The pessimism driving bond yields to record lows recently was served a reality check in the shape of an unexpectedly bullish Chicago Fed manufacturing PMI reading. Ever since the FOMC aired the notion of resuming its asset purchase plan two weeks ago, investors have warmed to risk appetite seemingly assured of lower yields. They assumed that while bad economic data would ensure further quantitative easing would follow, even tepid data wasn’t a bad thing. So today’s surge in the Chicago PMI index has created a bit of a nightmare scenario for those caught up in the fear that the economy is weakening and who had chased yields down.
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Eurodollar futures – The Chicago manufacturing PMI reading was supposed to fall from 56.7 to 55.5 making the pace of expansion the lowest since November. However, the index surged to 60.4 indicating an out-of-the-blue pick-up in the pace of activity. Suddenly, fixed income investors are falling over one another scrambling to exit misplaced purchases of 10-year notes. The December future slid from 126-13 all the way to 125-10 as longs dashed for the exit. The contract has since steadied at 125-25 sending the yield to 2.569%. Losses for Eurodollar futures were relatively minor with most contracts dropping by three ticks after the melee.
European bond markets –Europe markets got off to a flying start after Moody’s indeed downgraded Spanish government debt by one notch although it set the outlook from negative to stable. Fears that the ECB was being stingy by providing continuously smaller amounts of liquidity were turned upside down with investors figuring that just perhaps the need for cash was being met within the wholesale money markets. The December bund contract surged on the open to a high at 132.20 before plunging to 130.97 at its worst. Yields have backed up six basis points to stand at 2.30%. The tighter liquidity provision still weighed on euribor futures where the strip took a six basis point hit.
British gilts – Adam Posen told a regional newspaper that he may yet be convinced by fellow policy makers that a further round of quantitative easing might not be the best solution or even necessary. A slightly firmer pace of increases for British home prices also hung over the interest rate market today helping create a negative tone. Gilt prices slumped in response to U.S. data with the December contract lower by 60 ticks at 124.12, while the yield on the 10-year government bond rose by six basis points to 2.965%.
Australian bills – Aussie bond yields slipped by a pip to 5.03% as regional equity markets closed the quarter on a bad note. The Tokyo market shed 2%. Bill prices made minor gains with implied yields dipping by between three-to-six basis points at longer-dated maturities after a government report showed an unexpected slide of 4.7% in building approvals during August. The chance of an interest rate rise in October diminished from 64% to 52%.
Canadian bills – Although the U.S. treasury market fell sharply, data showing Canadian GDP dip for the first time since August 2009 reflected a bigger picture slowing at the edges for Canada’s economy. The rise in 10-year government bond yields was therefore tempered as the spread between the two nations narrowed. The December futures contract shed 20 ticks to 126.23 sending the yield four basis points higher to 2.776%.
Japanese bonds – Government bond yields rose once more despite weakness apparent in the August reading of industrial production. The decline of 0.3% compares to an estimate ahead of time of a rise of 1.1% and fits in with the drop in forward looking sentiment evident in this week’s Tankan survey from the Bank of Japan. The 10-year future expiring in December slipped one tick to close at 143.39 lifting the yield to 0.93%.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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