Euro bonds fall as Trichet pulls out the red pen

ECB Chief Jean-Claude Trichet pulled no punches on Thursday and warned that it would be no surprise if interest rates were raised at the next central bank pow-wow in a couple of weeks. Ahead of the meeting his words were expected to raise the specter of monetary tightening at some later point this year. Instead he let the cat out of the bag that the benchmark cost of borrowing is assured to rise in March. The German yield curve flattened considerably in response as short-dated contracts slumped while bond prices cratered.

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European bond markets – European credit markets crashed on Thursday as a rather transparent President Trichet pulled out his red pen and rewrote the yield curve sending implied yields screeching higher. Euribor contracts, used to predict forward three-month cash rates faced losses of up to 20 basis points with spreads against Eurodollar futures widening by five basis points. The short-end of the bond curve felt similar wounding with the two-year schatz adding 17 basis points as it rose to yield the highest since June 2009 at 1.718%. The March bund contract is in a second hour of free-fall as investors at least try to adjust to Trichet’s warning. Yields at the 10-year are higher by nine basis points to 3.28% although still well below the February peaks for yields – a clear objective over the next day or so. Mr. Trichet stated that “strong vigilance was warranted but also claimed that any increase would not necessarily be the start of a series of moves. However, when the world around you collapses or in this case as yields surge there are few crumbs of comfort to help.

Eurodollar futures – March treasury futures started the cascade for global bonds earlier. Following on from a rather robust Beige Book survey of the health of the economy, bond traders were already prepped for further stronger data. An initial claims report provided just that with claims for unemployment benefit falling to the lowest in about two-and-a-half years. Dealers looking for good news on the employment front have now been served up a glowing ADP report and a further 20,000 drop to 368,000 in weekly claims data. Tomorrow stock market bulls will be hoping for corroboration in the shape of a triple-play for the labor market with a jump in non-farm payrolls. Just 24 hours ago March notes fell to the lowest yield in a month at 3.37% but in the space of a day the yield has shot up to 3.53%. Eurodollar futures responded today with a decline of around 15 basis points.

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