Bonds recover from early losses

U.S. yields fell midweek as dealers bought bonds ahead of a key seven-year auction of government debt and after a 35-basis point increase in benchmark yields in less than two weeks provided support for bonds. Investors continue to tread wearily in the bond market on concerns that the Federal Reserve is mulling its exit strategy from a period of ultra-easy monetary policy. St. Louis Fed's James Bullard aired the prospect that the FOMC stops short of spending the full amount detailed in November when a second bout of quantitative easing was endorsed.

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Eurodollar futures – Although St. Louis Fed Chief James Bullard’s comments continue to raise the stakes that the Fed’s emergency stimulus measures may be coming to a close, they have not as yet sparked a riot in the Chicago bond pits. The shift in the 10-year yield from 3.15% to 3.50% today is only about half of the move back to the early February highs closer to 3.80%. Following a slightly tame ADP report showing the creation of 201,000 new jobs among private employers in March, Eurodollar futures have staged a mild rebound inspired by a bid for Treasury notes. A $29 billion auction of seven-year notes is expected to go well later with yields having risen apparently far enough. Three-month futures contracts rose by four basis points while the June 10-year note future last traded at its session high at 118-30 to yield 3.47%.

European bond markets – June bunds pared losses to as low as 121.16 incurred after data showed confidence across several sectors remained near three-year highs. However, the reality is that the survey data is showing signs of fatigue. The rally for treasuries helped the German market rebound, while pressure continued to build outside the core nations. S&P yesterday bashed another nail in to the lid of the Portuguese coffin by downgrading that nation’s creditworthiness. A bailout is clearly on the table, with a simple request the missing factor. The Portuguese yield curve screamed to its highest level since the 1999 introduction of the single currency as investors pondered the implications of a rescue on bond holders. German yields backed-up towards a 14 month peak at 3.40% before coming in to 3.33%.

Japanese bonds – A sliding yen paid to the recent buoyant conditions in Tokyo’s bond market overnight. Stocks in the Nikkei 225 index surged 2.6% reducing the post-earthquake deficit. Government benchmark yields gained two basis points to 1.24% ahead of what is expected to be a buoyant Tankan report later in the week. Large manufacturers are expected to prove that a recovery in optimism was already underway before the destructive tsunami breached defenses at the Fukushima nuclear reactor. Also weighing on investors’ appetite for fixed income was a report showing buoyancy across the industrial sector where production unexpectedly rose during February bucking a forecast calling for a dip.

British gilts – Dealers sold short sterling futures and bought the British pound on signs of a recovery in the services sector during January and within the retailing sector this month. A CBI trade survey showed a rebound from an index reading of six to 15 for retailers’ expectations as optimism recovered from its weakest level since June. Today’s report still came in at well below the average during the past 12 months as consumers respond to a higher cost of living and an increase in the sales tax. MPC member Martin Weale, who has recently argued in favor of a rate increase, said in a speech that inflation might not return to target as a result of the Bank’s failure to tighten policy. Implied yields jumped in response to the midweek news sending yields higher across the strip by about eight basis points at the darkest moment of the session. June gilts also suffered with the yield gaining five basis points to 3.68% as the contract rebounded from a passage to 117.09 before trading recently at 117.38.

Canadian bills – A rising domestic dollar continued to argue against tighter monetary policy as Canadian bills made minor gains allowing implied yields to decline by a couple of basis points. The year-end December futures contract predicts a three-month cash rate of 1.82%. Cash typically trades 20 basis points above the official short rate on average and infers that the Bank of Canada will raise rates twice more throughout the year. Government debt prices gained with the benchmark 10-year yield easing to 3.31% as the June future remained unchanged at 120.42.

Australian bills – Bill prices were largely unchanged awaiting a retail sales report scheduled for release later in the week. The pendulum has swung away from the expectation that interest rates will be cut in response to events in Japan although few are predicting the RBA will be back in tightening mode anytime soon. Bill prices were unchanged while the yield on the 10-year government bond added one basis point to 5.48% as regional stocks put in a solid performance.

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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