With confirmation that the Federal Reserve will resume government bond purchases and a scent that the Bank of England might do the same, yield curves have shifted lower midweek as investors force race along the maturity horizon, locking into what we all thought were already ultra-low yields. The dollar’s response to the FOMC statement and the ensuing tumble for equity prices around the world is the icing on the cake as many short-term interest rate contracts rally to new contract highs.
Click on link for updated table throughout the day at http://www.interactivebrokers.com/en/p.php?f=daily_analysis.
Eurodollar futures – The FOMC announcement that it would reinvest maturing mortgage securities proceeds back into U.S. treasury bonds essentially ensures no balance sheet contraction as bonds expire. One of the Fed’s major aims here is to drive down the cost of borrowing. It is effectively buying something like 10% of gross monthly issuance as it starts its reinvestment program of between $15-$20 billion per month this week.
A further five basis point decline in yields to 2.70% at the 10-year part of the curve is evidence enough that it has achieved that aim. However, the unintended consequence of Tuesday’s announcement is a slide in conviction that the economy remains in recovery mode. The Fed stated that the recovery was weaker and that growth is somewhat slower than expected. The surging dollar and sliding equity markets around the world imply a certain amount of distrust in the Fed’s minor policy adjustment.
Eurodollar futures maturing in three years time have seen gains of 10 basis points as investors lock into declining yields further out across the maturity spectrum. Looking at the one-year calendar spreads the curve continues to flatten. The December 2010/December 2011 spread eased three basis points to 50 basis points while the December 2011/ December 2012 spread eased another two basis points to 70 basis points.
Canadian bills – Canadian government bonds at the 10-year underperformed the comparable U.S. treasury note creating a blast out in the premium to 30 basis points this morning. September government bond futures rose 42 ticks to 124.95 while buying across 90-day bill futures saw implied yields decline by seven basis points. The Canadian market is lagging in response to the Fed’s reaffirmation of an essentially neutral stance since the Canadian central bank is in tightening mode.
Japanese bonds –Japanese officials cautioned surrounding the impact of a strengthening yen, which continued to outwit the dollar to its loftiest value since 1995. The renewed signs of quantitative easing in the U.S. encouraged a resurgence of purchases of Japanese government debt, where the 10-year yield declined to 0.99%. Although a report showed a 1.4% increase in machine tool orders for July, the volume increase underwhelmed investors who also grew increasingly wary of the shape of the recovery. The September JGB futures contract rose to 142.19.
European bond markets – Euribor futures rallied to their highest in several weeks but still remain below crisis levels reached in June. Gains for the series are almost matching those in both Eurodollars and short sterling, but the ECB’s proven reluctance to match the pace of bond purchases achieved by the Fed and Bank of England has investors marginally less prone to push the yield curve further down. Nevertheless, the 10-year German bund yield fell a huge nine basis points to a record low at 2.43% as the September bund future surged 105 ticks to 131.05.
British gilts –Short sterling futures surged to new all-time contract highs on Wednesday on an already-rising tide of interest rate optimism following the move in Eurodollars. However, it was the downturn in the Bank of England’s forecast for both growth and inflation two-years hence that bullied the entire yield curve lower. Even the front-month September contract traded at a new high of 99.25 to imply a three-month yield of 0.75%. The central bank lowered its ceiling for expansion to 3% while claiming that still tough lending conditions and the impact from spending cuts announced in the budget were likely to deliver lower inflation at the end of the two-year forecast horizon. While the Bank has admitted it stands ready to act in either direction on monetary policy, it also said today that it was “much too soon to say that we’re struggling to see a recovery.”
Yet an unexpected drop in the Nationwide Building Society’s consumer confidence index to its lowest reading since April 2009 seemed to argue the other corner. At the same time, labor market data also served to contradict the central bank. However, job growth merely fell short of expectations when job creation rose by 3,900 positions throughout July. The tally was expected to rise by 17,000 and although the number was disappointing, it remains on the right side of a zero value.
Gilt futures due in September surged on the domestic and global news and reached a contract high at 123.61 where the 10-year yield slid by 12 basis points to 3.12%. Gains across short sterling futures were sizeable and equally impressive as the shift in the gilt curve resulting in an overall softening of the curve. The June 2011 sterling future now carries a sub-1% implied yield following today’s rally to 0.97%.
Australian bills – A series of economic indicators from China hinted that the authorities there have been successful in garnering a slowdown in economic activity. Industrial production and retail sales data although strongly healthier than year-ago readings all cooled off throughout July. The positive tone to U.S. fixed income after the FOMC statement dented optimism for the Pacific region wafting fears that a follow-on slowdown would discourage any further moves from the Reserve Bank of Australia. Government bond yields mirrored gains for U.S. bonds and slipped six basis points to 5.03%, while 90-day bill prices continued to discount less chance of further monetary tightening.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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.