16th August - The Gilts look vulnerable
20 August 2012
TECHNICALS:
iShares ETF GILT WEEKLY CHART
The week chart places the small Double Top in context.
The medium term bulls will be watching the 11.87 level very closely as a break of that signals a break both of the rising diagonal and the major close horizontal support.
GILT DAILY SEP 12 CHART
The market has stalled and the short term picture looks vulnerable after the break of the diagonal and then the 120.23-36 support.
Expect a test of the 117-19/28 medium-term supports.
FUNDAMENTALS:
• Throughout the period covering the financial crisis/recession/Euro zone Sovereign debt crisis and now double dip recession, the Gilt has stood out as a safe haven trade; why when the UK was saddled with a mountain of debt and the incoming Conservative led coalition had pledged to cut the deficit so sharply that they were criticised for consigning the UK economy to years of underperformance, if not recession.
• To understand the Gilts appeal, lets look first at the Euro zone.
• The financial crisis/recession originated in the US with a collapse of the sub-prime mortgage market. This brought the global Banking system to the brink of collapse and threatened a 1930’s style slump, requiring the governments of the US, UK and EU to part nationalise some of their major Banks and expand fiscal policy to help stabilise their economies.
• The result was as intended, a stabilisation and temporary return to growth, but in so doing already bloated government deficits grew even further, pushing deficit and debt to GDP ratios to unsustainable levels.
• The US has yet to begin to properly address her budget deficit, the EU/EZ were also in no hurry to act, but the newly elected government in the UK recognised the long term damage posed by the unsustainable fiscal stance in the UK and unilaterally set about cutting debt and public spending, while at the same time raising tax.
• The rating agencies approved and the UK’s AAA rating was left in tact.
However the economies of the Euro zone refused to act and market forces/investors recognised some of the weaker Euro zone countries were not only running unsustainable public finances, but risked bankruptcy.
The result we know only too well; three years of the Euro zone Sovereign debt crisis that is still far from being resolved.
Back in the UK the Gilt began to enjoy safe haven status and 10 year gilt yields fell below their German equivalent. But as the UK spending cuts began to bite, so the economy cooled and the Bank of England implemented its long running Asset purchase program, or “QE” policy.
Since the program was almost entirely a gilt buying program, the Gilt benefitted in two ways, first through the governments determination to shrink the deficit and second because the Bank was effectively giving the secondary gilt market a floor.
But more recently the Gilt’s appeal has tarnished. Traders increasingly expect the major Central Banks to deliver a big Autumn stimulus, and although this will involve buying up government Bonds, traders are more interested in the impact they expect this to have on economic activity and so instead of buying the Gilt, their appetite for riskier assets has grown leading them to buy stocks.
In the UK the economy remains stuck in a double dip recession, but the Bank is cool to the idea of expanding further it’s QE program and doesn’t want to cut interest rates further. Moreover UK CPI disappointed this week and rose, instead of registering an expected decline.
The result is a shift out of the Gilt. Is its safe haven status gone; that depends on your view of the EZ debt crisis which as yet isn’t resolved..
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15th Aug - Can 76.4% Support in USD/JPY Hold?