and Ger-man bonds were too expensive is put into doubt after yesterday’s surge. However, while German bonds may continue to move higher on the risk aversion theme, it makes no sense to run behind the rising bonds. Our basic view would only need a change if we edge to another deep globalized crisis on the markets. The gov-ernment finances are a potential trigger for such a development, but remain a risk scenario we think. The close this evening might be important. A closure be-low 123.74 in the Bund and the inability of the T-Note future to move beyond 118-14 would be an indication that the situation hasn’t changed too much. However, it might be equities that contain the key for the global economic and market outlook. The S&P shouldn’t drop below the 1030/20 level in a sustained way or the odds are that another market crisis or at least an interruption of the global recovery looms. However, at long as the S&P cannot recapture 1104 level, downside risks remain.

In the UK, the calendar contains the PPI data (January), which are forecasted to show a further increase in producer prices.

The MPC of the BOE decided, in line with expectations, to keep its rates unchanged and to halt its £200B QE program. The statement didn’t contain many surprises. The MPC noted there had been some tentative signs of recovery and sees substantial slack in the economy that will push inflation again lower from temporarily elevated levels. On QE, the MPC decided to halt the program, but signalled that it may resume the program at some point, probably if the recovery wouldn’t take off in the first se-mester of 2010. The BoE will continue to be active in the corporate credit market, but purchases will be financed via the issuance of Treasury bills and not the creation of reserves. The activity of the BoE in this market has been marginal though.

The Gilts rose moderately yesterday with yields dropping 3 basis points at the front end and remaining unchanged at the long end, underperforming the German market though.

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Published on  Fri, Feb 5 2010, 10:51 GMT

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