Bonds suffer as Fed mulls inflation stimulus

Global bond prices are generally lower midweek after a raft of positive economic data collided with comments from the Federal Reserve suggesting how to spur inflationary expectations. Yields around the world have fallen back towards record lows as central bankers sought to depress the cost of money in an effort to spur lending. Consumers seem content, for now at least, to pay down debt or refinance outstanding loans. The new fascination with inflation is going to be a tough nut to crack for investors who now have to be mindful of the power to erode the worth of money.

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Japanese bonds – Japanese bond yields last week reached another seven-year low with the weight of a rising yen fully capturing the fears of investors worried over a slowdown on account of likely export led weakness. However, an August report showed an unexpectedly strong pick-up in machinery tool orders indicating better business confidence in the economic outlook. Governor Shirakawa at the Bank of Japan told parliament today that he would continue to watch with interest the exchange rate while also explaining that he would diligently find ways to expand the recently announced fund to include a broad spectrum of assets. Doing so would possibly make the ¥5 trillion fund more available to borrowers. Government bond prices fell for the first time in three years with the December futures contract slipping 29 ticks to 143.77 sending the yield two pips higher to 0.87%.

Eurodollar futures – Heading into the release of the minutes from the Sept. 21 FOMC meeting, we pretty much knew that the members were edging further towards a resumption of further bond purchases on account of insufficiently firm inflation pressures. The minutes revealed ways to lead inflation expectations higher by the nose including a GDP target. The central bank wants to avoid allowing inflation expectations to sink to the point that would cause real interest rates to rise and further deter borrowing. When business and consumers know that prices are likely to fall, they postpone purchases until prices fall further, reinforcing a deflationary move. Earlier data today showed a 15% jump in weekly mortgage applications but masked weakness in the housing market. Refinancing activity shot up 21% while purchase data slipped for the first time in three weeks despite historically low interest rates. December Treasury note futures are six ticks lower at 126-28 carrying a yield of 2.452%. Eurodollar prices remain unresponsive today.

Fixed income investors are, to an extent, having to rethink the inflation profile making for awkward trading along the curve. Fed purchases will be at short-to-medium-term maturities and should serve to depress yields. But the furthest dated 30-year area of the curve is most sensitive to inflation, which investors might sense the Fed is now attempting to encourage and will deal with later at the expense of economic revival.

European bond markets – On top of awkward tone to trading following the FOMC minutes, ECB council member Axel Weber painted a robust picture of the European economy. He argued that bond purchases should cease on account of the low likelihood of a recession within the region. As a result, December bund prices faltered today and reached a session low at 131.21 before recovering. Part of the selling followed a stronger-than-expected reading for industrial production through August building on earlier gains. Production surged 1% during the month lifting activity by 7.9% year-on-year. The yield on the 10-year bund rose by five pips today to stand at 2.28% as equity prices in the region rose by 1%. The threat of an exit to monetary stimulus is also weighing on short-dated cash markets where Libors continue to rise. The three-month cash rate fixing at 0.985% on Wednesday is the highest since mid-July 2009. Euribor futures are marginally lower in price today.

British gilts – December gilts are lower by 25 ticks at 125.30 adding four basis points to the 10-year yield. Short sterling futures look dead in the water and if it wasn’t for a decent chunk of volume, you’d swear the market was closed as prices are unchanged across the board. Unemployment claims for September rose by 5,300 leaving the claimant count at 4.5%. Claims rose to an eight-month high and coincided with a dip to an 18-month low in a consumer confidence as reported by the Nationwide Building Society. Earlier in the week Bank of England policy maker David Miles warned against premature removal of policy stimulus given the stiff headwinds likely to mount against the British economy in the face of budget austerity.

Australian bills – Risk appetite for higher-yielding assets lifted equity prices in the Asian region earlier, but it did little to encourage speculation over further interest rate increases at the central bank. Short dated bill prices rose over the front four calendar months while yields on 10-year government bonds did rise sharply by seven basis points to stand at 5.047%. A measure of consumer confidence for October reversed a loss reported last month. The Westpac consumer confidence index rallied 3.3% to 117.0.

Canadian bills – Canadian bonds prices are sharply lower with the December futures contract lower by 42 ticks to yield two pips higher at 2.733%. Bill prices reflecting shorter-dated cash are also reflecting greater confidence in the economic outlook that might encourage the Bank of Canada to shift from its current catatonic stance with short rates at 1%. Bills slipped by four basis points.

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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