Weekly Eurobonds_2010_08_30

Themes of the Week

Short-term dollar performance now looks clear

Fed Chairman Ben Bernanke’s comments have clearly predetermined short-term dollar dynamic and indicated further incentives. If the economy feels badly, Fed will traditionally provide support. But type of support and its estimated effect remain vague.

Fed may reduce swap rates, extend TALF (term asset-backed securities loan facility) by changing terms, dealers, requirements and other features in order to encourage consumers and increase access to credit market. The key goal is unlikely to be achieved since banking system funds are mainly allocated on deposits in Fed. The former may point out to banks that their deposited funds will lose value by reducing interest rate paid on excess reserves to zero. Anyway, one should rely on hopes on the dynamic of US economic recovery. We assume the first October estimate of GDP for 3Q10 in the US is unlikely to be upbeat for market participants and US Congress voters. Macro updates in the US imply pessimistic sentiments to follow.

Ahead of November Congressional elections, Fed should approve a new stimulus package, on the one hand, but on the other hand, budget is inflated, debt leverage is high and congressional electorate demonstrates ambiguous attitude. Hence, gradual dollar weakness will continue through the end of September, if markets do not receive any strong impulse either from another portion of statistics or from renewed troubles with any of EU-members.

We remind that a couple of unpleasant events will happen in a first autumn month in EU – redemptions of PIIGS’ debts and almost EUR250 bln repayments of banks to the European Central Bank (ECB). Now it is difficult to calculate the cumulative effect, but the countries are preparing for such developments despite the growth of sovereign yield curves and CDS. This week will see another portion of issues by Italy, Spain, Portugal and Hungary. These events would weigh on Euro performance more than macro updates and Thursday ECB meeting. ECB is rumored to prolong medium- and long-term liquidity program.

Meanwhile, Bank of Japan has already undertaken steps to prevent the return of cash flows and increased credit volumes for banking sector by prolonging liquidity terms. Now the market participants are able to receive not only 3-year liquidity (JPY20 trln) but 6-month liquidity (JPY10 trln). However, whether these measures will become new points of risk appetite growth while money in dollar terms is cheap remains under question. Stronger yen is likely to be an impediment.

Growth, balance, moving forward

Based on released statistic in the US, Fed Chairman statements and inflationary expectations, which are reflected in Tbonds vs. TIPS spread, suggest that the right step is to continue directing cash flows to funds that, in turn, will invest them into bonds. On the back of growing risk appetite, we expect rally in the Russian liquid corporate and sovereign bonds.
As we stated earlier, the key signal for markets came at the end of last week: Bernanke’s comments are more important than macro updates, but either of these factors imply growing demand on risky assets. Moreover, bonds came on investors’ radar screen due to slower economic growth and risks associated with double-dip recession or Japanese-style deflationary trap.

On Monday trading activity is likely to be sluggish – LSE is closed today for Summer Holiday. The major activity was last Friday. Players who were fast enough closed short positions. Our view is unchanged – we sold out low-liquid medium- and long-term bonds and even tried to open short positions in second and third tier names (e.g., Russia’s sovereign yield curve, Gazprom issues), but after Bernanke’s speech it is better to postpone opening of short positions. In addition, steps undertaken by other Central Banks, Bank of Japan for example, which continues money injections into the debt market under the comfortable terms for REPO pyramid (6-month term and close to zero interest rate) aiming at preventing the repatriation of capital, indicate high likelihood of a new wave of speculative buyings. ECB is likely to prolong liquidity program this week. Eurobonds of Russian issuers may attempt to achieve local highs late in August, while players who opened short positions last week in anticipation of disappointing statements from Fed Chairman may accelerate this process. Anyway, so called “ceiling’ is quite close.