The European Central Bank dipped its toe in to the water on Thursday lifting its key short-term benchmark rate of interest from a record low to 1.25%. Within the last 24 hours the government of Portugal finally admitted that all was not well and formalized a bailout request that estimates predict will reach €75 billion. Commodity prices at the heart of the nascent inflation debate merely flinched at the onset of an era of firmer monetary policy and carried on rising. Perhaps someone should suggest a commodity industry for Portugal – something other than grapes.
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European bond markets – President Trichet at the ECB didn’t shed much light on what the central bank might do next, although odds are that it will add another notch to rates over the early summer. He noted that inflation risks remain to the upside while monetary policy remains accommodative. That’s central bank speak for “there’s more to come.” June euribor futures reflect another quarter-point rate increase as does the December contract. The money market sees policy normalizing at perhaps just over 2% one-year forward. There was little short-end reaction to Thursday’s official move given the red-flag that Trichet raised at the March meeting. Consequently all the action occurred then. For today, short-end futures are remarkably static while June bunds couldn’t help but fall ahead of the meeting on fears that the move would presage a string of hikes. In the event Mr. Trichet noted that, “We did not decide that it was the first of a series of interest rate increases.” The June bund contract slid to 120.30 ahead of the announcement only to rally in its aftermath keeping the benchmark yield at 3.41%.
Eurodollar futures – The treasury market stopped falling as fears were dampened over a string of rate rises at the ECB. The tone changed notably on the charts with the June future for example jumping from a loss of eight ticks to a gain on the day. The 10-year note currently yields 3.54% and showed little response to a 10,000 dip in last week’s reading of initial claims, which declined to 382,000. Short-end Eurodollar futures made session gains of around three basis points with investors recognizing that discussion over an early end to U.S. monetary stimulus has not yet reached simmering point yet.
Japanese bonds – The Bank of Japan said it would provide ¥1 trillion in one-year loans to companies suffering in the aftermath of the March earthquake and ensuing disruption to business. For the first time since October the central bank revised lower its economic assessment. Bond futures declined with the June contract shedding 34 ticks to 138.64 sending the benchmark 10-year yield higher by two pips to 1.30% and close to the top of its recent range. Weighing on sentiment lately has been rising optimism over the health of the global economy, which has stolen from the need to held government paper.
British gilts – As expected the central bank left interest rates on hold and had little to add at Thursday’s announcement. Debate remains heated over whether inflation should be tackled having breached the ceiling for almost a year now with consumer prices running at more than double the Bank’s 2% ceiling. At next month’s meeting the Bank will have its quarterly inflation report prepared and will base its decision off this. This is the Bank’s last real chance to raise rates before growth probably tapers off under the weight of private sector job losses and tax increases. By May, they will also have a better expectation of first quarter growth. A sharp rebound in activity would be needed to sway the Governor’s mind on economic grounds rather than his current focus on fighting off demands to temper inflation just for the sake of a fight. Yesterday’s industrial activity report did not fit into the growth rebound camp and following today’s inaction at the Bank of England’s meeting short sterling prices made an advance of three basis points as implied yields softened. Gilt futures are little changed at 116.54 to yield 3.75%.
Canadian bills – A healthy gain of 9.9% in domestic building permits reminded investors that the local economy continues to glow. Canadian bill prices bucked the advance in Eurodollar futures and forced a widening of short-end spreads. The spread between the two December contracts has now widened out to 132 basis points and close to last month’s 141 peak. Government bond futures recently accelerated to the downside and are lower by 41 ticks at 119.07 adding four basis points to the yield at 3.45%.
Australian bills –A strong reading from the labor market increased anticipation of further rate increases from the Reserve Bank. Bill prices receded by seven ticks and the swaps market pointed to additional central bank tightening of 27 basis points over the next 12 months compared to 18 basis points earlier this week. Full-time employment increased by 32,100 while part-time employment gained by 5,700 after falling sharply in February. The overall rate of unemployment fell by one-tenth to 4.9%.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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