Bond recovery hampered by U.S. labor market

Bond markets are mixed around the world as continuous headline-grabbing inflation concerns play their role weighing on investor sentiment. A decline in U.S. initial claims to the lowest since July 2008 has reversed some midweek optimism following soothing words from Fed Chairman Bernanke. With equity prices weakening around the world, it’s surprising not to see a bigger bid for the safety of government bonds.

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Eurodollar futures – There remain competing pressures on the treasury yields. First, the medium-term tone set in place beyond the initiation of QE2 remains intact with declining bond prices finally lifting benchmark yields to 3.77% midweek. The positive flow of economic data must, however, be filtered by Fed Chief Bernanke and while he can’t mandate lower bond yields, he can provide insight to FOMC thinking. Investors spend so long talking up the recovery resulting in a rising tide of equity prices that they inevitably end up turning their backs on bonds under the assumption that one day the central bank will change tack. Yet central bankers appear to be towing in unison but in a different direction to investors. It’s becoming a common theme to hear them repeat that rising commodity prices are both externally driven and will leave a temporary impression on consumer prices. A midweek auction of U.S. 10-year notes in the aftermath of the high tide for yields drew an indirect bid, whose buyers include central banks, of 71% of available notes. The average during the past 10 sales according to Bloomberg news is 46%. Fixed income investors ought to be listening more to what central bankers say rather than worrying about what they are doing.

European bond markets – ECB governing council member Gertrude Tumpell-Gugerell picked up on the same line of thought when she played down inflationary concerns for the Eurozone when she told an Austrian magazine that interest rates “remain appropriate.” She noted that oil and other rising commodity costs “must be seen as temporary” adding that the euro area “will have price stability in the medium and long term.” During the week core German bond yields broke above a 12-month peak before buyers stepped in today. The March bund contract is off an earlier high of 122.98 but remains buoyant to yield 3.29%. The market was also buoyed by hopes that German hawk Axel Weber is set to announce he won’t be running for ECB Presidency in October.

British gilts – The March gilt future is holding on to a mild gain after the Bank of England left its benchmark rate of interest unchanged in London earlier on Thursday. The contract trades with a gain of 14 ticks at 115.50 to yield 3.87% ahead of more central bank insight when the Bank unveils its latest price and growth projections in next Wednesday’s quarterly inflation bulletin. Former Bank of England MPC member DeAnne Julius warned that the committee risks losing credibility if it fails to tighten policy to tackle inflation “sooner rather than later.”

Japanese bonds – Later in the week Japan reveals its fourth quarter growth performance, which is expected to reveal a 0.5% contraction or an annualized 2% decline. The turnaround in U.S. bonds midweek helped spur a snapback for JGBs after five daily losses sending the March JGB contract 35 ticks ahead to 138.92 where the 10-year bond yields 1.29%. During the recent shakedown for bond prices, few if any onlookers have not brought forward a timetable of monetary tightening from the Bank of Japan with most still deferring any alteration until 2013.

Canadian bills – Bond yields are unchanged at 3.44% and have little influence to drag them either way. Prices of 90-day bills of exchange are unchanged despite a decline in comparable Eurodollar futures, which fell in response to a larger than forecast decline in initial jobless claims through the weekend.

Australian bills – Ninety-day bill prices were higher by seven basis points at longer expirations following a mixed employment report. Investors deferred interest rate expectations after the statistics bureau said employers created 32,000 part-time jobs while 8,000 full-time positions were axed. The net addition of 24,000 jobs was good news but taken to confirm that the economy isn’t in danger of running away. Dealers bought government bonds, driving yields down by two pips to 5.70%.

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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