UK Government Bonds, Gilts Rebound

By: Seven_Days_Ahead

We started the New Year bearish of bonds as we judged the global economic recovery looked on track and although a slow recovery was still expected, traders seemed confident enough to turn their attention to the debt build up in the major developed economies.

This had the effect of hitting many major sovereign bond markets hard in the early days of January. Of course, the bear move had begun over the Christmas and New Year Holiday period, but it wasn’t until the New trading year had began that we judged the move was more than Year End activity.

Yet over the last two weeks the Gilt (with other bond markets) has managed a steady recovery away from the lows. At first we thought this was a reflex move caused by the pause in the equity market rally, but sentiment in bonds has clearly changed and the reasons are international rather than purely domestic.

This week UK CPI came in worse than expected, but the Bank of England has largely forecast this and they expect a reasonably rapid correction back below their target. And today the UK government borrowing data was a little bit better than expected, albeit still on track for the worst debt build up ever in peace time. That explains this week’s price action from a domestic stand point.

But what of the international dimension I mentioned?

The US President has over the last two weeks turned hawkish towards the US Banks. Previously traders were under the impression that those Banks that received money from the US authorities to save them from collapse, only needed to repay those funds to be free from the governments grip. Obama now intends raising a levy or tax on US Banks as a means of compensating the US taxpayer. Additionally, he is looking at introducing legislation to limit proprietary trading activities of the Banking industry in an effort to reduce risk. This has had a negative impact on bank shares and weakened stocks.

Also there has been weaker-than-expected US data over recent weeks with some patchy profit reports from leading US Banks and corporations.

Then there is China. The Chinese Central Bank has already announced it is tightening Bank’s reserve requirements in an attempt to cool lending and stop the economy from overheating. This too weighed heavily on stocks as it was seen as a prelude to higher interest rates. Additionally, China announced today Q4 GDP growth of 10.7%. This too hit stocks hard and further supported bonds as traders’ fears about higher interest rates intensified.

Why, you might ask, does it matter to western stock and bond markets what the Chinese authorities do? Simply, China has or is close to over taking Japan as the World’s second largest economy and it has been the engine of growth pulling the rest of the World out of recession. So while China has enjoyed strong growth, the major developed economies are only crawling their way better. If China acts to cool its economy, it will cool the global recovery too.

So the dynamic of the markets has changed. Traders have stopped worrying about debt, they see no threat from inflation short/medium term in the developed economies and are again worrying about growth.

Result: stocks weaker, bonds (including the Gilt ) stronger on safe-haven buying. Where does the Gilt go from here? Watch the data, not just UK, but globally - for a clearer picture.

The Technical Trader’s view:

WEEKLY CONTINUATION  CHART The market has bounced off the Pivotal low of 114.26. But the retracement has yet to meet the resistance from the Neckline above the market at 115.94 or thereabouts. Only a break of that would really upset the bears.

DAILY CHART This is sobering for the bears. The bear rising wedge has yet to complete (that would require a breakdown through the lower diagonal). But it remains intact. On the other hand, for the bulls, there is no clear bottom formation in the making yet. So, despite the penetration of the diagonal from the Prior Lows, we remain biased to the bear tack, but waiting for a short-term selling signal.

Philip Allwright
Mark Sturdy

Seven Days Ahead
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Mark Sturdy, John Lewis & Philip Allwright, write exclusively for Seven Days Ahead a regulated financial advisor selling professional-level technical and macro analysis and high-performing trade recommendations with detailed risk control for banks, hedge funds, and expert private investors around the world. Check out our subscriptions.

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