Questions over the extent of the recent scorching run for global bond prices came to a head after the release of FOMC minutes appearing somewhat more cautious than previously thought. Meanwhile a string of robust manufacturing surveys from around the globe pricked the bond bubble reversing the recent slide for yields. However, a private sector payroll report provided a foreboding signal for the labor market ahead of a key report due on Friday and helped to contain a midweek rout for bonds.
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Eurodollar futures – FOMC members sounded cautious about the recent run of weaker than hoped for economic numbers and said that risks to growth and inflation were now to the downside, especially in the face of further systemic shocks. The decision to expand the Fed’s balance sheet must, however, be carefully weighed. On the one hand, allowing it to naturally contract as borrowers prematurely repaid mortgage debt sent no positive signal especially if long-term rates were to rise. Reinvesting those proceeds would reinforce the Fed’s stimulus message. However, the FOMC still expects 2011 to deliver the fruit of growth from initiatives taken over the recent year thereby raising the question of whether more stimulus now would outweigh the cost of doing so. Once again, the Fed’s view of a “modest” recovery comes back to the fore. Pessimists believe that the current state of the economy is worse and that the U.S. faces a period of contraction.
But the real catalyst for a slip in bond prices today was the revival in the fortunes of the Chinese manufacturing sector. The official PMI for August reversed the slippage towards the breakeven line moving from a July reading of 51.2 to 51.7. The private HSBC reading confirmed the shift in gear. In July its proprietary index reading of 49.4 showed the sector contracted while the August measure grew to 51.9. Deferred Eurodollar futures gave back up to 10 basis points of a recent lunge forward, while September treasury note futures slumped by a whole point to stand at 125-16 after the U.S. ISM manufacturing survey confounded pessimists. Dealers were expecting the sector to cool off during last month. However, a rise in both the core index and a jump in the prices paid component was a double-blow for bonds. Yields at the 10-year surged 12 basis points to 2.59% after the data.
European bond markets – September bund prices are sitting on an intraday low at 133.55 ahead of the U.S. ISM seem destined to fall further. Indeed they did and quickly shed a further 40 points in the aftermath. Despite a slip in retail sales across Germany during July, the more recent Asian data corroborates the health of the core European manufacturing sector where the German PMI index remained static indicating robust output growth. Meanwhile French PMI showed a revival in output. Euribor prices remain static but 10-year yields within three basis points of an all-time low rose sharply to 2.20% adding nine pips to the yield.
Canadian bills – Strength in the U.S. economy is a welcome development for Canada. However, Tuesday’s disappointing GDP numbers for the three months ending in June have dampened investors’ expectations for the Bank of Canada to shift its policy stance in September. While the September government bond future is lower by 45 pips at 126.71 the yield increase of just five basis points is mild in comparison to that on U.S. notes as investors continue to favor Canadian paper.
Japanese bonds –Japanese bond prices slumped overnight with yields driven higher by the broader risk appetite rally sparked by Chinese manufacturing data. However, the news that Ochiri Ozawa will stand in a party leadership battle with DPJ leader Naoto Kan also raised the stakes in the bond market. Mr. Ozawa would tap the bond markets to fund public spending programs in the event that his challenge leaves him as the Prime Minister and dealers are taking the prospect pretty seriously. The voting happens in two weeks. September bond futures fell 49 ticks to 142.50 sending the yield to 1.015%.
British gilts – Despite evidence of a sharp recoil in manufacturers fortunes during August, gilt prices couldn’t sail into the headwinds facing other global bonds this morning. September futures lost a full point to trade at 125.68 yielding eight basis points more than Tuesday at 2.91%. Short sterling futures also dipped into the red as selling picked up and reversed earlier gains of as much as four basis points for contracts.
Australian bills – Australian yields rose by 10 basis points in response to the positively welcome data out of Beijing overnight. The yield at the 10-year government bond rose to 4.817% despite a dip in the domestic version of the PMI. Second quarter growth was also firm with the economy growing by 1.2% in the quarter leading to an annual pace of growth of 3.3% after a 2.6% pace in the first. Bill prices were swift to unwind this week’s slump in implied yields with futures declining by double-digits across the board.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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