Market Economics | Interest Rate Strategy - BNP PARIBAS ...
Market Economics | Interest Rate Strategy - BNP PARIBAS ...
Market Economics | Interest Rate Strategy - BNP PARIBAS ...
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<strong>Market</strong> Outlook<br />
Further flattening for<br />
Treasuries<br />
The strategy call for the Treasury market remains a neutral one in the short<br />
run, with a bias towards recommending long positioning later in the month.<br />
The market remains stuck in a very narrow range and instead of directional<br />
trades, the preference is to play the curve via the 5/10s flattener instead.<br />
With regard to macro news flow, the FOMC meeting next week looms large.<br />
It will be a two-day meeting, with the Fed to set out its quarterly forecasts<br />
ahead of the Chairman’s semi-annual testimony to Congress in February.<br />
Data have continued to confirm that Q4 is shaping up to be a strong quarter<br />
for final demand growth but the labour market indicators have shown little<br />
benefit to date. Headline inflation has picked up but the core rate, and wage<br />
pressure, remains unusually low.<br />
Fed status quo likely…<br />
…despite musical chairs at<br />
the FOMC<br />
Supply problem for<br />
EGBs…<br />
At December’s meeting, the FOMC opted for a cautious interpretation of the<br />
improvement in the economy and this is likely to continue. Indeed, Bernanke<br />
reiterated that cautious stance at his Congressional testimony following the<br />
release of December’s employment report, saying: “though recent indicators<br />
of spending and production have generally been encouraging, conditions in<br />
the labour market have improved only modestly at best…overall, the pace of<br />
economic recovery seems likely to be moderately stronger in 2011 than it<br />
was in 2010”. Most Fed speakers have publicly supported the completion of<br />
QE2 and we expect little change to the tone of the policy statement to be<br />
released on Wednesday.<br />
There may be some speculation over the implications of the annual rotation<br />
of FOMC voters. All Governors at the Federal Reserve Board are permanent<br />
voting members, as is the President of the New York Fed. However, four of<br />
the twelve regional bank presidents serve rotating one-year terms as voters.<br />
The regional Fed Presidents which are rotating in as voters this year have a<br />
more hawkish bent than those rotating out. This is not expected to make a<br />
material difference to the policy stance but it does open up the possibility of<br />
some dissent. President Plosser is the most probable dissenter as he has<br />
opposed nearly all of the Fed’s unconventional policies.<br />
The evolution of core EGBs over the last few sessions points to the absence<br />
of positive factors for sovereign debt during a period of huge supply. The<br />
market is struggling to absorb the paper at present, with supply apparently<br />
far outstripping demand. There is tentative evidence to suggest that what is<br />
bad news for the peripheral markets will also weigh on the core as the bigger<br />
the fiscal difficulties in the former, the bigger the burden on the latter.<br />
In this context, and with the macro news flow in Germany still going strong,<br />
positives for core markets are in short supply. The strategy call remains a<br />
neutral one, therefore. Curve wise, flattening remains the call. The front end<br />
has, according to our assessment of the economic and fiscal outlook, moved<br />
too far, too fast in discounting more than one rate hike this year. However, it<br />
makes sense for the market to discount a less favourable ECB scenario than<br />
previously given the signals of increased anxiety over inflation risks.<br />
…as we await progress on<br />
EFSF changes<br />
Regarding EGB spreads, peripheral and core markets have also been in a<br />
trading range, albeit with a wide corridor. This situation is likely to persist as<br />
long as there is no agreement forthcoming on the proposed amendments to<br />
the EFSF – this could yet take a while.<br />
Ken Wattret 20 January 2011<br />
<strong>Market</strong> Mover<br />
2<br />
www.Global<strong>Market</strong>s.bnpparibas.com