Saturday, November 6, 2010

Market Commentary : Credit – Bernanke relieves the tension

Market commentary
The past week was rather quiet as investors were holding their breath before the longawaited statement from the Federal Reserve on QE2. Most of the effect had already been priced in the market with CDS indices going tighter over the past month, and in our view risk was more to the downside. Nevertheless, iTraxx Europe is currently trading 2bp tighter and iTraxx Crossover is trading some 14bp tighter. The duration of the US treasury purchases is shorter than expected (with an average duration around 5-6 years) and the Fed will distribute the purchases over the next eight months. All else equal, investors are therefore likely to seek higher yields in the credit market as treasury yields are now more or less anchored in the 2-10Y segment with a bear steepening in the longer maturities.

The Q3 earnings season continued with results generally on the positive side from Danske Bank, Pohjola Bank, Sampo, Statoil, TDC and Norske Skog. Going forward, we believe that the corporates’ strong cash balances will shift focus away from balance sheets to shareholder focus (i.e. dividends, share buybacks, acquisitions, etc.) and we see risk to the downside in the longer perspective. However, in the near term deleveraging is continuing and TDC announced plans to prepay DKK8.2bn of senior debt on 12 November 2010 (corresponding to almost half of the proceeds from the Sunrise divestment). We recommend a minor overweight in credit with a six-month perspective as a carry trade.

The primary market
The primary market was also somewhat idle during the week and most of the activity was in long-maturity deals. We also saw another hybrid issue, this time from Alliander, the Dutch utility-provider. The Alliander deal closely resembles the issuances from Tennet, S&SE and RWE with a dual call structure and optional cumulative deferral . We expect issuance to pick up in the coming weeks before the big push-back in December with year-end closings.

Financial views


  • We are now halfway through the US reporting season with, so far, positive surprises for earnings (especially Financials). Despite this, we do not expect Q3 earnings to start a new wave of positive profit estimate revisions as seen in the aftermath of the Q1 and Q2 reporting seasons. Surprisingly, profit margins are still expanding in Q3, but with muted output prices and a slowdown in sales volumes, it is only a matter of months before profit estimates for 2011 will start to be revised lower. In the short term, we anticipate market headwinds coming from continued soft job and housing markets, weak small business and consumer confidence, and industrial slowdown.
  • We reiterate our recommendation to overweight financials and defensives against cyclical. Furthermore, we expect a soft stock market in the near term which could bring down global stocks by 5-10%.

Fixed income

  • There continues to be some modest downside to long bond yields for the remainder of this year, although most of the impact from QE is already seen. That said, we will probably not see new lows in German bond yields as the EONIA market has normalised. The debt markets in Southern Europe and Ireland remain a downside risk for yields. We expect a trough in bond yields early next year and forecast rising yields throughout 2011 as economic growth reaccelerates.
  • Intra-Euroland and Scandi: We are long Germany and Italy versus Spain and France. We also recommend buying T-bills issued from Italy, Ireland, Greece, Portugal and Spain. We are overweight Scandinavia versus Euroland.


  • We remain of the opinion that credit is a good place to be invested. Companies are still acting conservatively with modest investments and focus on cost-cutting although we believe that event risk is on the rise as companies embark on more shareholderfriendly actions (share buybacks, increased dividends and M&A).
  • We remain positive on credit for the moment, but it is becoming mainly a carry play as the spread tightening we have seen reduces the upside. Primary market activity is levelling off but we still expect activity in the coming weeks before we close off for the year in December.

FX outlook

  • We believe Fed’s QE2 and ECB’s exit strategy combined will push EUR/USD higher and project 1.45 on the 3-month horizon. Low rates for longer fuel demand for riskier currencies and AUD and NZD can continue to outperform while CHF might edge lower. USD/JPY is in our view heading for a new all-time low, below 80. Sterling experiences some tailwinds at present on no QE from the BoE, but we believe gains will be short-lived – the UK economy is too weak.
  • Scandinavian currencies are holding up against the dollar and we are positive on both SEK and NOK going forward. SEK seems likely to gain further in the short run on more rate hikes from the Riksbank while the NOK can appreciate if the oil price continues higher. Both EUR/SEK and EUR/NOK have to test the figure – 9 and 8, respectively.


  • The past week has seen commodities trading significantly higher on the new QE measures from the Fed. Overall, we remain bullish on commodities in 2011 on tighter market balances and a weaker dollar.
Full report: Market Commentary : Credit – Bernanke relieves the tension

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