Investors are starting to get a better understanding of the irritation Fed Chief Bernanke publicly displayed in November following the FOMC’s decision to launch phase two of its quantitative easing plan. Mr. Bernanke appeared to be on the defensive when quizzed about the need to bring intervention in the government and mortgage securities market to a total of $1.8 trillion. The problem, he said was that employment was lagging the apparent recovery and would likely continue to do so. And as we enter the final weeks of open market bond purchases by the New York Fed, several economic flagships confirm Mr. Bernanke’s worries over the health of the recovery. The housing market is a bigger worry than six months ago with foreclosures jamming the pipeline. Record low mortgage rates are failing to prod buyers into action even as nationwide home prices slump to the lowest in at least eight years.
Eurodollar futures – And just to ice the cake on Wednesday, analysts’ expectations for private sector job creation during May proved woefully optimistic creating a fresh wave of advancing bond prices that sent the 10-year yield to within an ace of 3%. In advance of the closely-watched ADP employment report, dealers were braced for growth of no less than 125,000 jobs and while the private sector report can often buck the government report due two days later, it does broadly track labor market activity. The tailing off in job growth is a red flag for the future health of the economy. Dealers continue to pressure new highs for the September note futures with the contract touching 123-00 at best sending the cash yield to its lowest this year. The economy is undoubtedly in better shape as a result of two rounds of quantitative easing, yet investors must be wondering exactly how precise this strategy is. The Mortgage Bankers Association’s index of mortgage applications through last weekend slid by 4% as demand for refinancing and fresh loans declined, which merely proves that you can take a horse to water but you can’t make it drink. Eurodollar futures are higher having traded with losses earlier.
European bond markets – German bunds were lower earlier in the session but have responded to weakness in U.S. data with a reversal that’s sent yields lower on the day. Hopes have been growing throughout the session that behind the scenes negotiations would see Germany drop its demands for private bond holders to take losses arising from investments in Greek debt. Negotiations are reportedly underway that would allow for maturing bonds to be rolled over to later maturities without falling into technical default. A default would likely set off a cascade of fresh liquidity problems for Greek and therefore European banks and as such is the least desirable outcome. German yields rose earlier as many investors traded out of their bund positions feeling more secure and therefore in less need of the safety element typically associated with German paper. Bunds earlier ignored a softening in Eurozone manufacturing following a dip in the PMI index. Euribor futures have rallied off the session lows but remain one tick lower across the strip, while the 10-year German bund yield has reversed a three basis point rise to stand at 3.01%.
Canadian bills – Bill prices are tussling with the dilemma of whether or not to follow the statement issued by the Bank of Canada as it maintained its short term rate of interest earlier in the week. Implied yields jumped sharply Tuesday when the Bank warned that at some unspecified point it would take back monetary stimulus. There were, however, two caveats. The exchange rate continued to bear down on inflation while the Bank also warned that weakness in the balance sheets of U.S. households and corporations would likely mean that the recovery would proceed at the pace of a snail. More anemic U.S. data lifted the spirit within the Canadian interest rate market as dealers suspected that the central bank’s desire to tighten would only be hampered by the pace of the recovery. U.S. 10-year yields fell at twice the pace of the decline in Canada’s equivalent yields Wednesday forcing the premium to shift back to Canada.
British gilts – Yields in the U.K. were already on the decline before the fresh push inspired by weaker U.S. data. A sharper than forecast slippage in the pace of expansion in the manufacturing sector was enough to prompt gilt buyers to force the benchmark yield down by two pips to 3.27%. Short sterling contracts at more distant maturities shed up to five basis points in yield as rate expectations softened in response to weak consumer credit and mortgage approvals data from the central bank.
Australian bills – Aussie credit markets responded to a well-flagged contraction in first-quarter growth by selling off sharply. The domestic currency surged on relief that the GDP contraction of 1.2% wasn’t any worse while implied yields rose by seven basis points as though the report was the harbinger of further rate increases from the Reserve Bank. In reality the market is expecting just one more interest rate increase over the course of the coming year. Benchmark bond yields rose by three basis points to 5.23%.
Japanese bonds – Rising political drama failed to shift government bond yields midweek even as Prime Minister Naoto Kan faces a possible vote of no-confidence for his handling of the March earthquake and nuclear crisis. JGB futures slipped by one tick closing at 140.61 to yield 1.145% while onlookers grow concerned that the political backdrop is insufficiently strong to enable delivery of tough enough measures to help ease the nation’s gigantic debt burden.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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