Euro bonds rise after positive inflation report

IB Interest Rate Brief: European policymakers quell inflationary concerns

European government bonds rose after inspiration came from the Bank of England’s four-times a year report on inflation. The central bank scotched concerns that it should raise rates immediately to address price pressures created by surging commodity costs. Governor King made the immediate point in his opening remarks at a press conference that monetary policy must be forward-looking rather than dealing with the here-and-now. His thought process was later echoed by a continental speaker who also allayed inflationary concerns and in the process helped spark life in to bond prices that recently fell to the lowest in almost a year.

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Eurodollar futures – Treasury futures reversed earlier gains having matched a last Friday’s high. Yields changed course following a strong showing for housing starts and a marginally better than expected reading for building permits, a harbinger of future activity for builders. March treasury futures reached 118-29 ahead of the data pressing the benchmark yield back beneath 3.60%. Dealers were also responding to a rise in the reading of core producer prices stripping out food and energy costs. The January report rose more than twice the expected rate coming in at 0.5% lifting the annual pace of producer inflation to 1.6% after 1.3% in December. Eurodollar futures abruptly changed direction with far-dated maturities worst affected. For example the December 2012 contract gave up two basis points on the day to imply a cash yield of 2.22% having earlier traded to imply a lower yield of 2.13%.

British gilts – Earlier in the day the Bank of England’s quarterly inflation report had fixed income dealers breathing slightly easier, with enthusiasm for low and stable interest rates fast returning. Gilts popped higher to trade at 116.44 in the March contract before responding to the strong U.S. data. The contract recently traded down to 116.18 although still remains well in positive territory for the day. The Bank stated that it still expects inflation to fall back below the 2% target rate after two years saying that the fourth quarter contraction for GDP materially affected its projections adversely. Investors subsequently scaled back their lofty expectations for firming monetary policy lifting short sterling futures in the process. The December 2012 expiration moved away from a forecast yield of 3% to reach 2.84% at its most bullish point of the day.

Canadian bills – Canadian government bonds were sharply ahead earlier in the day with the March future reaching 119.96 as it responded to the rhetoric from the Bank of England and matched a dip in U.S. yields. However, following firmer U.S. data dealers sold the contract, which had been 42 pips higher at one point, into the red for the day albeit for a brief period of time. Domestic data also revealed some weakness with manufacturers only moving slowly ahead in December compared to forecast. Bill prices remain in the black so far with implied cash prices a couple of basis points lower.

European bond markets – Soothing words from ECB member Guy Quaden helped soothe fears over inflation sending European bond yields sharply lower. Mr. Quaden suggested that euro-area inflation will likely “progressively decelerate in the second half of the year,” sounding very much like the Governor of the Bank of England. German bunds exploded to the upside to reach 123.44 at the session high shaving seven basis points off yields, which lately have reached 10-month highs.

Japanese bonds – Dealers used in part the excuse of a weaker than hoped for five-year auction as reason to sell bonds. Fewer investors than previously showed up to buy an equivalent of around $25 billion government bonds today with a wider tail also dragging on prices. However, the weakness in the yen caused by glowing attitude towards the recovery and as the Japanese shake off a dull patch of economic activity, is also undermining demand for bonds. The 10-year yield stretched to a 10-month high overnight closing at 1.34% as March JGB futures gave up 47 ticks to 138.51.

Australian bills – Australian markets were quiet with government bonds adding two basis points to close at 5.68% and below a recent peak at 5.75%. A leading index compiled using December statistics and therefore pre-flooding went unnoticed although pointed to healthy mid-year expansion. 90-day bill prices eased a couple of basis points.

Andrew Wilkinson

Senior Market Analyst

ibanalyst@interactivebrokers.com

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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