The front end of the Australian yield curve took a bashing after a surprise decision by the central bank to tighten its monetary stance for the first time in six months. Short-dated bill prices crashed by 12 basis points as dealers rushed to lock-in borrowing costs. Longer dated government bonds also lost ground as the fixed income community pored over the Reserve Bank’s statement and fast-arrived at the conclusion that perhaps this isn’t the final step as the Bank highlights rapidly-dwindling idle capacity.
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Australian bills –Tuesday’s decision to lift interest rates for the first time since May surprised most onlookers. After all October’s decision was “finely balanced” according to the RBA, who at the time noted that a firming Aussie dollar was also counteracting growth. Since then the exchange rate has traded through parity at an all-time high even as the pace of inflationary pressures reversed course. Today’s move added five basis points to the cost of government borrowing lifting the yield on the 10-year to 5.24%. Shorter dated 90-day bill futures fared badly falling by around half as much as the actual rate increase on Tuesday. The RBA suggested that the pick-up in the pace of growth has the potential to leave the economy in a dangerous position that might require further remedial action. Tightening labor market pressures and other formerly abundant resources are becoming stretched to the point that inflationary pressures are likely to build ahead. The implied yield on the December 90-day future rose to 5.02% while that on the June 2011 contract rose to 5.24%.
Eurodollar futures – Nerves continue to fray ahead of Wednesday’s policy statement from the Federal Reserve. The central bank is expected to announce plans to buy no less than $500 billion worth of notes from the open market. Eurodollar futures have no bias today and are resting on their laurels at unchanged prices. December 10-year note futures rose to 126-17 to yield 2.599%. Ahead of Wednesday’s announcement comes the first of three pieces of new evidence on the health of the labor market to be concluded ahead of the weekend. The first is the release of the ADP report for private employers’ recent hiring trend.
European bond markets – The price of Irish and Greek debt spiraled lower on Tuesday bucking the performance of the German bund and causing a fierce widening in yield spreads. Sentiment towards peripheral nations’ debt is looking increasingly fragile as fickle confidence wanes in their ability to restore a sound fiscal footing. December bund futures are towards session highs at 129.92. An earlier PMI survey of manufacturing activity rebounded bucking expectations and indicates improving health in the core of the Eurozone.
British gilts – Gilt prices rose, sending yields three basis points lower although remaining just above 3% following a decidedly bearish view of the building sector. A PMI construction survey was expected to ease marginally but in the event indicated that activity careened towards a standstill during October. Other data recently has surprised investors who all believe that the picture ahead is likely to darken as the economy responds to a huge reduction in public spending following measures aimed at tackling the budget deficit.
Canadian bills – Canadian bonds fell as dealers reflected on the similarity between the domestic and Australian markets. In October both central banks were expected to raise policy but both walked away saying that a short delay would hardly harm the economy while both also noted the impact of a stronger exchange rate domestically. The Aussie rate rise is weighing now on the Canadian market causing 90-day bill futures to trade towards higher implied yields. The 2011 futures strip fell by three basis points while the yield on the 10-year government bond bucked the trend towards lower yields and added one basis point. The December futures contract fell by 36 ticks to 125.85.
Japanese bonds –Japanese bond prices eased marginally moving yields further away from a recent low point in borrowing costs. Minutes from the October meeting released earlier showed that Bank of Japan officials expected investor confidence to improve by widening the array of assets the central bank’s fund could purchase to include real estate investment trusts and exchange traded funds. The 10-year JGB future expiring in six weeks rose by just two ticks to close at 143.10.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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