Weekly Eurobonds_2010_06_07

Themes of the Week

We were certainly right about turbulent week, increased volatility and sharp market response to any event. But it is difficult to predict anything else in terms of permanent verbal interventions, and attempts of such predictions have very low consumer value. In our view, the currency market looks “overplayed”...

What has happened that forced the currency market to move to indicators of the first months of 2006: euro is about 1.19, the dollar index is around about 89? It is not worth talking about the quotes of the yen, pound and other currencies. When was euro/yen currency pair at 108? Only till 2002, the period when euro achieved a place under the sun and carry trade was just beginning to unfold. This currency pair is the best reflection of the risk appetite, at least until the early 2009. This way or another, it is obvious that sentiments change very rapidly and in fact there no reasons for this. We believe that these movements on the markets will soon be bought.
We can not find any arguments for such sudden movements. To put it mildly, unmatched statements of some EU Prime Ministers, of course, surprised us, but we believe the reaction of the market was still excessive.

The debt load of Hungary can not be characterized as low (debt/GDP ratio is ~ 78%), and fiscal discipline is hardly balanced (-4%), but still the country always has its own set of instruments of monetary policy to balance the situation – at least to devaluate the forint, shifting the public debt on the shoulders of households whose mortgage loans were issued mainly in Swiss francs.
The main negative came from rumors on problems of “another” major European bank, Societe Generale this time, and its large losses received on derivative market, and then the largest Hungarian bank OTP also reported on losses as a consequence of the country’s officials’ comments.

In general, we fully adhere to the previously chosen strategy and expect “surprises across the board”, we will closely monitor Ben Bernanke’s address to the Budget Committee of Congress to be held on Wednesday, and data on the labor market, published on Thursdays, which have already become the common trigger, as well as press releases from a two-day meeting of eurozone Finance Ministers, started today in Luxembourg.

The other portion of “bids” in Tbonds, which are defended from European (in fact global) challenges, on the back of new proposal by Fed is not surprising.

Of course, we will not find here any cause-and-effect relation. This is nothing more than unverified expert perceptions. However, if this is a regularity (and we point to it), should the fearless speculative players right before or after Fed’s initial proposal buy or open short positions, respectively? It is dangerous, of course...

There could be a long discussion on the reasons standing behind the accumulating of US Treasuries. It is all because of fears but the question arises – which ones? We are prone to think the labor market is not the single reason, if it is in principle. Nonfarm payroll employment grew by 431,000 in May, while the number of 536,000 was forecasted, but this is still too much. A half of million of new jobs was created at the times when the word “crisis” was ephemeral. Private-sector employment edged up by 41,000 while the figure of 180,000 was expected. Real incomes as well as the average workweek increased – we view this data as neutral.

Obviously, we can say that the created public-sector jobs were fairly high due to the census, and private sector is more indicative, but in this case, we see the glass more half full than half empty.

As a result, our view on the Eurobond market is the same – buy credit risk, i.e. bonds with a small duration, a solid coupon, the issuer of which is a high-quality company or a credit organization in terms of credit profile. In other words, buy and hold strategy. We remain concerned about the developments in financial and political field and are committed to a simple rule: “do not understand – do not bother”. We must at least wait for G20 summit in late June or that in November.

The primary indicators of risk appetite and the state of the financial system as a whole continue reflecting market’s woes and its fragility: UST-3M and the relevant LIBOR as well as Libor-OIS spreads continue to expand, the volatility remains high, VIX is still at 35.

In light of this, investors’ interest towards Tbonds is unlikely to evaporate in the medium term, no matter what the fundamental valuations of overvalued/overbought US bonds are. UST-10 may move to yield 10% in moments of acute fears of investors, which have ample liquidity, again it is for the medium term.