Sunrise Market Commentary

• US Equities ended slightly lower on Thursday due to a late session pull-back. This morning, most Asian shares trade slightly up, while Japanese stocks ended the session a little lower.
• As the results of stress tests on the Irish banks were revealed, the government announced a radical shake-up of the industry aimed at restoring investor's confidence in Ireland's banking sector, which remains dependant on the ECB. Ireland's banking sector will require €24 billion in additional capital.
• Portugal revealed yesterday that its missed the 2010 budget goal as the gap reached 8.6% of GDP in 2010, above the 7.3% target. Lisbon added that the upward revision was due to a simple accounting change demanded by Europe's statistics agency rather than any attempt to deceive.
• The Federal Reserve could raise rates by the end of this year, sooner than expected by financial markets, according to comments made by Fed's Kocherlakota. The Minneapoliss Fed president signalled the Fed could raise benchmark rates by three-quarters of a percentage point by the end of the year.
• Rebels cheered the defection of a Libyan minister as a sign that Gaddafi's rule was crumbling, but US officials warned he was far from beaten and made clear they feared entanglement in another painful war.
• China's central bank may have to raise both interest rates and reserve requirements in April to combat a possible jump in consumer inflation to a nearly three-year high, a government researcher said.
• Japanese manufacturers' business sentiment improved slightly in the three months to March, the Bank of Japan's closely watched tankan survey showed, but a downturn in confidence is expected for this quarter as 72% of replies for the survey came in before the earthquake.
• Chinese factories raised production a touch in March while cost inflation slowed, early signs that China was scoring some success in taming prices with its gradual monetary tightening.
• Today, the eco calendar is well-filled with the US payrolls and manufacturing ISM, the euro zone (final) and UK manufacturing PMI and euro zone unemployment rate.

Markets

Global markets had an overall quiet trading session ahead of the US payrolls release today and despite a high number of interesting eco and headline news. Yesterday's session cannot be simply described as a 'risk on' or 'risk off' day. Commodities, including oil, made substantial gains, equities closed narrowly mixed in the US and modestly (Germany) to substantially lower (Spain/Italy) in Europe. In the FX market, movements weren't too important, but the euro was well supported versus the US dollar and sterling, while the dollar made gains versus the yen. Global bonds remained under some modest downward pressure with German yields up between 3.3 bps and 0.8 bps, flattening the curve. Also in the US, the curve flattened bearishly, which resulted in yields up by 4 to 7 bps at the 2-to-5-year and somewhat lower further out of the curve. The peripherals traded generally uneventful ahead of the publication of the Irish stress tests (see below) with the Portuguese debt making the exception and the country now very close to throwing in the towel and asking for EFSF support (see below). Global core bonds were 'hit' by the higherthan- expected EMU inflation data that played right in the card of hawkish ECB and by another set of strong German labour market data. The latter contrasts with the situation in the peripherals and might become a problem inside EMU. In this respect, remarks of ECB's Wellink are worth citing: 'the strong economic pick-up in Germany makes clear that a recovering economy comes with higher inflation and therefore a higher benchmark interest rate'. If the ECB would not deliver this, he added, its credibility in Germany may suffer.

Intra-day, global core bonds started the day on the same footing as they ended yesterday. They traded quietly with an upward bias until the publication of the March CPI data for the euro zone. Inflation rose unexpectedly from 2.4% to 2.6%, which pushed the Bund down and German yields higher, especially on the short end of the curve, up. The drop of the Bund was however short-lived and gradually struggled higher again to about opening levels. However, there was some renewed weakening in midmorning US session, this time in sympathy with the US Treasuries. The US eco data were mixed with factory orders a tad weaker, but with a solid and above consensus Chicago PMI. The market barely reacted, but somewhat later, talk about positioninginduced selling took global bonds lower.

