Yield party starts all over again

The Fed threw something of a curve-ball at bond traders on Tuesday. Bond dealers appeared tentatively bullish on the potential for a resumption of bond purchases following the FOMC statement. Hopes seemed pinned on stubbornly high unemployment and a recent downturn in activity. Although fixed income prices did rocket after the statement, it had more to do with a fresh take at the likelihood for deflationary pressures facing the U.S. economy. Yields slipped 13 basis points in the U.S. 10-year note while the two-year yield rushed to an all-time low.

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Eurodollar futures – Eurodollar futures prices rose along the strip with the curve getting back into flattening mode. The March 2011 contract rose to challenge the all-time contract peak set in August but failed to trade through it. However, the June 2011 contract did set a new all-time high yesterday at 99.515 implying a three-month cash rate of 0.485% although in today’s trade the contract has eased a little. While we know that there is little that true-blue monetary policy can achieve through already minimal interest rate settings, the Fed’s hint that further bond purchases may arrive soon was sufficient to extend the already distant horizon for any change in policy. The market currently sees only a one-in-four chance that the Fed will raise interest rates by mid-2011. Eurodollar futures today have dipped marginally into the red given the odds seemed to be stacked one way at present. The December 10-year note future remains positive on the session sending the yield to 2.547%.

European bond markets – July industrial orders for the Eurozone failed to clear the hurdle set by analysts and declined by more than expected during the month. The news plays second fiddle to the FOMC statement, which ushers in a bullish wave of bond buying. The December contract added 83 ticks to 123.91 to yield 2.358%.

British gilts – The December gilt contract surged after the FOMC statement. Any resumption of the Fed’s initial purchase program raises the prospect that the measure will be needed in Britain. Short sterling futures contracts surged by 14 basis points at far-dated maturities as investors reduced expectations over the turning point for monetary policy. Gilts rose by a huge 143 pips sending yields slumping also by 14 basis points to stand at 2.971%. A CBI report indicated that spending cuts likely to come into force towards the turn of the year will likely hamper growth in 2011. The trade organization reduced its 2011 GDP forecast by one half of one percent to 2.0%.

Australian bills – A rise in the Westpac leading index for July threw fuel onto the Reserve Bank’s fire. Policy makers have sounded off recently about the prospects for further monetary tightening in the event that the economy edges ahead much further. The central bank fears that growth much above the trend pace of growth witnessed today would start alarm bills as the economy overheats. Losses for 90-day bill prices continued with the strip declining by a further two pips. Government bond prices, however, made sizeable gains sending the 10-year lower to 5.067% yield. The divergent forces weighing on U.S. and Australian bonds forced the 10-year yield spread to a two year high.

Canadian bills – A surprise decline in the reading of retail sales during July helped buoy bill prices and made for good gains in the December government bond future. The retail sales report showed a -0.1% dip while the drop was larger when auto sales are excluded. Bond futures accelerated to 125.44 for a 56 tick gain sending yields lower by six basis points at 2.844%. Implied yields also eased on bills where the March contract added three ticks to yield 1.49%. The contract has seen implied yields decline by 11 basis points in two days.

Japanese bonds –JGB futures jumped by 35 ticks to close at 142.73 sending yields down to 1.015% as the bond environment remained friendly. Prime Minister Kan told the Financial Times that the solution to weakening the yen is to create economic and monetary policies to do so.

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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