Interest rate monitor for Nov. 25

IB Interest Rate Monitor: Aussies ramp up rate expectations: Canada welcomes Russia

With pre-market media coverage firmly fixated with a fresh swoon in the value of the U.S. dollar, we can only observe that it is fortunate for interest rate futures traders that short-term rates pay little attention to the flight from the greenback. In many nations currency pressure has resulted in a death-spiral as market expectations for defensive central bank measures have come to the fore. In the current climate, Eurodollar futures traders have no worries that weakness in the greenback will cause a pre-emptive move from the Fed to ratchet short-term rates higher in an effort to curtail currency weakness.

Although in terms of killing the carry-trade in which the dollar is borrowed and then sold short, increasing the short-term price of doing business might be a fine shot across the bows of anyone partaking in that seemingly one-way bet. And while such a weapon is certainly in the armory of the Fed, at present its efforts are spent on pinning down borrowing costs to aid banks. But one provokes the notion that the Fed, if it chose to, could tighten overnight lending rates out-of-the-blue in an effort to deter dollar shorting. It’s not something one might expect to see this year from the Fed, but when the health of the economy becomes better assured, it might be a fair ploy.

In its November meeting the FOMC discussed the potential for its policy of an extended monetary hiatus to spur bubbles in other asset classes. It would seem that the Chinese government was not the only one thinking out loud when official comments coincided with President Obama’s Beijing touchdown earlier in the month. The FOMC concluded that a not-disorderly crack in the dollar’s value was a relatively low risk to financial market stability. Also it was important not to confuse rising asset prices and a falling dollar as being totally correlated. The ailing dollar remains a barometer of the improving health of the global economic recovery rather than a cause to reflate assets around the world.

Eurodollar futures are lower after the premature release of a 446,000 reading on weekly jobless claims. This is the first sub-500,000 reading we can recall in the longest time and as we noted two weeks ago, is very probably a the start of a trend that should run through year end. Despite a weaker reading on durable goods orders, short interest rate futures are giving up a couple of ticks across the curve, while the 10-year note is now down on the day after a buoyant start borne out of follow-through buying after yesterday’s minutes. The June Eurodollar future is trading with a yield of 0.5% while notes are trading at 3.32%.

European interest rate futures are three basis points lower across the front couple of years. The debate begins to rage on what the ECB might do when those 12-month loans come due in December. They of course have the option to refinance banks at a fixed rate as they did last year, but the suggestions from the ECB that overall conditions may tighten (read stimulus withdrawal) may leave them choosing to switch to a variable repo rate. While this need not infer near-term tightening, investors are choosing to mark up yields in a less friendly interest rate environment. Meanwhile German bunds continue to bask in the low-inflation rate environment and no doubt the rally in the euro is also spurring the notion that the economic recovery in the Eurozone might be somewhat challenged at least from the perspective of the export sector.

British rate futures showed a muted reaction to confirmation that the economy contracted marginally less in the third quarter than was first reported. GDP in the three months ending September shrank 0.3% as upwards revisions to consumption helped spur the notion that the fourth quarter performance might actually be better. The governor at the Bank of England appeared non-plussed with the economic recovery describing it as not “particularly strong.” A notion that the exercise of monetary control won’t be needed for two-to-three more years is spurring gains in further-dated short sterling futures, which have increased price wise to reflect yield expectations by December 2010 at 1.78%. Gilts continue to see yields erode as the timing of any tightening is scrubbed further from the agend. The December gilt contract is 30 ticks higher and yields 3.62%.

Australian rate futures – Now who said there won’t be a rate rise in December? According to sellers of 90-day bills on the Sydney Futures Exchange today, the odds took a sharp turn for the worst. The RBA meets next week and odds shortened on another 25 basis point rise following a speech by its deputy governor, Ric Battellino. He described a “new upswing” in the Australian economy – one that may be around for several years. His comments bolstered the value of the local currency and wound up interest rate expectations where short-dated yields picked up about six basis points. The March contract yields 4.54% while the yield on the 10-year rose five basis points to 5.38%.

Canadian 10-year yields continued to push beneath that of the U.S. 10-year today with the spread widening to around four basis points. The catalyst driving Canadian credit markets is perhaps the comments from a Russian official who said that the central bank has made way for including Canadian dollars into its reserves. While the local dollar is bid due to greenback aversion this morning, the yield curve is also bid and a rally for 90-day bills of acceptance (BA’s) has relaxed far-dated futures yields by nine basis points. The December 2010 contract has seen the implied yield decline to 1.32%.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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