Bond rally comes to a halt

Fixed income buyers reemerged on Thursday following an unexpected rise in U.S. initial claims fanning flames surrounding the pace of economic slowdown. Yields around the world continued to decline, although the initial burst appears to have calmed as both equity prices and the dollar stop moving in opposite directions.

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Eurodollar futures – Minor gains for Eurodollars have given way to a five basis point loss as traders book gains with contracts rising to all-time highs earlier in the week. The short-term contracts are also taking a cue from a reversal in longer-dated maturities. The two-year note future couldn’t manage to take out earlier-in-the-week yield lows below 0.50% and today the yield has backed up to 0.533%. Meanwhile the yield on the 10-year reversed direction to remain unchanged at 2.713% after initial unemployment insurance claims rose 2,000 to a six-month high of 484,000. The four-week moving average rose to 473,500. Continuing claims dropped sharply to 4.45million but this series neglects those receiving Federal extended benefits.

Canadian bills – Canadian government bonds declined beneath a critical 3% handle midweek as stocks and commodity prices crumbled. Eager bond buyers started to pare back expectations on the Bank of Canada’s monetary policy. Today, however, the two-basis point underperformance of the 10-year government bond has the September futures contract 16 ticks down on the day at 125.33 yielding 2.975%.

Japanese bonds – Fears continue to mount on the global economic slowdown and the commensurate pressure building beneath the domestic currency. The bad pairing contributed to another visit to a seven-year low for Japanese yields with the 10-year again maintaining its stay below 1% at 0.989%.

European bond markets – An unexpected contraction in the pace of industrial production for June across the 16 nations sharing the single currency helped fuel more slowdown concerns while simultaneously propelling the 10-year German bund future expiring next month to another record intraday peak. Its session high of 131.40 saw yields briefly reach 2.40%. The recent slowdown talk has also brought peripheral nations’ debt back under the microscope. A global slump in stocks that fuelled dollar gains has also exposed the flip side of the same coin. The sliding euro has also yielded worries over structural economic concerns in the Eurozone. An earlier decline in Irish bond prices was rumored today to have created interest from European central banks who apparently stepped in to buy debt. As yields on the continent push lower, Euribor prices continue to do the same and have added three basis points today as implied yields drop by the same amount.

British gilts –A well received auction of British gilts maturing in 2022 helped shave a further couple of basis points off U.K. government debt today. An earlier drop in the central bank’s two-year forward forecast for inflation and growth have encouraged buyers of bonds across the curve and allowing a slide in the yield premium investors demand to hold British debt compared to German bunds. Immediately following the election three months ago that premium stood at 103 basis points and today has shrunk to 70 basis points. Short sterling futures continue to creep higher making two basis point gains as implieds give further weight to the potential for more quantitative easing at the Bank of England in the final quarter of 2010.

Australian bills – The 5% yield line appears to cause pause for thought from Aussie bond bulls. They haven’t been able to breach that line of resistance at this point even as the bond market continued its advance overnight. The 10-year Australian government bond yield shed another basis point to 5.019% as the July unemployment rate rose two-tenths of a basis point to 5.3%. Overall employment rose but most of the gains were in part-time jobs. Money markets are still giving credence to the prospect for a further and final one-quarter point increase in official interest rates. One year forward contracts are now starting to rally above 95.00 to reflect sub-5% implied yields down the road as the yield curve flattens.

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.

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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