Bond market tone buoyed by central bank comments

A setback for the recently improving U.S. jobs market and a far more cautious approach to European monetary policy setting set government bond trading alight on Thursday helping propel yields lower. Various Federal Reserve members have stepped up a message warning investors that the economic recovery remains modest. And while we could entertain that philosophy without central bank or government intervention during normal times, the reality is that the Fed is fast-approaching the final days of its policy of massaging yields lower. Once again a seed of doubt is growing in the minds of investors who wonder how well or otherwise the economy might withstand a stimulus-free environment in less than two-months’ time.

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Eurodollar futures – Midweek weakness in the ADP report was coated with precursory warning over the health of U.S. employment in the form of the highest reading for initial claims since August. The rise of 474,000 initial claims in Thursday’s report left few bond traders wanting to head into Friday’s official non-farm payroll report short. Benchmark yields tumbled to 3.19% and within a handful of basis points of the low for yields inspired by the events at the Fukushima power plant. Dennis Lockhart of the Atlanta Fed warned that it would take three years to restore the health of the labor market to pre-crisis levels, while cohorts from San Francisco and Boston aid that the Fed was failing to promote full employment. Bond traders are perplexed by the ongoing drip-lower for yields because the economy has recently shown strong signs of better health. Eurodollar futures pushed forward by two basis points as the curve shifted lower in parallel out as far as the 10-year maturity. The 30-year Treasury bond advanced for a sixth day, which would create its longest-winning streak since December 2008 in the aftermath of a financial meltdown.

European bond markets – The ECB appeared to sidestep an early summer rate increase in coded-fashion as investors responded to President Trichet’s change of wording. At the post-meeting press conference Trichet steered away from the use of a need to remain “strongly vigilant,” opting for a need to monitor inflation “very closely” instead. “We continue to see upward pressure on overall inflation, mainly owing to energy and commodity prices,” Trichet said today. “It is essential that recent price developments do not give rise to broad-based inflationary pressures.” Don’t be surprised if his colleagues follow-up in the coming days and weeks with comments suggestive of the imminent need to tighten policy. For now, however, investors focused on the short-end of the curve lapping up both euribor and the two-year schatz contracts helping remove downward pressure on bonds that has recently lifted yields to the highest in 29 months. Euribor futures advanced by 16 basis points while the two-year yield sank by 12 basis points to 1.78%. The June bund future saw gains accelerate leaving the contract 56 ticks higher on the session trading at 123.04.

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