IB Interest Rate Monitor: Risk aversion sees yields ease
Global short and long end yields have moved down in response to another negative episode in the unwinding story surrounding the state of sovereign finances for Greece. Today S&P made its second 2010 downgrade citing the lack of credible action from the Greek government towards plugging Europe’s biggest budget deficit. Short end interest rate futures are up in price sending yields down by anywhere from two-to-seven basis points, while yields have also dropped at longer-dated bond maturities as investors trade in equity gains for the safety of fixed income.
The rather upbeat assessment over improved labor market conditions contained within the FOMC statement on Wednesday had the potential to strike a raw nerve in terms of extending a bearish period for bonds and notes. Even the affirmation that the Fed would withdraw its emergency measures in a timely manner didn’t seem to fan the flames over higher yields. Having artificially depressed yields in order to force open the spigots and spur lending has worked, and even the housing market appears to have touched bottom. However, the Fed warns that the evident restraints on consumer-led activity are likely to hold the economy back.
But the fact that the Fed is in the process of concluding its emergency measures will also create upwards pressure on bond yields. Those have been artificially depressed for several months as the Fed tries to ensure that efforts to stimulate lending don’t fall foul of a log-jammed mortgage market. But in recent days as investors recognize the arrival of even mercurial improvements in the health of the economy the yield curve will continue to steepen and work its way towards normalization. Quite what the Fed does, other than jawboning, at a time when it needs to transition successfully as it removes emergency lending practices remains a challenge.
Eurodollar futures – A seven basis point rally at the deferred December 2010 expiration today sees implied yields down to 1.22% in a year’s time. However, that’s an improvement on the high point seen Tuesday when implied yields reached 1.37%. Initial claims earlier showed a slight uptick on last week and showed that 480,000 workers filed initial unemployment claims before the weekend. This isn’t a robust enough reading to upset today’s tone despite the fact that the four-week average is now holding below the half million mark. March t-note futures are 20 ticks higher at 117-28 to yield 3.54%.
European short futures – The overflow of the Greek downgrading by S&P continues to reach credit markets in Europe where investors are closely watching developments unfold. German bunds are 66 ticks better at 123.45 in the March contract, which compares to tough 123.76 resistance when the situation first heated up. The short end of the curve as indicated by euribor futures benefits from a six basis point rally today. The September contract, for example has jumped to 98.65 to imply a yield of 1.35%.
British interest rate futures – Pessimism over the economy was swift to return in light of an unexpected slump on British retail sales for November. While data for October was revised higher there was no hiding investor disappointment with economic prospects. March gilts are higher by almost a half point to 115.75 sending yields down to 3.85%. June short sterling futures rose by seven basis points to 99.03 to yield 0.97%.
Australian rate futures –The weaker interest rate tone helped Aussie 90-day bills continue a rise put in place earlier in the week following a speech from the RBA deputy governor in which he appeared to deliver a pause in monetary policy. Investors seem to believe that his reference to monetary policy being in a neutral state may mean a lower than previously expected ceiling. After a 20 basis point surge on Wednesday, Aussie bills continued with gains of eight basis points for contracts expiring beyond September 2010. That now puts predicted yields nine months forward at 4.86% compared to a current benchmark rate of 3.75%. As you can see there is still a large amount of tightening that remains priced into the curve, which is what will make this story of ongoing interest.
Canada’s 90-day BA’s are underperforming Eurodollars today. Short-dated bills are up between three and five basis points while investors are narrowing the yield differential in favor of the 10-year U.S. note compared to the same maturity in Canada, where yields stand today at 3.37%. The March government bond future is just five ticks higher at 120.02.
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