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• Progress around the ‘fiscal cliff’, but not there yet
• Favour ‘buying on dips’ into y/e/UST supply
• Gilts look to data leads; not all bad news X-mkt

Coming off the back of the latest expansion of the Federal Reserve’s balance sheet, it would appear that the outcome of the Japanese general election will usher in yet easier global monetary policy. An LDP-led government is likely to herald an aggressive expansion of BoJ asset purchases, which only serves to remind that there remains a long way to go before a global recovery is assured beyond doubt.

Indeed, it would appear that the major central banks continue to seek methods by which they can ameliorate the current situation. While we do not doubt that monetary policy has and will continue to offer assistance to an eventual recovery phase, it is at the fiscal – and by proxy at the political – level which will prove the dominant feature over the near-term in relation to assuring eventual macro recovery traction. Nowhere is this more immediately apparent than in the case of the US ‘fiscal cliff’.

In the meantime, as markets enter the final trading week ahead of the upcoming festive period, market depth and liquidity is expected to be at a premium. Such a backdrop is expected to see participants keeping positioning/exposure relatively ‘close to home’. Under such conditions intra-day moves are likely to be overly impacted by intervening new news whether that comes in the form of political/macro developments or market-moving end user business.

With the euro area effectively ‘done and dusted’ ahead of Christmas in the wake of the positive Eurogroup decision in relation to Greece and the latest Ecofin agreement in the form of the Single Supervisory Mechanism, it falls to the US political class to continue to edge towards a workable resolution to the problem of the fiscal cliff. The latest tax concessions from the Boehner camp mark a welcome shift in stance.

However, there is evidently plenty of effort required on the part of both sides to produce yet further compromises and arrive at a successful conclusion to the stand-off. While Obama and the Democrats already feel emboldened by the presidential election outcome and recent nationwide poll evidence, having seen House Republicans ease their opposition to taxes at the extreme upper end of the earnings curve, they (Democrats) are unlikely to rush to offer a cascade of concessions on their side if they feel they are gaining the upper hand in the high stakes poker game currently being played out in Washington.

From a market perspective, besides fiscal cliff considerations, US Treasuries still have to negotiate the current round of supply. Having already absorbed 3s, 10s and Bonds this past week, coming sessions see the Street needing to accommodate $113bn worth of 2s, 5s, 7s and TIPS. Not an insignificant amount.

We have no doubts the market can handle such an ongoing barrage, using any additional post-weekend back up in yields as an opportunity to pare tactical short positioning. Having looked to fade recent ‘strength’ in anticipation of this period of heavy net supply, we now shift to a ‘buying on dips’ bias, believing the broader range trade mentality will remain a feature of current core market make up. In the UK, a busy data week lies ahead, with CPI (Tues), retail sales (Thurs), public finances and GDP (Fri) set to accompany the latest BoE minutes (Wed).

In light of recent underperformance versus Bunds, we anticipate additional near-term weakness will generate X-market covering demand for 10yr gilts. This would tie in with both prospective short-term technicals and a longer-term analysis from a seasonal pattern perspective.

Read the full report on Lloyds Bank website, click here.

December 17, 2012
From Lloyds Bank