Yields rally on U.S. rating threat after Q4 surge

A further pick-up in growth in the world’s leading economy might not have driven yields higher at the end of the week had it not been for an earlier warning from Moody’s. The credit ratings agency warned that the clock was ticking for the U.S. to cut its budget deficit, which has surged relative to output over just three years. As the economy expands and as investors sense the Fed will ultimately step away from its period of excessively loose policy, the two-to-30-year curve reached a record 404 basis point gradient on Friday.

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Eurodollar futures – Fourth quarter GDP might have been higher and indeed fell short missing by just three-tenths of a percentage point expectations for growth of 3.5%. However, excluding the drag brought about by inventories the economy grew at 7.1% and its fastest since 1984. March Treasury note futures slid in reaction to the report hitting 120-06 before dealers locked in to the intraday rise in yields. Eurodollar futures also pared losses as dealers conclude that the Fed will remain on hold for the indefinite future. One reason perhaps was a slip within the GDP report for prices, which only rose by 0.3% after a third quarter gain of 2.1%. Elsewhere Moody’s said that the U.S. might need to be taught a lesson for failing to take the lead in cutting its budget deficit. The agency said it might take the inevitable step of putting the nation’s debt on watch for possible downgrade citing concerns that lawmakers are lacking the will to tackle the bloated deficit. In 2007 the deficit represented 1% of the overall size of the economy yet today that number stands at 8.8% following rescue efforts to prevent the failure of the financial sector. Moody’s noted that not helping alleviate its concerns over a worsening of the fiscal environment was the recent extension to tax cuts and the plausibility that lawmakers might not commit to cut spending. Treasury Secretary Geithner responded in Davos, Switzerland by saying that fiscal policy must also support the near-term challenges facing the economy.

Canadian bills – Short-dated bills dipped in response to the improved health of the U.S. economy following remarks by Bank of Canada Governor at Davos. He welcomed signs of improvement given the close-linkage between the two nations but warned of the perils of a strengthening local currency. Government bond prices have clawed back to almost unchanged on the session at 121.20 following earlier weakness to 120.75. The 10-year yield trades at 3.30% to close the week.

British gilts – Inflation worries continue to dominate European credit markets and have taken over as the number one force behind implied yield movements as sovereign debt crisis woes appear to subside. Short sterling prices fell despite the biggest monthly decline in two decades for a consumer confidence report. Investors would currently rather trade shorter-dated futures from the fear perspective at present after ECB officials woke the market up to threats to the inflation target. The 2012 strip of futures fell by as much as five basis points on Friday. Conversely gilt buyers pushed the cost of government borrowing lower with 10-year yields declining to 3.67% as the March future rallied 24 ticks to 117.23.

European bond markets – The 90-day euribor strip edged down lifting implied yields by three basis points after ECB member Tumpel-Gugarell served up a strong criticism of member governments’ failure to implement properly the concept of monetary union. March bunds rallied later in the European afternoon as fixed income bidding increased with the contract putting in new intraday highs at 123.67. Investors ignored earlier signs of weakness in terms of a rise in fourth quarter unemployment and a dip in Italian consumer confidence.

Japanese bonds – Japanese economic data improved with unemployment falling and the pace of deflation abating somewhat. Earlier in the week S&P delivered a credit downgrade, but this still failed to deter fixed income buyers who today looked at regional weakness for equity markets and a rebound in the yen and determined that yields remain high enough to warrant locking in. The March JGB contract added eight ticks to close at 139.86 yielding 1.21%.

Australian bills – The tax levied on middle-to-higher income earners in Australia to help pay for flooding damage has eased a little of the pressure on the RBA to maintain ots policy of tightening interest rates. Short-dated bill contracts advanced spurred by a dip in Asian benchmark stock indices. Government bonds were bought driving the 10-year yield lower to 5.50%.

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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