The Gilt bulls remain intact but cautious
14 October 2011
TECHNICALS:
WEEKLY CHART
The market’s medium-term chart remains unmistakably bullish.
But the integrity of that bull structure is being tested.
The core pattern is the large continuation Triangle formed since the beginning of 2009.
Such is the size of that pattern that any short-term re-penetration needs time to prove that the structure has failed.
Nonetheless, the pull back through the upper diagonal of the triangle needs careful watching. In that context, the support from the band of prior Highs 125.58-126.93 is a good test of the strength of the market.
DAILY CHART
The sharp pullback to the medium-tern horizontal support 126.93 is showing signs of finding support there.
But the small triple top is unmistakable.
And bulls should watch for the market to overcome the resistance at 128.44-56 before getting confident
FUNDAMENTALS:
The protracted rally in the Gilt has paused over recent weeks as the market suffered a correction, but with the Bank of England starting QE2 is the Gilt’s failure to rally bearish or are there other forces at work?
The Gilt, like most other Bond markets, enjoyed a sustained rally driven by fears generated by the Eurozone sovereign debt crisis. As the Euro zone leaders tried and serially failed to get to grips with the root cause of the problem, equity markets sold off hard, sending the Euro lower against the Dollar and propelling Bonds higher.
The Gilt stood out as a buy as the UK government pushed ahead with its austerity program, in an effort to bring public spending under control and avoid a fate similar to the one gripping the Euro zone : loss of confidence and slashed credit ratings.
However, the Eurozone bought itself some time recently and breathing space when the leaders of the Bloc announced their intention to recapitalise the zone’s banks, dealing with a parallel fear that they were under-capitalised and sitting on undeclared bad debts which made them highly vulnerable to sovereign default and a fragmentation of the Euro area.
The reaction in markets has been clear cut:
We judge the forces that originally propelled bonds higher are still in play.
The focus on recapitalising the Banks is essentially a side issue. The core of the problem is sovereign solvency and the lack of political will among Eurozone policymakers to take the necessary difficult decisions to tackle it.
But after almost two years of crisis markets reacted have so positively because they hope policymakers were at last getting serious. However, the banks are none too happy about being told to acquire more capital.
The reaction from some bankers has been that they would rather shrink their balance sheets by disposing of assets to make their current capital levels adequate. That would be very unhelpful to the Eurozone.
The Eurozone looks on the brink of recession: if banks shrink their balance sheets, there would be less credit available and that would make a recession more likely.
Meanwhile what of the Gilt? Although not part of the Eurozone, the Gilt isn’t detached from its influences, and as equity markets have rallied on Eurozone generated optimism, all government bond markets including the Gilt have sold off.
The big question now is can the Eurozone solve its crisis? If not, then equity markets will sell off and bond markets will rally, including the Gilt.
And in such an environment, the Gilt would probably outperform as the Bank of England implements its QE policy to the tune of £75Bn.
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