Rating agency Moody's might review the Spanish rating

Rates

On Thursday, the session had two faces. Initially equities and credit spread products (especially peripherals) were heavily hit, a continuation of the past risk-off sessions. The Spanish bond auction went bad and Greek concerns grew. Core bonds tested highs (German 10-yr yield 0.72%). However, the tide turned around noon. Equities found a bottom and rose very gradually higher while the sharp sell-off in the peripheral bond stopped. Various factors contributed to the turnaround. First, oversold conditions in equity markets and overbought ones in the core bond markets. Second, the EU released a statement on Greece, pledging that it will do whatever is necessary for Greece to regain the confidence of investors. The Greek 10-yr yield stopped its surge higher a tad below 9%. The ECB also raised the amount of loans available to Greek banks by around €10B and adjusted haircuts on Greek government bonds. Later in the session, riskier markets got help from strong US eco data, even if the immediate post-publication reaction was modest. Finally, St-Louis Fed Bullard suggested that the Fed may delay the end of its QE programme (that normally should be finished at the October FOMC) and wait for more evidence on inflation and growth. So, US equities managed to close the session virtually unchanged. German 10-year yields rose by 1 (2-yr) to 6.4 bps (10-yr) and US yields by 1.8 to 3.6 basis points (bull flattening). Peripheral and semi-core 10-yr bonds trimmed the spread widening to less than 10 bps. The Greek 10-yr yield spread still widened by 104 bps (8.96% yield) suggesting that announced measures didn’t ease all concerns.

Today, in the US, the housing starts and permits and Michigan consumer confidence will be released. ECB’s Constancio and Nowotny are scheduled to speak as well as Fed Chairwoman Yellen and the ECB will announce the amount of LTRO repayments.

Recently, both US housing starts and permits have been very volatile, showing huge month on month swings. The underlying trend remains positive, although the recovery has slowed substantially, we believe that the risks are for an upward surprise. The first estimate of University of Michigan consumer confidence for October is forecast to show a limited weakening in sentiment.. Risks might tilt to the downside.

St. Louis Fed Bullard said yesterday that the Fed should consider delaying the end of its QE-programme to halt a decline in inflation expectations. The US 5yr5yr inflation swap fell from around 3% this summer to 2.61% currently. This indicator stood around 2.5%/2.6% when the Fed launched QE-2, operation Twist and QE-3. Bullard is the first Fed governor to publically call for an extension of QE. His comments are quite remarkable as the Fed governor also confirmed his view of a first rate hike in Q1 2015. A pause in purchases would be a “low cost move that we could make, because purchases are already at a low level – it would buy us a little bit of optionality, a little bit of ability to take a more aggressive stance if we had to.”. His comments had an intraday price impact (especially equity and currency market). We closely monitor speeches from other governors for more clues ahead of the Oct 29 Fed-meeting

Today, rating agency Moody’s might review the Spanish rating. Spain is currently rated Baa2 with a positive outlook. A one-notch increase would bring the rating in line with Fitch’s BBB+ rating (stable outlook). S&P rates Spain BBB (stable outlook). An upgrade would be marginally supportive for Spain.

Overnight, Asian equity markets are mixed with China and Japan underperforming. Yesterday evening, WS managed to regain opening losses. There is no headline news and the Note future is upwardly oriented.

Today, the eco calendar is thin with US housing data and Michigan confidence. We forecast a mixed outcome which would be irrelevant to trading. ECB speakers are plenty with Coeure, Constancio, Nowotny and Weidman but the big wildcard for today is a speech by Fed chairwoman Yellen. Will she voice confidence in the recovery of US labour market or voice concern about the inflation outlook? What about the disconnect between the Fed’s rate projections (1.375% policy rate at end 2015) and market expectations (1st rate hike in Feb2016)? Is the Fed on the eve of changing its forward guidance?... Apart from these items, equity market sentiment remains key. Dark expectations about the global economy/inflation and fears that monetary policy reached its limits took investors hostage this week. European/US equities suffered but yesterday we had some first signs of consolidation. Any slowdown/consolidation in the downward correction of equities, could be a signal for bonds to further shrug off overbought conditions. Ahead of the weekend, profit taking is likely. In that respect, Wednesday’s trading session could have been something of an exhaustion move. If the sell-off on equity markets continues though, we will likely revisit contract highs/gradually move to the intraday lows in yield terms (see above). The technical picture is bullish for bonds.