The yield on the U.S. 10-year treasury hit 3.50% late on Tuesday evening following a rather boiler-plate statement from the Fed that left some of us scratching our heads over whether the Fed is looking at the same data improvements we’re watching. The tone simply hasn’t been the same since the Fed launched QEII as bond traders lightened their own boatload of fixed income as data suggested the economy continues to heal. Maybe the buying opportunity needed was a jump in yields back to yesterday’s seven-month high. This morning a somber and unchanged inflation reading of 1.1% in the year through November enticed bargain-hunters to drive yields back to 3.40%.
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Eurodollar futures – The shift in implied and actual yields has been dramatic. In aiming to drive down the cost of borrowing the Fed now has to do battle with improving investor sentiment that has quelled the appeal of fixed income. What was once a cheap trick for investment bankers of buying at new government bond auctions and selling back to the New York Fed as it steps up its daily bond-buying schedule has become a hazardous venture as many investors liquidate their holdings. You can see from the chart above just how expectations have changed with the CME Eurodollar curve bringing forward by a whole year the timing of a return to a 1% fed funds rate. At the time of the November meeting investors had expected rates to remain low until December 2012. That contract then implied a yield of less than 1%. After investors rushed to lock-in to rising yields the contract has slumped sending its yield up to 1.90% this week. Previously investors didn’t expect yields to reach 2% until early 2014 but the wake-up call has brought that appointment forward to the end of the New Year.
European bond markets – Some of today’s lunge back into fixed income is driven by events in Europe after ratings agent Moody’s said it was tinkering with the notion of putting Spanish debt on downgrade watch. It was likely to do so on account of its “vulnerability to funding stress,” with almost €300 billion of maturing debt to be rolled throughout 2011. The good news for anyone looking for a silver lining is that Moody’s doesn’t expect the nation to fall victim to the EU bailout fund. That’s good news indeed because Chancellor Merkel is laying the ground works for keeping it at an unchanged €750 billion come hell or high water. And we all know that as far as Spain is concerned, the rain falls mainly on the plain! German bund prices are unchanged at 124.12 having reached a session peak at 124.36 after rebounding from an early in the day low at 123.76. The benchmark yield today stands at 3.01%.
British gilts – A tiny shortfall in the number of people claiming unemployment is upsetting gilt buyers today. In the bigger picture investors are starting to worry about the pace of inflation, which yesterday showed nine-straight months of above target price gains. March gilt futures have stalled at 117.39 to yield 3.60% as investors think about the low likelihood of any positive trend for inflation into 2011 while more public workers face an austerity boot from their desks. In the third quarter some 33,000 government employees lost their jobs making it the harshest rise in losses since 1999. Today’s employment report revealed the highest reading of long-term unemployed – those out of work for more than 12 months – sine 1996.
Japanese bonds – The Bank of Japan’s fourth-quarter Tankan was also somber but did an intention by large manufacturers to boost spending ahead. March JGB futures declined by 17 ticks to 138.98 while cash 10-year yields remained at 1.25%, close to a seven month high. However, yields at the five-year maturity reached 0.60% making it the highest reading since November 2009.
Australian bills – Australian 90-day bill prices had little to respond to apart from a rise in a Westpac consumer confidence indicator. However, that reading was countersunk by ongoing chatter from mainland China that it would continue to tighten monetary policy in 2011. Bill prices fell by a small amount as yields conformed with the global trend towards higher rates. Don’t forget that the Australian central bank has mainly accomplished its monetary tightening and anything next year will likely be considered fine-tuning. The government benchmark bond shed four basis points in yield to close at 5.62%.
Canadian bills – The widening trend between core government bond yields north and south of the border continues and during yesterday’s melee reaching 14 basis points (U.S. above Canada). Following today’s tame inflation outturn in the U.S., it was domestic American notes that made the running with investors shaving off seven basis points while Canadian debt yields declined by half as much to stand at 3.316%. Short-dated bill prices rallied by four basis points.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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