U.S. yields pushing 2011 lows on labor market fears

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%.

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