Bonds face tough time even after ECB compromise

Government bond prices are coming back from the brink of a precipice following large declines yesterday. As investor appetite for risk has recovered globally, equity and commodity prices have gained at the expense of a rising cost of government borrowing. As the risk-on attitude continued earlier today the yield on the 10-year U.S. treasury briefly breached 3% for the first time since July. In Europe the central bank has removed the urgency with which it will withdraw its extraordinary stimulus measures and has provided a reprieve for recent slippage in regional government debt and permitted underperforming peripheral nations to close the gap with traditionally safe German debt. But still, there remains a sense of “what next?” from bond traders having a hard time digesting the resurgence in global economic activity.

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Eurodollar futures – The March 10-year note future slid to an early session low at 122-08 before a softer than hoped for reading of weekly initial claims data. But with 3% yields suddenly looking appealing, buyers stepped in and drove the futures contract back up to 122-20. A massive day for equities on Wednesday along with further signs of economic recovery helped drive yields 17 basis points higher in a single session. Investors sensing trouble ahead in the form of increasing borrowing costs forced the two-to-10-year yield curve to steepen to a four-month high at 244 basis points. Just like yesterday, deferred Eurodollar futures face outsized losses as implied yields continue to climb.

European bond markets – A soothing conclusion to the ECB press conference ensured regional bond prices bounced in its aftermath. The central banks said it would continue to maintain its provision of liquidity and so reversed its previously announced decision to turn its back on extraordinary measures. The fixed income market might be slightly disappointed by the lack of provision of extending its bond purchase program, but given national central bank buying of Irish and Portuguese bonds it remains hard to see the big-picture benefit. What matters is that Eurozone banks retain access to unlimited funds over the credit-crunch month of December. A well-attended Spanish auction also quelled investors’ anxiety today with more buyers turning up for a three-year auction of €2.5 billion in government paper. March German bunds ranged from 125.95 up to 126.71 before giving up post-ECB gains to trade at 126.23, but once again the trend towards higher yields looks appealing. Nevertheless, Spanish 10-year yields slid 22 basis points, Greek yields fell 14 basis points while those on Irish and Portuguese fell by 10 basis points.

British gilts – March gilt futures have picked up off a floor at 119.06 but still trade in negative territory at 119.40 where the 10-year yields 3.37%. An earlier PMI construction report indicated strengthening expansion across the sector and built on the recent negative tone for fixed income. Short sterling prices are marginally higher.

Japanese bonds – A surging appetite for stocks lifted the Nikkei 225 index to its best performance in many weeks leaving it higher by 1.8% on the day. The yen slipped to a near two-month low as evidence of global recovery continued to show up. The firmer tone sent benchmark yields higher by six basis points to 1.195% and to the highest since June. The March JGB future fell by 29 ticks to close at 140.25.

Australian bills – Australian government bond yields were unchanged after a weaker than expected retail sales report for October. Forecasters had predicted a gain only to be served up a 0.1% decline on the month adding to the argument that the RBA has little option but to remain on the sidelines. Yet a weaker tone to global interest rate markets continued to weigh on domestic 90-day bill futures, where implied yields rose by up to seven basis points.

Canadian bills – Canadian short-dated bills of acceptance fell by three points ahead of Friday’s key employment report. The move corresponded to similar declines for U.S. Eurodollar contracts. The benchmark March government bond contract slid by 26 ticks to 121.33, yielding 3.21%, five basis points higher on the session. The spread over comparable U.S. treasuries widened to 22 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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