Risk aversion took a step forward following analysis by Wall Street Journal staffers, claiming flaws in the methodology of the July stress-testing process across 91 European banks. The contention is that banks have understated the value of government paper they are holding, which underestimates maximum potential losses in the event that a government defaults. The story unleashed yesterday also claims that certain banks failed to include paper issued by specific nations, which might help explain why so many Eurozone analysts missed the mark at the time. Yields across the globe have claimed back much of last week’s losses as data warmed up, especially in the world’s largest economy.
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Eurodollar futures – Treasury notes rallied strongly following the release of the article to reach an intraday peak at 124-20 after the contract slumped to 123-20 in response to a healthy jobs report on Friday. Deferred Eurodollar futures contracts were swift to follow and today have risen to double-digit gains. Meanwhile the shorter end of the curve is facing extremely minor losses. However, the response to the stress-test bust is that liquidity fears are once again on the prowl. The flattening of global curves today has significantly missed out nearby expirations as cash traders ponder the likelihood of growing tensions between lenders.
A New York Times interview with Donald Kohn states that the recent Fed retiree is in favor of more quantitative easing should conditions warrant. He says that the recent rise in real interest rates caused by a dip in inflationary expectations may be cause enough for the FOMC to act further to bolster its policy of quantitative easing. The ongoing discussion of lower interest rates for longer is also leaning on the yield curve today pushing the 10-year yield back to 2.64%. Following Friday’s employment report the yield reached 2.75%.
European bond markets – Investors fearing fallout from the stress-test allegation story sought the safety of German debt today, selling Irish, Portuguese and Greek debt along the way. Spreads demanded by investors in order to hold debt issued by those nations blew through records set the day before the ECB announced it would buy ailing government’s paper. While German bund yields shed nine basis points, sliding the most in two weeks, yields surged around peripheral nations. Greek bond yields rose by 34 pips while those on Irish debt jumped by 26 pips. Elsewhere, a disappointing reading for German factory orders also lured investors to switch off from the recent bullish air to stocks.
Canadian bills – The Bank of Canada’s monthly meeting later this week has divided analysts significantly with several betting that the central bank won’t pause before reaching 1% or a further quarter point move above its present rate. Others fear that conditions outside of Canada have deteriorated significantly to the point that its central bank might end up suffering from monetary remorse if its actions turn out to be premature. The December government bond future outpaced gains on U.S. treasuries sending the yield down by seven basis points to 2.87%. Implied yields on 90-day bills tumbled by up to eight basis points.
Japanese bonds –Japanese bond prices surged sending the 10-year yield lower by five basis points to stand at 1.13% after a key supporter of Mr. Ozawa played down his chances of dethroning Prime Minister Kan at next week’s party vote. Mr. Ozawa would spend more and likely issue more bonds in order to fund an expansionary program.
British gilts – British yields recoiled by seven basis points to stand at 2.91% in response to the flight to quality in core European bonds. Gains for short sterling were restricted to 90-day contracts expiring beyond June 2011 and heaviest at even further maturities.
Australian bills – The RBA left policy on hold today citing a “somewhat uncertain economic outlook.” Government debt prices advanced, shaving five basis points off 10-year debt at 4.858%. The implied yield on 90-day bills slumped by five basis points.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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