=EUROPEAN MORNING BRIEFING: Stocks Likely To Rally -2-
BONDS:
European government bond prices are likely to start lower on Monday, after markets fell Friday, reversing early gains as a recovery in European equity markets triggered profit-taking in government bonds.
European data this week ahead should show German business confidence has deteriorated while euro-zone inflation has picked up, a mix that should fuel debate about the outlook for European Central Bank interest rates.
Economists said the Ifo Institute's closely watched report due Tuesday will show German business confidence deteriorated for the seventh month in a row in November.
"Developments in the U.S., financial market volatility and new highs in the oil price and euro all argue for weaker German business sentiment," BNP Paribas said.
Meanwhile, economists expect rising oil prices to help the euro zone's first estimate of November consumer price inflation, due Friday, to rise to 2.8% on year from 2.6% in October.
The ECB's key objective is to keep consumer price inflation just below 2% over the medium term.
In the U.K, the Monetary Policy Committee will face questions Thursday from the Treasury Select Committee on recent and future interest rate decisions, and the inflation and growth forecasts published in its quarterly Inflation Report.
Treasurys are lower on Monday, as investors take a break from the recent strength in the market after U.S. retail sales over the holiday weekend boosted enthusiasm for stocks.
Last week, Treasury prices climbed and the yield curve steepened sharply as risk averse investors continued to pour into the safest possible assets, ignoring more sanguine signals from the Federal Reserve. The two-year yield dropped one basis point below 3% - a level last breached in 2004 - and the 10-year pushed through 4%, leaving the spread between the two at more than 100 basis points, the steepest it has been since January 2005.
But how long that positive sentiment holds depends on how the face-off between agitated markets and the Fed plays out, with Treasurys zeroing in on any negative headlines or talk about the financial system. Year-end pressures should boost bonds as well, with several major U.S. banks closing their books end-November. Investors are worried that the fourth quarter could see more write-downs on structured finance and mortgage-related holdings.
"It's a spiral situation that's clearly getting out of control," said Richard Gilhooly, senior fixed-income strategist at BNP Paribas, pointing to reignited strains in money markets, stock markets in corrective mode, and blown-out risk premiums on credit spreads. "It's a panic situation, and the Fed needs to do something."
For many, that something is another drop in interest rates at the Federal Open Market Committee's Dec. 11 meeting, with some investors betting on a 50 basis point cut. Many though are looking for the Fed to act sooner, Gilhooly said, a desire reflected in the ultra-low level of the two-year yield, which is nearly 150 basis points below the 4.50% target fed funds rate.
"The market and the Fed have diverged," said William O'Donnell, rates strategist at UBS Securities. "The market is saying 'we need your help, and we need it now.'"
The Fed has thus far lowered its target rate by a cumulative 75 basis points since September, with officials giving no indication that a subsequent easing is in the cards.
Given the multiple signs of market strains, BNP Paribas' Gilhooly said there appears to be no limit as to how far three-month Libor can rise or how far U.S. Treasurys can rally.
"We're only going to get more and more illiquid as the year progresses," he said. "The Fed is conducting monetary policy through the rearview mirror, and as long as the Fed buries its head in the sand, the more we will rally."
There are those though who are more optimistic that the U.S. economy will be able to weather the storm, with markets bouncing back once year-end pressures have subsided.
"It feels like we're in the midst of year-end pressures," said Stephen Stanley, chief economist at RBS Greenwich Capital. "Liquidity has dwindled, and as a result, the markets are really skittish."
Stanley said that once year-end pressures have passed, markets should improve, with the fourth quarter weak, but the consumer and more broadly, gross domestic product, "gradually improving" into the new year.
Rate markets have yet to buy into that view though.
This week, the market will receive several bits of economic data that could be telling, including home sales figures and durable goods. Several Fed officials will speak - including St. Louis Fed President William Poole and Fed Governor Randall Kroszner - and the government will auction both two- and five-year notes. The amounts will be announced on Monday. But the bond market's focus is likely to remain on financial market woes.
"There's this game of chicken going on between the market and the Fed," RBS' Stanley said. And for the time being, "there's no question that given the illiquid situation, interest rates are going to remain quite low."
In Japan, prices of government bonds fell after a report that China's sovereign wealth funds may invest in Japanese stocks. "It will be difficult for this low yield level to stick for too long. If stock markets start to pick up and the subprime crisis starts to stabilize, we might see a selloff at a much faster pace," ABN Amro strategist Nhan Ngoc Le said.
ENERGY:
Oil prices continued to approach $100 a barrel Monday, on the weakened U.S. dollar and amid expectations of colder U.S. weather.
"The onset of cold U.S. weather is going to boost fuel demand," said Victor Shum, an energy analyst with Purvin & Gertz in Singapore.
January Nymex added 58 cents to $98.76 a barrel.
"The weakened U.S. dollar remains at record low levels and so we've got pricing trying to test $100 again," Shum said.
Shum said that data suggesting OPEC is increasing production more quickly than expected is likely to keep a temporary cap on oil prices.
METALS:
Spot gold is up $5.40 at $827 a troy ounce, and traders are waiting for new incentives to drive the price beyond the $30/oz gained since the end last week. High oil prices provide reason for optimism for now, while Asia waits for European traders to take the market's reins.
LME 3-month copper is down $35 at $6,675, with strong technical resistance at $6,800/ton blocking the upside. A continued rise in copper inventories make lower prices this week more probable, says Triland Metals. Still, BNP Paribas and Standard Bank both report Chinese consumers have been stepping up purchases as copper's slide at start of the month has made prices more attractive.
CALENDAR:
Monday, November 26, 2007 Exp Prev
GMT
0930 UK Annual Business enterprise research & development (BERD)
1015 EU ECB Member Tumpel-Gugerell speaks in Warsaw
1130 EU ECB Chief Trichet speaks at the Reserve Bank of India in
Mumbai
1330 US Oct Chicago Fed Natl Activity Index
-0.45
1400 EU ECB Member Papademos speaks in Nicosia, Cyprus
2350 JPN Oct Corp Service Price Index
On Year +1.4%
N/A UK