Market Mover - BNP PARIBAS - Investment Services India

gave a few specific details on the Fed’s exit strategy. This was interpreted as
stepping up the rhetoric on eventual tightening. The discount rate is likely to
be raised at some point, although the discount window is barely used and
had already failed the test of being a “cap on Libor” earlier in the crisis. The
issue of paying interest on reserves is more relevant and could be bearish
for Fed funds, which in turn will filter through to OIS, repo and Libor.
All in all, Bernanke’s testimony could serve as the catalyst for even higher
yields as the market’s attention shifts away from sovereign debt fears and
back to the FOMC and major economic data. Recall that it only took a few
positive data surprises for yields to jump. This asymmetric bias towards
higher yields prompted us to be bearish at the start of the week; we remain
in that camp.
The technical picture looks fragile for Treasuries: when looking at a
2007/2010 daily chart, we see that the market has drawn a wide bottom
head-and-shoulders pattern with a neckline at 3.83% on the 10y T-note; this
level was tested in early January.
JGBs likely to stay rangebound
Whatever the exit to the
current EMU crisis, the
medium-term outlook
looks negative for the euro
The JGB market has fluctuated within a narrow range since the start of 2010
despite the global decline in stock prices. Intraday volatility has also fallen
sharply, with the market showing very little reaction to factors that would
ordinarily be considered buying or selling triggers. Next Tuesday's (16 Feb)
5yr offering is likely to be readily digested, given that banks remain awash
with surplus funds. We see no obvious ramifications for the yen bond market
from upcoming decisions regarding the EMU crisis; JGB yields are unlikely
to rise by more than the tiniest amount while the Nikkei 225 remains mired
near the 10,000 mark.
In the FX market, the euro remains at the top of the agenda. While a
European rescue package for peripheral bond markets could allow the EUR
to benefit from a short covering rally, the long-term prospects remain outright
bearish for the single currency. Deflationary adjustment pressures will be
unleashed for almost a fifth of the eurozone economy, suggesting inflation is
likely to undershoot the ECB’s internal staff projections. Rate and yield
differentials should continue working against the euro in the medium term.
At the same time, when the EUR loses yield and rate attractiveness, central
bank reserve managers are less inclined to shift USD reserves into euros.
Last year, currency reserves rose by an impressive USD 768 bln, mainly
driven by Asia. China has printed money and, by its quasi-fixed USDCNY
6.82 exchange rate, has added to the supply of USDs. However, Asian
monetary authorities generally and China’s in particular have started
tightening monetary policy, imposing measures to curb hot money inflows
even as net export growth is declining. As a result, currency reserve growth
will ease, automatically reducing the supply of USDs added to the market
and thus suggesting a lower EURUSD.
Short GBP, long AUD &
SEK
A big currency investment theme is selling currencies where the credit
multiplier is not working – as opposed to currencies benefiting from credit
expansion. In the UK, the adjusted M4 has continued to decline, supporting
our view that a high level of leverage is deflationary, especially if banks bear
a substantial share of the leverage. The BoE’s revision of its two year
inflation projection down to 1.2% will not bode well for the GBP as the
sterling money market curve will have to flatten out. The performance of the
GBP and 3x9 sterling FRA are tightly correlated. Hence, we expect sterling
to remain under selling pressure.
Australia and Sweden are two countries where there is a positive credit
multiplier. The outperformance of the AUD and SEK has received additional
support from the low sovereign debt levels reported in the countries.
Cyril Beuzit 12 February 2010
Market Mover
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