Bonds swing as fears grow for change in Fed stance

Bond prices have curiously swung between earlier losses and gains and despite some unambiguously hawkish assurances from German Bundesbanker Axel Weber. The cost of government borrowing around the world had continued to climb, forcing steeper yield curves in the process as investors’ alarm grew over the implications of rising crude oil prices. Investors remain nervous over how much more inflation will show up as a result of Middle Eastern turmoil while equally concerned over the impact on recovery. Despite a pullback in crude oil futures on Tuesday it seems that worries over growth are stealing the spotlight. The early morning rebound came to an abrupt halt when market-talk surfaced suggesting that the Fed might drop its “open-ended” commitment in a possible subtle shift to its strategy.

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European bond markets – Inflation in the Eurozone rising at 2.4% has exceeded the ECB target and last week its President Trichet was quick to conclude that a move to remedy rising costs was officially in process. Following that up today was uber-hawk at the Bundesbank, Axel Weber, who bluntly stated, “I wouldn’t do anything here to try to correct market expectations at this point.” Weber was asked by Bloomberg News about whether the market had over reacted, but he was in no mood to dampen the flames adding, “I see no reason at this stage to signal any dissent with how markets priced future policies.” Mr. Weber’s bottom line is that faster growth in emerging markets is resulting in faster inflation that may become “more sustained” than the central bank projects. “This has to be countered in a timely way. I do see considerable future price pressures.” June bunds had fallen earlier to 121.53 in response to a vigorous gain for German factory orders during January. Yet despite the affirmation of Weber’s comments the contract is now towards its session highs at 121.82 to yield 3.26%.

Eurodollar futures – Treasuries crawled back up the ladder in the hour ahead of Wall Street’s opening bell and following a reversal of intraday losses for crude oil prices. Investors are putting the impact of oil’s gains under the microscope to assess which is worse; inflation or lack of growth. At this point in time it appears that a lack of growth as a consequence of protests in the Middle East is winning the day. Earlier, treasury futures expiring in June fell to 118-11 as investors emphasized the risks from rising inflation on fixed income. But just to illustrate the state of flux in the state of affairs the June contract sank close to the session low as a discussion started over a possible removal of the FOMC’s “open-ended” commitment to keep policy loose. Eurodollar futures were trading flat ahead of stock’s opening print but have subsequently shed four ticks and are back to session lows. The benchmark 10-year yield has now added two basis points to 3.53%.

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