The desire to hold the safety of government bonds appears to have passed. A recovery overnight in the Nikkei 225 stock market index from a 5% slump has equity prices rebounding around the world. Meanwhile, analysts the world over are poring over the anatomy of a spike in the value of the yen that currently represents a capitulation in the catalog of Japanese disasters in the space of less than one week. It’s almost as if they believe the potential disaster at the failed nuclear power plant in Northern Japan is under control. Equity markets opened in typically good spirit for St. Patrick’s Day as though the world was back to normal. Bond yields around the world are on the rise again.
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Eurodollar futures – At the height of panic-buying of government debt on Wednesday U.S. benchmark yields tumbled to 3.15%. With equity prices rebounding hard today, investor demand for treasuries has fallen by the wayside and yields have crept back up to 3.25%. The pause in Japanese output and its removal from trade relationships for a currently undetermined period is harmful to global growth. Apart from a lower trajectory for growth, certain commodity prices have also come well off the boil and lowered inflationary concerns. And so on top of demand for safer government paper, dealers have also flattened yield curves during the crisis. The Eurodollar curve has flattened significantly with the June11/June12 one-year calendar spread coming in from 110 basis points exactly one month ago to just 62 basis points today. Likewise the Dec11/Dec12 spread has narrowed from 143 basis points in February to 106 pips today. The Eurodollar strip faced losses also following the February CPI report, which came in a shade worse than expected with the headline pace running at 2.1% in February and up from 1.6% the month before.
Japanese bonds – Fears that the crisis in Japan was worsening sent 10-year yields to their lowest in two months to 1.19% overnight and in the face of stock index losses surpassing 5.1% shortly after the opening. Bond futures, however, eased by one pip to close at 139.71 having earlier reached a session peak at 140.39.
European bond markets – June bund prices are lower by 60 pips sending the 10-year yield higher by five basis points to 3.14%. The gravity of the disaster in Japan pulled yields lower yesterday, especially in light of comments from one central bank who warned that the situation would be a factor in rate decisions at the forthcoming policy meeting. But as global stocks rebound, yields are starting to trek higher with implied yields on short-dated euribor contracts adding as much as eight basis points today. The bund contract has virtually unwound all of its positive work from midweek.
British gilts – A Bank of England quarterly survey of consumer price expectations revealed a nudge higher in inflation expectations one year ahead. The index showed a rise to 4% in response to the survey question of “where do you expect inflation to be a year from now?” At the time of the previous survey taken in November, respondents collectively predicted 3.9%. The survey also showed that 65% of those asked said they would seek out cheaper groceries in response to the level of inflation while only 9% said they demand higher wages. Yesterday the government reported wage growth in the three months ending January of 2.2%, which is tame compared to the current 4% pace of price increases. Such insight into the consumers’ thought and response process is likely to be a positive factor at the MPC who will be pleased to see that inflation is far from becoming entrenched in the wage-setting process. Gilt futures fell sharply in line with other long ends sending the benchmark yield six basis points higher to 3.54%.
Canadian bills – Canadian bill prices matched declines in eurodollar prices while its government bond prices fell far less than treasuries did. While the U.S. benchmark yield added eight basis points to 3.25% today, the Canadian yield added just three pips to 3.15%. Next week Finance Minister Flaherty should deliver good news on next year’s fiscal budget as the government continues to aim to become the first G7 nation to balance its books following the financial collapse.
Australian bills – Australia’s economic exposure to Japan has helped shift forward yield expectations. The world’s third-largest economy accounts for about one-in-five dollars in GDP and the temporary disappearance from a normal trading relationship will weigh on the Australian economy. Bill prices were marginally lower overnight after a giant flattening of the curve and after the Japanese tragedy, dealers are now positioning for an interest rate cut as soon as the April meeting at the RBA according to swaps markets.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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