Review eco releases

Yesterday, the first estimate of euro zone CPI inflation for the month of March came out significantly higher than expected. CPI rose from 2.4% Y/Y to 2.6% Y/Y, while an unchanged reading was expected. Earlier released national data show that upward surprises were mainly based in Spain and Italy, which was probably due to the changed methodology. Nevertheless, these data provide further evidence that CPI inflation is running further away from the ECB's target, which supports the ECB's view that action on rates is needed. In the US, economic data came out mixed, with the claims and factory orders somewhat weaker, while the Chicago PMI came out slightly stronger than expected.

Peripheral news and markets

The INE statistics agency announced that it has upwardly revised the Portuguese budget deficits and debt-to-GDP ratios for the last two years. Portugal's budget deficit reached 8.6% of GDP in 2010, above the previously commented 7.3% target with Brussels. The 2009 deficit was revised from 9.3% to 10%. The debt to GDP ratios for 2010 and 2011 are now seen at respectively 92.4% (up from 82.8%) and 97.3% (up from 88.8%). The changes in last year's deficit came after a visit by Eurostat and the inclusion of capital injections at nationalised bank BPN and the accounts of three pubic transport companies. The worse debt/deficit data, which were mostly due to accounting issues and not skeletons falling out of the cupboard, is the latest in a series of events recently (collapse of government, several downgrades, yields reaching euro lifetime highs) that extends Portugal's walk of shame and takes away the (now caretaker) government's last bit of credibility. The optics of the moves do not look good and are reminiscent on what occurred in Greece. Portugal announced after the closure that it will hold today a special 1-year Note auction for an amount of €1.5B. It apparently has specific demand for such a Note and it is rumoured that Brazil will be the buyer. It is however still unlikely that will be enough to avoid a bail-out. The Portuguese yields increased further and the 2-year yield exceeded the 10- year, with the yield spread of the latter breaching the 500bps. The National Bank of Belgium on the contrary had better news and announced that the country's debt load increased less than initially estimated, as its 2010 budget deficit narrowed more than the caretaker government had previously expected. The 2010 budget deficit decreased to 4.1% of GDP from 5.9% in 2009 and compares to a previous estimate of 4.6%. The debt to GDP ratio was downwardly revised from 97.5% to 96.8%. Similarly the French deficit and debt levels were reported lower than hitherto assumed.

Irish stress tests

The Irish stress tests revealed that Irish banks need an additional €24B of capital injection, which was close to expectations and falls within the amount of capital the bail-out package had reserved (€35B). The total bill for the clean up of the banking sector mess is now about €70B, approaching 50% of GDP. The Irish government will restructure the sector and merge the main four banks into two centred on Allied Irish and Bank of Ireland. All may end up nationalized. There had been speculation that the ECB would put a medium term funding facility into place for the Irish banks, but apparently, there was resistance in the Council and earlier remarks of ECB's Stark indeed pointed to resistance. However, the ECB declared officially that it would continue to accept Irish sovereign debt as collateral regardless its credit rating and promised banks continued access to liquidity. The Irish government promised to deleverage and downside the balance sheets of the banks. According to the press, the Irish government would drop its threat to impose losses on senior unsecured bonds in both remaining banks. The Irish central banker suggested that a lower rate on the bail-out package was a possibility over time and added that its ability to meet its deficit and debt targets would depend on a return to growth. We need to examine more closely the arrangement and have more still missing information to judge whether it might put Ireland on the road to recovery. We think that the market will be cautious in its attitude and do expect the spread to remain (unsustainable) high for the time being. It might be that the financing of the Irish banks might again entirely go through the ECB repo-operation (instead of partly via the ELA). This might pose problems if the ECB would decide to go back to the variable rate procedure (in QE-3?) or does it mean that the ECB will be obliged to continue its Full Allotment procedure for longer.

