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Sunrise Market Commentary: Fixed Income

Sunrise Market Commentary: Fixed Income < News < Bet On Markets

 — Bond Markets: US Treasuries surge higher, as weaker payrolls spark terrific rally European bonds boosted by Payrolls and euro
— Currencies: USD disappointed by payrolls
— News: Thin calendar, but does that mean calm markets?

US: Belly of Curve Outperforms
On Friday, US Treasuries closed at the highs of the day after a weaker than expected payrolls report sparked a terrific rally.

The market had lost quite some ground in recent weeks and seemed po-sitioned for a stronger payrolls report. However, November payrolls were much weaker than expected, the October and September payrolls revised lower, the length of the workweek shortened and average earnings were barely up. That took many traders awry and prices shot up. Following a slight pullback, buyers came out in force and pushed prices further up, until the market settled down near the highs later in the session.

During the massive re-positioning, a slightly stronger-than-expected non-manufacturing ISM survey and positive comments on the economy by Fed governors Minehan and Santomero (however without breaking new information) were ignored.

While on the data release, the curve steepened, it was the belly of the curve that took over fur-ther and leading to an outperformance of the belly in a daily perspective.
From a technical point of view, despite the huge movement only the picture of the 30-year became again bullish. The 10-year yield is close to, but still above the key 4.25% support level and the same applies to the 5-year yield (3.55%). In the money markets, the payrolls didn・t put into question a Fed tightening at the December 14 meeting, but the debate on a potential pause in the tightening cycle at some point in H1 2005 is open again.

Equities were little changed and had no impact on Treasury trading. Lower oil prices were ignored.

The dollar sold off once more against euro and yen. While we consider it as intrinsically Treasury negative, some observers point out that it played a supportive role via the expectation that the weaker dollar would lead to forex interventions and recycling of the proceeds into the Treasury market.

Equities weathered the weaker payrolls rather well. Good guidance of Intel and lower oil prices were positive factors. These offsetting factors led to mostly sideways trading following some early session volatility. At the end of the session, equity indices closed little changed.

Previewing this week, the economic calendar is thin with little market moving releases. Only the November PPI and the final November Michigan consumer sentiment reports on Friday are able to impact the market in a more than very mo-mentous way. Besides these, the market will be pre-occupied with the 5- and 10-year Note auctions on Wednesday and Thursday. Market participants will also keep a close eye on the dollar and eventual BOJ interventions. Last but not least, it is probably the last week of the year with normal market conditions. Investors will start squaring positions from here onwards.

Looking more into detail at the economic calendar, on Monday there are no economic data releases scheduled, while on Tuesday, consumer credit and productivity (Q3 revision) are second tier releases. Somewhat more than usual attention will be given to the weekly retail sales as the Christmas shopping season is in full swing. No more ex-citement on Wednesday with the Richmond Fed survey for November. On Thursday, the calendar is busier with the November import prices, the initial claims and the wholesale inventories. November import prices should be subdued, as lower oil prices should offset the impact of the weaker dol-lar. The claims will be looked at more closely. In the previous week, claims unexpectedly rose but the rise was more than likely due to a Thanksgiving re-lated statistical distortion. So the market expects claims to be lower again. Given the weaker payrolls, the market may react somewhat nervous in case of a surprise. On Friday, the November PPI and final Michigan consumer sentiment survey are for release. In October, PPI unexpectedly surged 1.7% M/M higher driven by oil and food prices. However, also core PPI was up a surprising 0.3% M/M. For November, both core and headline PPI are expected at 0.2% M/M. This would nevertheless push headline PPI up to 4.7% Y/Y. If the payrolls had not been weak, an eventual other upward surprise would have unsettled Treasury markets. Now, such a surprise might be less harmful. The final Michigan consumer senti-ment is expected to be slightly up from a disap-pointing early month reading. Lower energy prices might indeed be a positive for the consumer, but we fear that the gains will be modest given the weaker labour market conditions.

The Treasury will hold a 15 billion USD 5-year Note auction on Wednesday and a 9 billion USD 10-year Note auction on Thursday. These auctions will be the last of the year, if one makes abstraction of the 2-year auction between Christmas and New Year. They will raise almost all new cash as no redemptions take place, while on a small 600 M USD mid-December coupon interest payment will occur. This is in sharp contrast with the November refunding auc-tions when cash flows were very positive (large redemptions and big cou-pon payments). So from this perspective, the auc-tions might be somewhat more difficult to digest. The November refunding auc-tions were a big success with deep and aggressive bidding, but it is no guar-antee it will be the same this week.

We are not aware of ap-pearances of Fed governors, but the US oil inventories on Wednesday and the BoC rate decision on Tuesday (market is divided whether rates will be hiked by 25 basis points) are of topical interest for the Treasury market.

Regarding trading, we expect the shorter end (2-year) to trade more sub-dued this week. Friday・s good run brought the market in overbought conditions, but also the up-coming FOMC decision will probably make further gains difficult. Key support stands at 2.82%.
For the 5-year, Friday・s steep fall in yields didn・t really improve the picture and we are afraid that there will be little follow through buying. The technical picture remains bearish as long as the yield stays above 3.55%. The relentless rise decline of the dollar is another negative even if some respite for the dollar could be nearby. Also the 5-year Note auction may weigh on price action early in the week. For bears the plunge in yields offer good entry opportunities. The situation for the 10-year is similar. Despite Friday・s rally, the 4.25% in yield support held and if the level is rejected to-day/tomorrow, yields may start to move gradually higher. However, it is likely that a more sideways pat-tern develops in the near future with Thursday・s auction a point of attention. So overall, we keep a rather bearish stance towards Treasuries, at least until the technical picture improves more. From a fundamental point of view, we think that much lower yields are unlikely. The current account re-balancing needs not only a lower dollar, but also higher rates/yields to slow domestic demand.

By KBC Bank & Insurance

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