Bonds struggle to prevent losses

The resumption in risk appetite cooled in part after unexpected weakness in a U.S. manufacturing report. Bond prices pared earlier losses and yields are fast-approaching unchanged. The lack of fresh negative news coming out of Tokyo continues to keep a bid below stock prices as investors hanker for the return of the type of bullishness that typified trading in the first two months of the year. The resignation of Prime Minister Socrates of Portugal has the potential to spark resumption of the sovereign debt crisis in Europe although dealers appear to be handling the event as though it was fully expected.

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European bond markets – After a bold effort to reduce the budget deficit, opposition lawmakers turned down further measures forcing Jose Socrates to step down as Prime Minister. The nation must surely be closer than ever to requesting an official bailout from the EU, which will most likely come over the weekend. Market estimates claim that Portugal will need about €90 billion and will be the third bailout-nation. Its government bonds fell sharply widening the premium over safer German debt. It does appear that as the day wears on, markets are taking this prospect in its stride and bond prices across all corners of the Eurozone are rebounding. Earlier data showed a cooling in the German manufacturing sector with a PMI reading for February declining to 60.9 although PMI services increased to 60.1. These reports are unlikely to deter the ECB from its decision to raise interest rates in two weeks time. June bunds fell to 122.10 before the contract recovered with yields barely changed at 3.24%. Euribor contracts also gained as cash markets remained nervous over the plight of Portugal and the implications of potentially generous liquidity provision from the ECB.

Japanese bonds – A ¥2.6 trillion ($32 billion) auction of two-year notes found increased demand with almost five investors trying to purchase compared to three last time a similar auction occurred in February. Stock markets reversed earlier gains to finish in the red inspiring buyers of government paper. The June JGB future added 16 ticks to 139.89 with the benchmark 10-year yield losing a further two pips to close at 1.195%.

Eurodollar futures – Durable goods orders slid bucking expectations of a gain and weighing on hopes that the recovery continued to build momentum. Excluding orders in the volatile transport sector investors wanted to see a 2% February gain for durable goods, but in the event were disappointed by a drop of 0.6%. Yet while the poor report has the capacity to diffuse some earlier optimism, it appears that investors refuse to stop wanting to drive the rebound for stocks. June notes reached a session low at 119-18 ahead of the report sending the benchmark yield higher to 3.38%, only to rebound afterwards. But a stubborn bid to S&P index futures has maintained upwards pressure on yields. Eurodollar contracts which were higher before the report have now turned lower sending implied yields four basis points firmer.

British gilts – Gilt prices are drifting lower in sympathy with European bonds as the enthusiasm for Wednesday’s budget loses its value in a rising environment for yields. An earlier retail sales report shocked analysts as February store sales dropped. Making matters worse is the outlook for sales in the face of a drop in living standards brought on by inflation running at more than twice the target rate set by the government. June gilts trade 11 ticks lower at 118.17 to yield 3.56%. Short sterling prices rose to reflect growing optimism that the Bank of England may yet win the argument over responding to exogenous price increases that are not fuelling wage growth. Most contracts rose by three pips sending implied rates lower.

Canadian bills – There remains little sign of either inflation or an interest rate change in Canada. Today short-dated bill yields rose although marginally less than those in Chicago. Government bonds futures stemmed a decline before the contract could reach its lowest price in two days. The 10-year yield has also matched that of the U.S. treasury contract gaining two basis points as spreads remain constant. Canadian debt today yields 3.21% with the spread widening midweek to 16 basis points.

Australian bills – Aussie government bond yields gained by one basis point overnight with little domestic news to exert an influence either way. Bill futures were mixed although swap rates have shifted sides of the bed once again with dealers no longer looking for an imminent monetary loosening when the RBA meets in April. Those expectations have evaporated as investors discount news of a recovery package from Japan. The trading relationship between the two nations accounts for about one-fifth of Australian GDP.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC

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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