Bonds rebound after nine-month high for yields

A poor auction on Tuesday and rising equity prices around the word saw U.S. bonds put in the worst price performance in a month driving yields to a nine-month high. Ahead of testimony from Fed Chairman Ben Bernanke on Wednesday, notes are clawing back from the brink as yields recoil from above 3.76%. German markets were hit earlier by speculation that Bundesbank inflation-hawk Axel Weber is unlikely to add Presidency of the European Central Bank to his credentials.

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Eurodollar futures – Chairman Bernanke might provide bonds with a bid if he maintains his view that a recovery isn’t worth crowing about until labor market trends are strong enough to drag the economy out of what he characterized as a “deep hole.” Mr. Bernanke appears before the House Budget Committee on Wednesday morning and is expected to discuss latest economic developments and fiscal policy. Cohorts at the Federal Reserve sounded more upbeat than their leader. Richmond Fed Chief Lacker yesterday said that the FOMC has a duty to check itself over the second-round of bond-buying program as the recovery gathers steam. Earlier Dallas Fed Fisher said he’d not vote for a phase three faced with improved evidence of recovery. The March Treasury note future rebounded from an overnight low at 117-22 to trade back in the black ahead of Bernanke’s testimony at 118-05 with the 10-year yield at 3.69%. Short-end futures made minor gains also.

European bond markets – Axel Weber, the man at the top of Germany’s inflation-fighting Bundesbank will not attempt to replace a retiring Jean-Claude Trichet when he steps down as President of the ECB. The two have clashed over the bond-buying plan with Trichet publicly stating that Weber’s public outcries don’t represent the view of the ECB’s governing body. German bund traders spiked the March contract to an intraday high at 122.88 on the breaking story hoping that a slightly less hawkish leader might emerge. In the grand scheme of things the story isn’t huge, which is possibly why the bund pared gains and remains 19 ticks lower on the session at 122.63 to yield 3.27%. The current yield is also close to a nine-month high. Euribor futures also initially rallied on the news with the implied yield on the December 2011 contract slipping from an earlier peak at 1.97% to 1.90%.

British gilts – The downtrend for the March gilt future in place since the end of January remains intact, although at 115.69 the contract is off an earlier low at 115.46. The bearish tone continued following an upwardly revised prediction of consumer prices for 2011 from Britain’s leading trade body, the CBI. It raised its average inflation forecast from 3.3% set in December to 3.9%. However, short sterling futures are facing a short-covering rally after ongoing declines in recent days as investors perceive that growing threats to the inflation backdrop leave the Bank of England with little choice other than to bite the bullet and raise interest rates. No one expects any change in policy, however, from this week’s MPC meeting when the Bank publishes its monthly statement on Thursday.

Japanese bonds – Fixed interest payments are failing to maintain the attention of investors watching more appealing opportunities unfold offshore. The Japanese yield curve shifted in parallel as investors sold bonds across the maturity horizon in sympathy with rising yields around the world often in response to increasing optimism embodied by rising equity prices. The five-year yield reached its highest in 14 months following a 5% gain in a monthly reading of domestic machine tool orders. Although investors have refused to rein in the timing of a Japanese monetary tightening from the Bank of Japan, the yield on the 10-year government bond has risen from its October record low at 0.82% to 1.32% on Wednesday. The March JGB future slipped by a further seven ticks to 138.69 lifting the yield by a single basis point today.

Canadian bills – Canadian yields continue to rise semi-shackled to the fortunes of U.S. treasuries although the plot takes a couple of turns on the way. Tuesday’s negative response to a poor U.S. auction helped send notes into an abyss sending yields sharply higher and reminding investors of the sovereign risk. Arguably the threat of U.S. default remains small, but the state of Canadian fiscal health is vastly superior to that of Washington. As a result the spread between the two 10-year yields widened further with Canada’s interest rate burden rising in a mild fashion. The spread between the two widened to 24 basis points on Wednesday from around 10 basis points one week ago. The raw 10-year Canadian government bond of 3.45% compares to 3.69% on U.S. debt.

Australian bills – An index of consumer confidence in Australia rose in February gaining from 104.6 to 106.6 and following the Queensland floods, one expects that the outlook should brighten. Bond prices marked time and already reflect a resumption of monetary tightening later in the year. With Asian markets backing off after Tuesday’s interest rate increase was announced, bill prices had nowhere to go and remain unchanged on the day. The 10-year government bond closed at a yield of 5.73%.

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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