Fed comments

Interesting comments from Fed policymakers yesterday: it seems the hawks have started a campaign to make their point that policy cannot stay as accommodative for much longer than it is now. Richmond Fed Lacker suggested the Fed should trim its QE-2 programme by $100B, a suggestion already ventilated by governor Bullard before and for which also Hoenig and Fisher would vote. However, these members (maybe partially with the exception of Bullard) are the hard core hawk wing from which nothing else can be expected. However, there seem to get other governors on board too. Minneapolis Fed Kocherlakota (late yesterday), quite influential with well-known moderate hawkish tendencies but who fully supported the QE policy, surprised by suggesting that if core inflation would move to 1.3% Y/Y by the end of the year, the Taylor rule would call for a raise in the target rate by more than 50 bps. While the majority of the FOMC still wants to complete the QE-2 unaltered (confirmed by governor Pianalto, who spoke yesterday and even didn't exclude more QE if needed) the debate on the exit of the monetary very accommodative policy is open. In this respect, the speech of NY Fed Dudley, a key FOMC member with outspoken dovish profile, this afternoon might be worth giving all attention. Eco data preview and Markets today

Today, the eco calendar contains not only the eye-catching US payrolls report, but also the US manufacturing ISM, euro zone (final) and UK manufacturing PMI and euro zone unemployment rate. Fed's Plosser, Dudley and ECB's Bini Smaghi are scheduled to speak. Portugal holds a surprise 1-year Note auction

After three consecutive months of very disappointing payrolls data, last month's February report finally met expectations, partially due to a weather-related rebound after the weak January report. In February, non-farm payrolls rose by 192 000, the biggest monthly increase since May 2010, when payrolls were boosted by the Census. For the March report, the question is whether this decent February figure can be confirmed. The consensus is looking for an increase at almost the same pace (190 000), while the weather related boost will have faded, which indicates a significant underlying improvement in jobs growth. Although we expect to see some improvement in the payrolls data, we believe that the consensus might be a bit too optimistic. Manufacturing payrolls were probably strong, but construction payrolls will be significantly weaker than in February. Besides that, also the late Easter holiday poses a risk for the payrolls in the retail, hotel and food sectors. The unemployment rate is forecasted to stay unchanged at 8.9%. In the US, the manufacturing ISM reached a multi-year high in February. For March however, the consensus is looking for a slight decline (from 61.4 to 61.0). We believe that the risks might be on the upside of expectations as all regional business confidence indicators surprised on the upside too, despite the Richmond Fed index. In the euro zone, the final reading of March Manufacturing PMI is expected to confirm that sentiment weakened slightly. According to the first estimate, euro zone manufacturing PMI fell from 59.0 to 57.7. We have no reasons to distance ourselves from the consensus. Finally also in the UK, manufacturing PMI is forecasted to come off its record high reading from the previous two months. A slight drop from 61.5 to 60.9 is forecasted, but we don't exclude a downward surprise. Regarding markets today, while we put ourselves slightly on the downside of consensus expectations, the major risk, market-wise, might be a real big payrolls number at the time the debate on monetary policy flares up. The market though seems already positioned for a somewhat stronger number. Also the technical pictures for both bonds and currencies merit a heightened alert. For US bonds, the 2-year is close to 0.85% and a strong report would suggest that the consensus economist expectations that the Fed would act before mid 2012 are too conservative.

The picture of the June Note future is bearish, but no key levels are nearby. That is different for the German Bund and yields. A strong payrolls report, combined with the recent upped hawkish ECB talk and the upcoming ECB meeting (where rates will be raised) might push the 2-year yield above the high highs (1.84%), while the Bund is approaching the key 120.92 level. A break would paint a bearish double top on the charts with first target at 119.11. Similarly the 10-year yield might test the 3.50% level.

The technical picture of the main currency crosses is very interesting too. A strong payrolls report might prevent EUR/USD from breaking through major 1.4282 resistance level. Weak payrolls may however be threatening for that resistance level, which if broken paint a double bottom on the charts with theoretical targets at 1.5706 and 1.6690. USD/JPY might profit from a strong report to threaten the 84.51 resistance, which if broken would point to a much stronger pair. Also for EUR/GBP the technical picture is highly interesting. While we don't dare anticipating on sustained breaks of these levels, traders and investors might set up strategies around these levels.

About the Author

Disclaimer: This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.