It was in the early fall of 2010 that the Federal Reserve sent out a survey to its primary dealers – those obliged to bid at government debt auctions. The central bank asked, if it was to perform further quantitative easing, how much more should it buy and over what time frame. Following the huge disappointment of the May employment report on Friday, it looks like someone at the Fed might be stuffing envelopes again to get a sense of whether or not a further round of quantitative easing might be appropriate. A rise in the rate of unemployment to 9.1% during May confirms what Chairman Bernanke warned about six months ago and reaffirms the soft patch the economy hit some weeks ago.
Eurodollar futures – September notes surged to a session high of 123-26 making fools of sellers who responded to Thursday’s warning from Moody’s over an admittedly slim chance of government default. Ironically Friday’s report showing weak payroll growth of just 54,000 and more than 100,000 short of consensus actually reinforces the Moody’s forecast by signaling a likely shortfall in tax revenues. Still, bond yields slid back over the 3% threshold to 2.95% as investors fled other asset classes grabbing for yield at any cost. The data was worsened by a back revision to the past two months giving credence to the recent sour patch for the private sector ADP report. Eurodollar futures surged at longer-dated maturities. The deferred September 2012 maturity rose lowering its implied yield to 0.80% and close to a contract high reached in November when its implied yield slipped to 0.73%. During the subsequent seven-month period as investors predicted that the Fed would soon be tightening policy the implied yield at one point rose to 1.94%. Spreads also narrowed as investors bought back-month futures with the September 2011/September 2012 calendar spread narrowing to 45 basis points today from over 100 basis points just six weeks ago.
Canadian bills – Trading in Canadian bills was brisk in the 30 minutes following Friday’s U.S. data with the economic pessimism clearly spilling north of the border. Earlier in the week when the Bank of Canada left its monetary policy unchanged it warned that while policy would need to be restricted at some point, decisions would be finely balanced in light of the constraints on household balance sheets. Today’s rise in the unemployment report questions once more the benefits of raising interest rates in a cooler economy. Dealers bid bill prices higher sending the year-end implied yield down to 1.45% matching its lowest since August last year. Investors have to wait another week for the domestic reading of employment from Ottawa. Gains for government bonds north of the border matched those on comparable U.S. issues with the yield at the 10-year sliding by seven basis points to 2.95%.
European bond markets – An earlier slide in German bunds was fast-reversed in light of the latest jobs report in the United States. Dealers had earlier sold bunds on growing hopes that the Greek default issue might be successfully put to bed before the end of June. A gauge of service sector activity across the Eurozone surprised to the upside as activity strengthened during May leading to a rise in yields during the European morning. However, news that growth in the labor market was hitting the skids caused a flurry of fresh buying on implications for global growth. The June bund future rose from its session low of 125.34 to reach 126.04 sending the 10-year yield lower to 2.96%. Euribor traders also carved out a healthy range of six basis points across most contract months with implied yields currently softer by a basis point in late afternoon trading.
British gilts – Gilt futures also wiped out earlier losses of around 25 basis points for the September contract as news of a weakening labor market depressed yields lifting the contract by the same amount. The benchmark government yield slipped by two basis points in to the weekend at 3.22%. Early morning weakness in short sterling futures prices was reversed following the release of a softer-than-expected PMI gauge of service sector activity. Unlike on mainland Europe, service sector activity was curbed in Britain with the reading slipping to 53.8 from an April number of 54.8 as government spending cuts and tax hikes bite into inflation-weakened disposable income.
Australian bills – The perceived likelihood of further monetary tightening softened marginally at the end of a tough week for equity markets, falling in response to softening growth prospects. Although bond prices in Australia remained unchanged, with the 10-year yield static at 5.20%, bill prices at the short-end advanced by a pip or two following the revelation that service sector activity returned to contraction territory during May. Arguably this is a less important sector than the key export-sensitive and investment-driven mining sector, unless of course you are reliant on the services sector, which many Australians are. Activity within China’s service sector softened last month albeit from an already high reading of 62.5 to 61.9.
Japanese bonds – Bond yields remain static in Tokyo with onlookers concerned that 10-year yields below 1.2% are too low to encourage fresh buying in coming weeks especially in light of escalating political turmoil now that Prime Minister Kan said he’ll stand down. The timeline for his departure remains uncertain with some party members saying that post-earthquake order will not be restored until early 2012. Meanwhile yields rose by 1.5 basis points on the week to close at 1.13% with the June JGB future attracting a flurry of buyers towards the close to end the session eight pips better at 141.13.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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