Market Opinion Interest Rates Trichet Ups The Ante Last week, we suggested that euro rates were on the rise, due to the ECB’s growing hawkish stance over inflation. Since then, the June 2006 euribor contract has slipped a further 8 points from 97.58, to close at 97.50, having hit a low of 97.47. Any bounce, which is possible short term, should meet strong resistance around 97.60.
Instead, the overall trend looks to be down, for now, with a move towards the 97.25-30 area over the coming weeks, courtesy of Mr Trichet. At Thursday’s central bank press conference, the ECB president acted in true Mr Greenspan fashion in attempting to forewarn the markets of things to come. The latest flash estimate for E12 CPI data showing a 2.5% y-o-y rise in September was sufficient to persuade Mr Trichet to state that strong vigilance is now required with regards to monitoring inflation.
This tougher rhetoric is backed up by an improvement in manufacturing and service sector activity in euroland, as well as an upturn in business sentiment. The European Commission’s industrial confidence index rose to –7 last month, from –8 in August.
Clearly, should business confidence be sustained into Q405, along with any uptick in domestic demand, then a rate hike may well happen before the end of Q106.
However, despite the rise in headline inflation, the core number is still under control, with the annual rate rising by just 1.3% in August, reflecting a downbeat consumer and a difficult labour market. As a result, the economic recovery continues to be fragile, as reflected by the European Commission reducing its 2005 real GDP growth forecast for euroland to just 1.2%.
Still, this game is all about second guessing central bankers. And for the moment, Mr Trichet is in hawkish mode.
As for the bund, it too has adjusted lower in accordance with our recent view. Our short-term bearish stance has seen the December contract fall from around 123.50 on September 4 to test our 121.80-122.00 support area, actually hitting a low of 121.93. The bounce to close the week at 122.28, and an RSI in potentially oversold territory, suggests that the bund can rally over the next few days, possibly back to 122.50, a break of which sets up a move towards 123.00. Beyond the short term, we are fairly neutral the bund for now, although more disposed towards the instrument than the 10-year US Treasury.
Nevertheless, a short-term bounce in the bund would tie in with our view that the US 10-year Treasury can recoup some recent losses over the coming days. In yield terms, the market moved exactly in line with our suggestion last week, from 4.33% to a high at one point of 4.45%. Readers will know of the technical significance we have placed on the 4.44% level, saying that any close above this mark would take the 10-year yield to the 4.80-5.00% area. However, as we have been saying for a few weeks, this 4.44% level will continue to act as strong resistance for a while longer. Indeed, the yield subsequently retreated from this point on Friday following the weak non-farm payroll number – which was generally to be expected due to the Katrina effect. The end of week close at 4.35% could well take the 10-year back to 4.28% level, a break of which would set up 4.20%. However, as mentioned two weeks ago in Treasury Time Bomb?, the pressure does seem to be growing for an eventual move higher in Treasury yields. Although, as we have long argued, any such spike is likely to be somewhat short-lived, given the growing needs of the pension fund industry.
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