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Bunds look good

28 August 2008

The Technical Trader’s view:

Daily Bar Chart:

The bunds have been going better for a while, but remain the best buy of the Bond markets because of the completion of a neat Double Bottom at 112.88.

The minimum target is 116.25.

The market has more to go we think, but cautious bulls will wait for a break up through the 114.94-6 previous high before adding on.

The Macro Trader’s view:

As Euro zone economic data over recent months began to reveal the true extent of the weakness affecting the Euro zone economy, the Bund began to bottom out, even though the ECB continued to focus on inflation as the main risk to economic stability.

Then, as the oil price begun to correct lower back in July, traders started to take the Bund higher as it became apparent that the combination of slowing growth and falling oil prices would eventually correct inflation lower, meaning short term interest rates needn’t rise any further.

Indeed at the ECB’S August monetary policy meeting, Trichet re-enforced that impression when he said

…“the downside risks to growth seem to have materialized”…

prompting the market to conclude that the next move in Euro zone interest rates would be an ease.

But with inflation still way above target, a rate cut wasn’t about to arrive anytime soon and as growth continued to slow, longer-term yields came lower as the Bund rallied.

Only this week the German IFO report came in below consensus and is now well off the highs seen only a few months ago, pointing to yet even weaker conditions in the German economy; the motor of the Euro zone economy, while German inflation even managed to come in just below consensus; an early benefit from lower oil prices.

But just to remind the markets that it is too soon to sound the all clear on inflation, ECB policy makers have again warned that inflation is too high and remains a threat, in a move designed to stop traders pricing too much, too soon into Euribor.

And although the Bund has eased lower on this, we judge this a short term hiccup. Any delay in cutting short-term interest rates in the Euro zone, will only worsen the slowdown (now so obviously underway) and act to drive long term yields lower, forcing Bund futures higher.

We believe the ECB will not rush to cut rates. They will hang on until they see signs of definite progress against inflation.

In this environment the yield curve adapts to take the strain of a slowing economy left to cope on its own without the help of monetary policy stimulus and that is why we are bullish of the Bund.

Mark Sturdy
John Lewis
Seven Days Ahead

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