Investors are jumping off the risk-on bandwagon today and scrambling to get into fixed income as risk aversion rears its head. While Asian equity markets were buoyant overnight with Japanese investors returning after a long weekend the focus migrated to the actions of China’s central bank, after it raised its reserve requirement staring next week and engineered a lift in short term rates through an auction of one-month bills. That was the second consecutive such move and together the central bank is clearly demonstrating that it will back its words of warning when it comes to taming the dragon. The near double-digit pace of growth recently prompted government officials to forewarn that it would take remedial measures to contain the impact of a surge in bank lending.
The interest rate move from the Chinese central bank caught investors off guard and at this point it’s tempting to predict that the path of risk aversion down which investors are running today will prove to be a blind alley. The switch from riskier plays to the safety of bonds is largely inspired by today’s Chinese rate move aimed at curbing excessive bank lending and does not stem from any signs that growth is waning. Indeed yesterday’s domestic Chinese data depicted a voracious pace of growth.
However, over and above the Chinese news overnight there are other factors causing investors to switch back into bonds. Alcoa’s earnings were as typically disappointing as they usually are with costs – as ever – crimping profits. A poor start to the earnings season is not what investors who have lifted the fortunes of the market each day of 20102 so far wanted to see. The poor start to earnings season coinciding with a weak jobs performance at the tail end of last week has combined to dampen the spirits of some recovery enthusiasts. The back-up in yields associated with the days of rampant optimism is fast being reversed with yields sliding across all maturities today, regardless of the prospect of supply.
Eurodollar futures – Two year treasury notes rose sending yields to 0.91%, while the yield at the 10-year benchmark fell to 1.73%. March 10-year note futures rose 19/32 and are trading at 116-20. The trade deficit widened as the price of buoyant crude oil imports rose. With stocks lower as investors think twice about the prospects for Chinese growth, investors have suddenly found value in bonds and notes. The December expiration Eurodollar contract today traded at its lowest yield since December 1, when you may recall the Dubai World collapse was breaking just after Thanksgiving. At a contract high of 98.865 (1.135% yield) today, the December contract is within 10 basis points of the high that date, when investors feared for a massive second round collapse of the financial system stemming from the middle east. Today’s question is whether the current rally is as deserving as that shocker was?
European short futures – Adding to bullish bond market movement today is the drive into German debt leaving the yields on peripheral European nation’s debt languishing. Spreads over German bunds, a typical safe haven have widened out following a report on Monday alleging that Portugal had been warned over its deficit repair plans. This week several Eurozone nations are issuing debt and supply woes are helping keep the pressure on bond prices until after the auctions. March German bunds are up by 37 ticks to 122.08 sending yields down to 3.31%.
British interest rate futures – Housing market data showed a pause in the recovery process for prices at least. A strong reading for December retail sales from the BRC helped promote the view that the economy possibly threw off the shackles of recession in the fourth quarter. However, the touch and go recovery of the all-important service sector is critical to accepting that view. Short sterling futures are three-to-four basis points higher today while March gilt futures have jumped 54 ticks to 115.27 where the yield is lower on the session by five basis points at 3.92%.
Australian rate futures –The monetary policy tightening from China is helping unwind rate rising expectations in Australia. It’s doubtful that interest rate futures are rallying on account of a slide in November home approvals. Rather the 10 basis point drop in short-term yields is the market’s way of taking on the view that the Chinese move to calm its economy represents a de facto tightening of Australian policy. The 10-year government note dropped five basis points to yield 5.61%.
Canada’s 90-day BA’s – Canadian government bonds shed four basis points to yield 3.56% as the March contract rose 46 ticks to 118.59. Bill futures at the short end stayed on course alongside the minor up day for Eurodollars.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers. firstname.lastname@example.org
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