The US Treasury note future set a new ST high

Markets: Fixed income

On Friday, the week closed with yet another range-bound session for core global bonds, even as the US Treasury note future set a new ST high. The sole eco release of the day, US industrial production, was once more ignored due to Storm Sandy distortions.
Risk-off sentiment was dominant until well into the US session, but affected equities much more than core bonds, also a feature that was visible the whole week long. However, later on in the US cash equity market session, equities turned around. After the first postelection meeting between Republicans, Democrats and the president on fiscal policy and more in particular on how to avoid the fiscal cliff, all parties showed willingness to negotiate constructively. While the joint statement didn’t contain new information, it was enough to convince some equity shorts to cover their positions that proved so successful in the past two weeks.
There was some spill-over towards the core bond markets, but once more limited. In a daily perspective US yields fell between 0.4 to 1.3 basis points in the 2-to-10-year part of the curve. The 30-year bond underperformed and saw its yield go up 0.2 basis points. In Germany, bond yields were slightly lower (less than 1 bps), but also here the 30-year underperformed, leaving its yield marginally higher on the day. On intra-EMU bond markets, EMU bonds closed a quiet trading week with another quiet trading session. Ten year spread changes (apart from PIG) ranged between +1 bps and -2bps.

Greece remains the centre of attention in the run-up to Tuesday’s Eurogroup meeting. So far, the internal divide between Greece’s official creditors (IMF/Europe) doesn’t seem to be solved although German rhetoric was slightly softer over the weekend. The IMF is still pushing for a permanent solution (haircut for official sector, ie OSI) for Greece and to hold on to current debt targets (120% by 2020).
IMF Lagarde said she is driven by two objectives: The first objective is “to build and approve a programme for Greece that is solid, that is convincing today, that will be sustainable tomorrow, that is rooted in reality and not wishful thinking.” The second objective is safeguarding the IMF’s credibility. Europe/Germany on the other hand seems to look for quick fixes for Greece (like cutting interest rates on outstanding loans). Taking a hit on Greek debt is politically difficult for Chancellor Merkel, who faces elections next year. While FM Schaeuble repeated that they won’t take a haircut, other German politicians for the first time took softer stances. ECB Asmussen said that the Eurogroup meeting will bring a solution for Greek funding in 2013-2014, but that a new programme will be needed to cover funding needs after this period. ESM Regling said EMU would only take a haircut on Greek debt in extremis and CSU leader Seehofer, which shares power with Merkel’s CDU, indicated that if the Greeks need more time, his party is ready to talk. Overall, we believe that there will be some technical, political solutions but that the solution will fit within Europe’s “muddle through” framework. So the immediate threat of a bailout will be gone. Next, negotiations can start for a sustainable solution (pulled over the German elections), as the Asmussen comments indicated.

Today, the eco calendar is slightly better filled than is usual the case on Monday. In the US, the NAHB survey on the housing sector and the Existing Home sales are due for publication. In EMU, the overall construction output for September and the Italian orders are scheduled for release. None of these release will have a lasting impact though. On the event calendar, speeches by ECB Coeure, Liikanen and Weidmann will get some attention, while the Netherlands and France issue T-bills. .

Looking forward to trading this week, activity will be subdued as US markets will be closed on Thursday for Thanksgiving holiday and trading desks will be on skeleton regime on Friday, when most Americans go shopping (Black Friday). Also the eco calendar is thin with only some housing market data, Michigan consumer sentiment and the (distorted) claims on the menu. The fiscal negotiations between Congress and the president will continue (next meeting on Friday), but as the president tours Asia, no breakthrough is expected this week. Finally, Fed chairman Bernanke gives a speech at the Economic club in NY, which might be interesting, but coming just ahead of the Thanksgiving and thus in thin trading conditions, we would be surprised if he would really convey new messages towards the markets. In this context, it would surprise us if the Treasury market would not remain largely range-bound, unless European markets show strong directional moves. Nevertheless, we closely eye the 134-18 resistance (contract high), which if broken would improve the technical picture. The European calendar is more enticing. Attention will remain on Greece with the Euro group meeting tomorrow on the subject (see above for a rebound up of current positions). A “resolution” of the Greek issue is a risk-on event and thus negative for core bonds (also via the prospect of a bigger mutuality of debt). However, it looks that the “solution” won’t really solve the issue for once and all. On top of it, a number of events like the US fiscal cliff, the fate of the Spanish demand for ESM help and the banking union are still pending, which would dampen any optimistic reaction on a breakthrough on the Greek issue. Nevertheless and despite the constructive technical picture of the Bund, we would remain cautious and think the upside is limited this week. Following the confirmation last week that the euro area is in recession, attention will also go towards the November PMI business sentiment index on Thursday and the national German IFO and French INSEE surveys on Friday. Will they show that the economy slid further away in Q4 or are there signs of a bottoming out of the cycle, as is the case in the US and China? Should we be wrong and the Bund makes more substantial advances, the next key resistances stands at 144.49 (contract high), 145.88 (July high on continuation chart) and 146.89 (all time high continuation chart).

Overnight, Asian equities trade mixed to slightly positive with the exception of Japan that remains very strong on expectations the elections will bring a new government focussed on reviving the economy. EUR/USD is somewhat higher in Asian trading and the Bund opened modestly lower, suggesting indeed an underlying mild risk-on sentiment at the onset of European trading. Why? ECB Asmussen suggested that Greece may receive its money and that 2013-14 funding will be secured, but another aid package for the post-2014 funding will be postponed (after the German elections?). Some softening in the German position on Greece was also heard in comments of the CSU and ESM chief Regling.