It does feel somewhat like the calm before the storm, with investors favoring fixed income over equities this morning. Yields are slightly softer as dealers await two key events later today. Bond prices firmed sharply after a weak reading for U.S. new home sales, which fell for a second month. A tonic for investors from the FOMC later this afternoon in its statement might come in the form of a plan for mortgage backed security purchases after current purchases finish in March. While they’re at it, a gentle reminder that the domestic economy is indeed recovering wouldn’t do much to harm investor confidence either.
Risk aversion failed to cause further damage to sentiment overnight but clearly those lingering concerns over the impact of Chinese monetary policy measures continue to weigh on investor sentiment. From the perspective of the stock market, Asian and other emerging markets have come off their Q4 peaks by around 10% in some cases and we’re guessing that current indecision is leading some to conclude that, like at the start of last year, a bigger correction might offer deeper price discounts.
Still, weakness in equities is not yet creating a bigger bid for fixed income, a traditional safe haven in times of stress. It’s interesting to observe that the obliteration of stocks in the last week has not sent yields lower than they actually are. That’s especially noteworthy in light of President Obama’s call last week aimed at curbing risk taking. Arguably taking away speculative demand could conceivably dampen volatility and so create even stronger demand for steady yields albeit at relatively low levels. But doesn’t that cast a firm light on the available 3.59% yield on 10-year U.S. notes?
The obvious counterpoint to this argument is the ongoing mountain of bond supply as central banks do the dirty work for governments who have been forced to spend billions to keep their financial systems from failure. As economies recover and inflation concerns mount, the legacy cost of dealing with the crisis is likely to keep budget deficits sky high for years. We saw an example of both events earlier today.
While doubts continue to be cast over the strength of the British economy, one of its central bankers today cautioned over whether or not the Bank of England might be able to meet its mandated inflation target in light of cost pressures from rising service sector and import costs. Gilt prices managed to move ahead during the session but looked constrained by the comments from Andrew Sentance.
Elsewhere Greek bond prices slumped once again as apparently pent up market hopes were dashed that the government of China would buy a truck-load of Greek issued bonds. The Greek finance minister denied that Goldman Sachs had been mandated to sell €25 billion in Greek bonds, which would be a large band aid over an otherwise gushing wound. The denial of the story caused a huge slide in Greek bond prices sending the yield spread over core German bunds at the 10-year horizon out to 332 basis points. It might be safer for a Chinese sovereign wealth fund to actually buy the nation of Greece rather than run the risk of a bond default at a later date. At least that way the Chinese get some nice beaches if it all goes wrong.
Eurodollar futures –10-year note futures are off their highest point of the day inspired by the 7.6% decline in new home sales. The yield is at 3.59% heading into the Fed’s statement with Eurodollar futures higher by a tick or two along the curve. The March 2010/March 2011 curve gradient stands at 106 basis points.
British interest rate futures – Short sterling futures fell by four basis points after Andrew Sentence raised the prospect that the Bank of England must face prickly inflation data head on at its February meeting. The meeting will be based upon the latest quarterly inflation report prepared ahead of the MPC meeting. It’s extremely doubtful that there will be any change to monetary policy as a result of the recent CPI data, but today’s speech perhaps heralds an end to quantitative easing. Governor King recently played down the spike in consumer prices and blamed temporary factors. That might make for an interesting showdown at the February meeting. Gilt yields are unchanged at 3.87% as gilts are the first bond market to turn south on the day.
European short futures – Bund futures have recoiled from an earlier 123.61 intraday peak inspired by the Greek finance minister’s denial surrounding Goldman Sachs. Bunds are back to unchanged at 123.31 where the yield is 3.20%. Euribor futures, like short sterling are now nursing a four basis point rise in yields.
Australian rate futures –Aussie bill prices rose during the session as the yen continued to strengthen, strangling equity prices and sending the region’s largest stock market to a five-week low. Despite a strong local CPI report investors didn’t see a need to change their perception on the current yield structure given there’s approximately a 62% chance of a tightening already priced into nearby futures. Bonds dropped seven basis points in yield to 5.39% as risk aversion remained buoyant in the Pacific time zone.
Canada’s 90-day BA’s – Canadian bond prices jumped and sent yields down an oversized six basis points to 3.29% on prospects for ongoing commodity price weakness in the event that the fallout from Chinese banking operations spills over into risk aversion. Crude oil prices have come back to flat and this helps depress sentiment towards the economy.
Japan – Japanese bond futures jumped the day after S&P ratings agency raised a flag over the conundrum of deflation, economic weakness and a staggeringly high amount of government debt. Still, since only 7% of government bonds are held by foreigners there is a degree of immunity from what the outside world thinks. The drop to a five-week low in the Nikkei in Tokyo boosted appetite for 10-year bonds, which rose by 24 ticks to yield 1.29%.
Senior Market Analyst firstname.lastname@example.org
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