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Bunds fascinate

09 January 2009

The Technical Trader’s view:

WEEKLYCHART The market is teetering at a critical level – the very longstanding previous high (an all-time-high) established in 2005. The fascination lies in the balance of forces – the bull surge from the Double Bottom has not yet reached its minimum target - somewhat higher than 123.64. Yet the market is hesitant. And a failure here would be powerfully negative. When would we know that the market had failed? Look closer.

DAILY CHART Here is the short-term situation. The market has failed twice already at the 125.39 level. A breakdown through the 121.60 would complete that Double Top. And, at the same time signal a second failure at the long-term 123.64 level. That would be a good sell, surely?

The Macro Trader’s view:

The Bund has enjoyed a strong Bull Run which began in late July 08 and peaked at the end of December. We at the Macro Trader’s Guide remained sidelined from the market during the early stages of the rally, as we harboured concerns about increased sovereign debt issuance resulting from the authorities globally pumping vast amounts of money into their Banks to prevent a threatened meltdown of the financial system, which as is now widely accepted, was precipitated by the collapse of Lehman Brothers. However, our view changed as we concluded that the outlook for growth, not just in the Euro zone, but globally, had weakened to such a degree that worries over a recession turning to a slump took priority over the sustainability of public finances.
As the US announced sizeable piecemeal publicly-funded rescues of various financial institutions, culminating in President elect Barak Obama announcing a fiscal stimulus (close to $1.0T upon inauguration), the markets reacted positively as they judged these as prudent measures designed to defend against deflation. The UK and Euro zone too, announced their own stimuli with the Euro zone pledging Euro 200.Bn in addition to individual packages pledged by member states. Indeed, the earlier reluctance shown by Germany and France to commit to anything other than a modest fiscal stimulus has now evaporated. Additionally, as interest rates globally increasingly look set to converge on zero, Central Banks have began seriously considering quantum easing measures, which involve governments issuing debt to raise funds for public works/tax cuts etc and the Central Banks buying them as a means of expanding the money supply. This led to a change of tone in equity markets as stocks staged a Year End rally that spilt over onto the New Year. But bonds, including the Bund, have recently corrected lower. It seems traders/investors may have awoken to the longer-term implications of ever-bulging budget deficits and growing National debt. While Central Banks buying bonds as part of a quantum easing plan places something of a floor under the market, there are some real risks to this:

 Will the Central Banks withdraw in time to prevent excess liquidity from causing a massive burst of inflation?
 Will governments retain the confidence of investors, or will the credit worthiness of the major economies be called into question?
 Will private investors simply continue to buy all the debt issued not bought by the Central Banks?

Already this week the German government failed to cover a Euro 6.0Bn Bund auction. Was this an aberration or a sign of things to come? While the current economic outlook remains weak (the recession in the Euro zone and elsewhere continuing to deepen) and inflation continues to correct ever lower (assisted by collapsing energy prices) that concern is not immediate, but at some point all this debt will need financing in the open market and hopefully repaid.
Traders easily switch their attention from one concern to another, especially if the flow of data and news becomes yet more of the same. They could start casting around for the next big development and in Bonds that could well be the next bout of inflation or the fiscal burden being built into the future for Western taxpayers.

It may be too soon to suggest the Bund is about to turn bearish, but we judge the lights are flashing amber. Will they go back to green or turn red?

Mark Sturdy John Lewis Seven Days Ahead

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