Disaster aversion sends bonds packing

Treasury bonds and notes saw an acceleration of losses as equity prices staged a strong rebound and the U.S. Treasury said it would edge towards the exit by selling mortgage backed securities. The demand for government-issued paper eased as the Japanese government said it could see “light at the end of the tunnel” believing that power sources would soon be restored to overheating nuclear reactors damaged in the wake of the tsunami.

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Eurodollar futures – It’s a Tokyo holiday but the news flow has turned more positive over the weekend with hopes that the worst of the nuclear crisis may now have been averted as engineers rush to restore power to the disaster-stricken plant. The rush to buy government bonds has thereby come to an abrupt halt and with equity indices up by 1.5% within the first hour of trading dealers are fast-rotating between asset classes. An earlier report showing that the national economy came off the boil in February has been overlooked. The Chicago Fed’s national activity index peaked in December and turned negative in January and even more so in February. The data incorporates 85 data points including output, employment and inflation and the further slip below zero last month indicates a lesser pace of expansion and lower price pressures. However, this report was trumped by a release from the Treasury stating that it would start to sell off its $142 billion MBS portfolio in piecemeal fashion without stating any timing. The New York Fed is scheduled to wind up its bond purchase program in June and together these two factors clearly represent a move to the ultimate end of monetary stimulus. Eurodollar futures slide by 13 ticks at the long end while the June note future is three-quarters of a point lower sending yields rising by seven basis points to 3.34%.

Japanese bonds – The benchmark yield rose by one basis point to 1.20% as better news reports came in indicating that the peak of the crisis may now be behind the battered nation. The yen eased once again at the start of the week taking further pressure off bond demand. June JGBs rose by one tick to 139.73 while estimates for the repair package rose to ¥10 trillion or approximately $125 billion. While the government issues the paper via the Bank of Japan investors will be watching closely at just how strained relationships between the two become. The Bank has stated that underwriting already towering government issues would risk its credibility.

European bond markets – ECB Governor Trichet is scheduled to discuss monetary affairs at the EU parliament on Monday and dealers will be keen to hear whether the Japanese disaster has at all softened the central banker’s attitude to inflation. Earlier Luxembourg’s central bank chief and fellow European policymaker Yves Mersch noted in a quarterly bulletin that the ECB must show “strong vigilance” to prevent the inflation outlook from materializing. The June bund contract is close to session lows and stands at 122.25 for a session loss of 38 ticks. The 10-year bund yield added three basis points to 3.21%.

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