European yields weighed by Portuguese auction

A successful bond auction for Portugal on Wednesday following ECB purchases of its bonds on Tuesday has instilled a little more confidence in the health of financial markets. The implications of lower Portuguese bond yields are weighing on the safe haven status of major world bonds this morning sending bond futures contracts lurching lower.

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European bond markets — The benchmark Portuguese bond yield slipped further away below the line in the sand that market observers say would mark the threshold of investors’ patience before the government resorts to a bailout from EU partners. Its 10-year yield yesterday hit 7.19% before the European Central Bank stepped up to buy from banks across the Eurozone sending fickle prices higher and yields slumping to 6.70%. Analysts note that 7% was the level at which investors grew so frustrated with Greek and Irish authorities that life in the bond markets became sufficiently awkward as to cause each to resort to official aid. Today’s successful auction has shaved a further three basis points off the nation’s borrowing costs as investors are soothed by the first major test for markets in 2011. Its successful access to capital markets proved a boon for Greek debt where prices surged sending the 10-year yield sliding to 11.09% and narrowing the premium over German paper by 54 basis points on the day. Irish and Spanish spreads also compressed as debt markets were soothed by EU Monetary Commissioner Rehn’s article appearing in the Financial Times raising the proposition that the bailout facility is enlarged and revamped to allow it more flexibility has allowed investors to breathe a little easier on Wednesday. Meanwhile core Eurozone debt prices are sliding sending yields up from near one-month lows. The March German bund future slumped 75 ticks to a session low at 125.01 before rebounding to 125.23 to yield 2.99%.

Eurodollar futures — March treasury note futures reached a low at120-02 after import prices rose less than expected at 1.1% in December, with the drag coming from an upwards revision to a 1.5% increase in the November series. The benchmark note yield rose to by five basis points to 3.39%. Higher bond yields are also weighing on the Eurodollar complex at least at deferred maturities where dealers sold contracts to lock into a rising cost of borrowing. Implied yields rose by two basis points from March 2012 onwards.

Japanese bonds — Benchmark yields remained unchanged with the 10-year closing at 1.175% after a decline in bank lending for the month of December. Rising regional stock prices might have argued against the extension of an ultra-low monetary policy at the Bank of Japan, but the lack of demand for investment funding argues otherwise. Government bond futures expiring in March added six ticks to close at 140.08.

British gilts — A widening trade deficit to its worst reading ever hurt the pound and sent investors scurrying from government bonds. The March gilt futures contract slid by 87 ticks at its worst point of the day to trade at 117.33 lifting the 10-year yield by six basis points to 3.61%. Investors don’t expect any change to monetary policy as an outcome of the Bank of England’s two-day meeting concluding on Thursday although nerves are starting to fray following a string of nine consecutive above-ceiling readings for inflation. At the weekend a sympathetic Prime Minister Cameron said the Bank was charged with an “extremely difficult task.” Investors continue to trade short sterling futures from the bearish side and today sold contracts sending implied yields around six basis points higher. The December 2011 contract implies a cash rate of 1.58% compared to a current short rate of 0.50% set by the Bank of England.

Australian bills — Investors locked into lower yields after Monday’s drop in government bond yields sending the benchmark yield higher by five basis points to 5.55%. Investors have recently flattened the Australian curve in light of the economic damage likely to result from the heavy flooding affecting Queensland. Short-dated bill futures also reversed earlier gains to end the session with losses of around eight basis points despite comments appearing in the Sydney Morning Herald from a board member at the Reserve Bank of Australia. Warwick McKibbin forewarned of a likely 1% loss of GDP as a result of the flooding. Other economists seem less pessimistic and calculate only a fraction of that loss. As a result today the market recoiled from its recent trend towards a flatter yield curve.

Canadian bills — March government bond futures are not far away at 121.31 from an intraday low as a rising yield curve took its cue from the performance of the U.S. treasury market. The 10-year U.S. yield premium over Canada widened three basis points to 14 pips as Canada’s bonds outperformed those of its southerly neighbor. Shorter-dated bill prices remain unchanged ahead of the opening of equity markets.

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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