U.S. yields surge as risk appetite starts anew

Most fixed income markets remain closed until observation for New Year holidays comes to a close later in the week. Of the major markets open, only U.S. treasuries and German bonds are in motion. The response to New Year enthusiasm for economic recovery couldn’t contrast more between the two with the cost of government borrowing on the rise in North America while German bunds are attracting inflows from defensive investors wary of a mountain of maturing debt falling due in the early part of the year across the Eurozone.

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Eurodollar futures – With an ISM manufacturing report due later in the day likely to corroborate a strengthening economic recovery, and one that’s shifted from inventory rebuilding to forward-looking business decisions, treasury prices are lower to start the year. The yield on the key 10-year note has already surged 10 basis points to 3.40% as equity index futures and key commodity prices indicate the recovery is not only underway but must also be underpriced at closing levels for 2010. The March 10-year note future fell three-quarters of a full point to 119-22 while deferred Eurodollar futures contracts fell by increasing amounts over the time horizon allowing the curve to steepen. The March ‘12/March ’13 calendar spread steepened by another three basis points as the yield on the far-dated contract rose by seven basis points.

European bond markets – The single European currency came under early attack, although it has regained its poise after a shaky start. While investors remain encouraged by the pace of escalating recovery in the core German economy, they recognize the Herculean task in the months ahead for domestic governments facing huge funding shortfalls. And so, while U.S. yields respond by rising as the economy shows clear signs of healing, German yields are driven lower by investors worried that the outlook for risk is a decidedly ugly one in the coming months. European leaders have tried to forge a permanent solution to the lingering fiscal crisis ahead of the expiration in two years’ time of the €750 billion emergency bailout fund. Confidence among investors accustomed to buying government debt within the Eurozone is clearly low as the club seems to have a canny knack of leaving new battles until the eleventh hour. Spain and Italy have an aggregate maturing sum of €400 billion by April and it seems hard to imagine today what the Eurozone will do in advance to better the investment climate ahead of time.

It would take a massive recovery in confidence that the euro will survive in its current form to usher in an all-clear for tier-two Eurozone governments before the pressure on their bonds dissipates. In the meantime, investors continue to seek solace across the German yield curve. Earlier gains of 62 ticks in the March contract to 125.93 have, however, been tempered by two events. The sliding U.S. yield curve is finally taking its toll and bringing out sellers. Earlier in the day Eurozone PMI data for December showed a further gain in manufacturers’ health with the index reading 57.1 from 56.8 in November. The reading also beat expectations. The data highlights the still robust pace of expansion within the German manufacturing core, while French data recoiled somewhat. The 10-year bund yield rose two basis points to 2.96% as March bunds erased gains fighting to remain in positive territory on the day.

Australian bills – Markets closed.

Canadian bills – Markets closed.

British gilts – Markets closed.

Japanese bonds – Markets closed.

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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