Market Economics | Interest Rate Strategy - BNP PARIBAS ...

Market Outlook
Fragile rebound in risk
appetite after a positive
start to the earnings
season
Government bond markets gave up some of their recent gains over the past
week following a positive start to the earnings season. In Europe, the
assumptions behind the stress test appear increasingly credible and the
remaining question concerns the recapitalisation funds that may need to be
made available. In addition, the European Financial Stability Facility should
be operational by the end of August, according to the CEO of the SPV.
Finally, Greece passed the test of the primary market with relative ease: the
auction of 26-week bills was well received.
However, the recent setback in safety trades has remained limited, notably
as the fundamental context remains bond-supportive. Most of the recent
economic data have indeed continued to paint a picture of a recovery that is
losing momentum. The latest FOMC minutes indicate an adjustment to lower
long-term forecasts for growth and core inflation, and higher for
unemployment. These concerns about the growth outlook are generating an
immediate policy response. The Fed is suggesting that excess liquidity will
remain in place for longer than the market had been expecting while several
FOMC members are putting forward the view that additional measures
should be considered if the outlook deteriorates further. This has led to the
market pushing its rate hike expectations out further along the curve, also
providing support for the Treasury market.
The strong start to the earnings season supports risk appetite but
govvies remain resilient
4.0
10 yr N ote Y ield
3.9
3.8
3.7
3.6
3.5
3.4
3.3
3.2
S&P (RHS)
3.1
3.0
2.9
Jan Feb Mar Apr May Jun Jul
10
Source: Reuters EcoWin Pro
1225
1200
1175
1150
1125
1100
1075
1050
1025
1000
Supportive environment
for Tsy though the upside
potential looks limited on
short-dated maturities
We remain constructive on Treasuries over the coming weeks, with the
prospect of another downward surprise to core CPI looming. The FOMC
minutes should now set the stage for a dovish monetary policy report from
Bernanke to Congress next week. With long-term forecasts being revised to
show a bleaker picture than forecast a few months ago, the talk has shifted
away from when the Fed could tighten. Instead, Fed speakers are now
discussing the implications of disinflation, and possible further asset
purchases or other forms of stimulus.
One risk to our positive call on Treasuries is that the stock market continues
its recovery as expectations for corporate earnings are generally upbeat. We
are certainly wary of this and favour having short exposure in the front end
as cheap protection against our main view. At 0.60%, the 2y note is again at
the low end of its yield range so risk/reward favours a short, although with
the cost of negative carry.
Cyril Beuzit 16 July 2010
Market Mover
2
www.GlobalMarkets.bnpparibas.com