Bond ends diverge on policy amelioration at ECB

Global long ends are trapped between conflicting arguments. On the one hand, the European Central Bank unwound investors’ fears over nearby changes to monetary policy as inflation picks up initially sending German yields lower. Meanwhile a rampant U.S. service sector caused investors to worry about how long the Fed might be able to reconcile temporary inflationary pressures with prevailing policy settings.

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Eurodollar futures – March 10-year Treasury note futures slid to 119-06 following news that the ISM service sector index rose above expectations to show the fastest pace of increase for the non-manufacturing companies since August 2005. The curve steepened on rising prospects for a change in tack from the Fed lifting yields on the contract to 3.54%. Eurodollar futures also backed off with deferred contracts seeing implied yields rise by eight basis points. Earlier in the day initial claims data revealed a resumption of the trend back towards 400,000 in initial claims data. Later in the day we’ll hear the latest overture from Fed Chief Bernanke.

European bond markets – President Trichet did more than unwind expectations that the ECB may tighten monetary policy during this year when he addressed the post-meeting press conference on Thursday. He also warned that now is no time to be complacent nor to assume that matters have returned to normal. His comments managed to initially lift German 10-year bund futures, which hit a session high at 123.16 as investors were swift to cover bets that bond yields would rise as the ECB moved into rate tightening mode. However, his bigger-picture thoughts about the overall health of the Eurozone in light of the sovereign debt crisis sparked further weakness in peripheral bond prices. While German yields initially shed three basis points to yield 3.22%, yields in Portugal rose 14 pips while Greek and Spanish yields were higher by eight pips. Euribor futures recovered from recent selling pressures with contracts rising by up to eight basis points as implied yields declined.

British gilts – March gilt futures remain near session lows after a double-blow on Thursday. The general tone is sour following the latest signs of health within the U.S. economy, with investors likely to remain fractious ahead of Friday’s employment report. Domestically, the British service sector also showed more than a glimmer of life with its index of activity surging from contraction and well into expansion territory during January. Gilt yields have risen by three basis points to 3.79% while short sterling prices faced a significant reversal of fortunes after the ECB press conference. The change in attitude towards what many consider to be transient inflationary pressures tripped investors badly. European markets, including the short sterling strip, have sold off recently for fear that policy tightening is close at hand. Sterling futures sold off once more after the rise in the PMI services index with the year-end contract reaching 1.75%. But inspired by a less hawkish tone at the ECB the strip has turned 10 basis points off its session lows with implied yields finally lower on the day.

Canadian bills – Yields rose in Canada, but by slightly less than in the United States forcing a widening to 11 basis points for the 10-year bond spread. Canadian government bonds fell in sympathy with American markets as firmer data forced investors to lock-in to rising yields. Tomorrow brings employment reports for both nations. Bill prices also fell in advance of the data with the year-end contract reflecting a rise to 1.88% in the Bank of Canada’s cash rate.

Japanese bonds – March JGB futures were 34 ticks lower overnight, although the yield on the 10-year government bond closed only one pip higher at 1.24%. The ongoing push into rising equity markets continues to sap investor demand for the safety of government paper.

Australian bills – An improvement in the number of building approvals during December took some attention away from the recent flood damage to the economy sending bill prices marginally lower. Yields on 90-day paper rose by as much as nine basis points as investors watched rising confidence in surrounding markets raise confidence in more actions out of the domestic central bank at some point this year. Benchmark government bond prices slid sending the cost of government borrowing up seven basis points to 5.64%.

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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