Weekly Eurobonds 2010_05_24

CURRENCY

As expected, volatility is high with this statement being correct not only for the currency market, but for its commodity, equity and debt counterparts as well.

The week ahead is important due to the upcoming newsflow and events. We still expect the markets to fall deeper and view most of their movements as technical in nature.
The fears did not evaporated, they just took the back seat as strong technical resistance is evidenced across the board.

We believe the markets would focus on China and the United States negotiations. Chinese Vice Premier Wang Qishan, US Treasury Secretary Timothy Geithner and US Secretary of State Hillary Clinton would participate in high-level talks in Beijing, where key issues for these countries and for the markets in general are on the agenda, in particular fair yuan rate, European debt crisis, North Korea as well Iran nuclear program.

While we do not expect any hasty decisions following the talks, some officials’ comments may considerably impact the markets. China and the USA agreed to tie yuan to currency basket instead of its coupling to US dollar. Despite the Chinese government express worries on Eurocurrency performance – this is quite explainable taking into account China’s trade balance surplus, yuan forwards are showing signs of strengthening.

Risks which are associated with European story and become acute due to unexpected steps of EU authorities to regulate the markets (Germany’s ban on short selling) and the US Senate approval of Obama’s plan to tighten the control over financial institutions (the details are still unknown), in our view, do not bode well for the markets.

All in all, the previous trends are only gaining the momentum. Some investors withdraw money from the markets while others heighten volatility by swinging the market and putting more pressure on assets’ prices. Watchdogs have nothing to do but to intervene – first, we saw ECB buying PIIGS’ sovereign debts, second Central Bank of Switzerland was making interventions on the currency market, third ECB was rumored to support euro rate. We assume, euro rates influenced by ECB bids and troubled EU countries’ bond yields would result in market fair levels. This is only a matter of time, and we see the current market levels irrelevant to global events. Default contracts amid German regulator’s bans keep growing. Our assumption that euro may become funding currency is gradually materializing. Despite the fact that euro funding does not look cheap for now as compared to US dollar or yen, in case of worse market conditions euro would be under stronger pressure while yen and dollar would remain safe havens. The bigger difference between rates has been already on hand.

EUROBONDS

There is another excellent chance for US Treasury Department to borrow money at low rates. Is this fortuity? Some calamities happen too often which premise huge auctions and create negative news background that, in turn, spikes buying high liquid issues on the market.
Given the increased interbank rates in US dollar terms abroad (UST 3m and LIBOR 3m spread doubled less than in two weeks), we believe this auctions will be successful.

Another series of Tbonds auctions is expected this week – 2-, 5-, 7-year Treasuries in amount of $42, $40, $31 bn, respectively. Net funds raised are estimated at as much as $83 bn.
In addition to interest towards risk-free instruments, investors have to solve a few important tasks: first, to absorb cheap and available liquidity nominated in US dollars; second, on the back of tighter control over stock market transactions, to reduce positions in a large amount that taken into account their willingness to keep profits at the same levels, requires accumulating stop-losses.

Strong interest towards Tbonds is likely to remain intact. However, positive sentiments on risk-free instruments would be unable to draw EM Eurobonds. The market is still not ready, at least for Monday morning. Although UST levels, which were approached over the last trading sessions of the previous week, looked very attractive for opening of short positions, and under the current conditions short positions in Tbonds is, in our view, too risky. Market volatility looks alike Lehman Brothers collapse, investors’ nervousness reached its peak at least in 2010 with all the key markets are on the verge of changing from bullish into bearish. It is not the time to tempt fate taking short positions, coming stop-loss may be unable to lend the support and under such a high volatility it is difficult to foresee the momentum of sliding down. The only choice is a barrier option.

Thus, we do not see any grounds to change our previous week’s strategy – the less risky on Risk/Yield scale bets are investments into short-dated (medium-term) currency Eurobonds (up to 3 years) of Russian corporations which enjoy transparent credit risks and enable to minimize market risks and to receive fixed profits nominated in so far strong currency regardless of permanent revaluation.