Investors lost no time in reshaping their forecasts for monetary policy in light of the March labor market report. A sixth-monthly addition by employers put jobs at the vanguard of discussions on future Federal Reserve decisions. Earlier this week the St. Louis Fed chief floated the notion that perhaps the Fed should leave its second round of easing incomplete in light of the health of the U.S. economy. His words were echoed by the head of the Richmond Fed today. Investors wonder now whether Chairman Bernanke will pump up his view on the employment situation, which until now was disappointing, at least in his eyes.
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Eurodollar futures – Given the drama of Friday’s move, in the big picture the rise in the 10-year yield back to 3.50% is not really a big deal. In February yields stretched to 3.77% after an optimistic start to the year. Fixed income traders have perhaps had their senses dulled by the Japanese earthquake. James Bullard warned earlier that despite global catastrophes the Fed might not have the capacity to leave the engine idling while economic gauges heated up. Minneapolis Fed Chief Kocherlakota told the Wall Street Journal that the FOMC may need to lift its official fed funds rate by 75 basis points before the end of 2011. Richmond fed Chief Jeff Lacker reiterated Bullard’s observation that perhaps it doesn’t make any sense to conclude a second round of quantitative easing. An hour after today’s labor market report showed an above forecast gain of 216,000 jobs during March bond prices have settled down. The June note future is off by one half point, but has pared its losses from a session low at 118-09. Eurodollar futures plunged at the sight of another strong posting and within minutes reflected a surge in implied yields of 17 basis points with the curve steepening at further maturities. The one-year calendar spread starting at year end (Dec11/Dec12) widened by seven basis points to 142 basis points on Friday with the farther dated contract currently implying a fed funds short rate of 2.09%. Two year yields rose to 0.89% following the labor report sending short-dated notes to the lowest in 10 months.
European bond markets – German yields rose as bund prices saw accelerated losses following the U.S. report. An earlier manufacturing PMI report eased but that’s not likely to stop the ECB from following through on a warning served up in March that it is now back in rate-rising mode. The June bund future slid to a session low at 120.73 before rebounding. The 10-year yield rose by four basis points to 3.39%. Heading into the weekend, euribor futures contracts softened in preparation for Thursday’s ECB decision.
Japanese bonds – Favorable Tankan data admittedly collated in advance of the March 11 earthquake and the first gain in four months for Chinese manufacturers boosted confidence in the health of the global economy. A decline in the yen also boosted prospects for exporters and sparked further weakness in government bond prices. The June JGB contract slid by 38 basis points to 139.17 sending the 10-year yield higher by a couple of basis points to start the new fiscal year at 1.27%.
British gilts – British fixed income was a poor performer heading into the weekend with the 10-year gilt future falling heavily sending the benchmark yield seven basis points higher to 3.76%. Short sterling futures also suffered in a week when the environment for global interest rates worsened. Implied yields rose despite a weaker-than-forecast reading for the PMI manufacturing survey. It was revised down for February and came in at 57.1 as activity softened.
Canadian bills – The Canadians report labor data in a week’s time but the U.S. report created some fireworks for fixed income. The selling of 90-day bill futures was mildly less aggressive north of the border although the parallel shift in the yield curve reflected confirmation that the domestic monetary situation could shift at a moment’s notice if sentiment at the Federal Reserve swings in response to improving labor market conditions. Bill futures fell by seven basis points across the curve with spreads on deferred contracts North and South of the border therefore widening out by as much. As the U.S. economy improves, so does the Canadian economy. However, such improvement brings the demon of a strengthening currency, which also suppresses inflation and offsets the desire of the Bank of Canada to tighten monetary conditions.
Australian bills – Bonds in Australia were slammed lower sending government yields higher by eight basis points to 5.56% after the first pickup in activity at Chinese manufacturers. The official Chinese PMI for March rose marginally from 52.2 to 53.4 despite several attempts by the central bank to cool activity. Rising stocks around the region persuaded investors to forego the safety of yields in exchange for riskier stocks. Short-dated bills of exchange fell by as much as six basis points as implied yields rose.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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