Proving that “it ain’t what you say, it’s the way that you say it,” the highly anticipated wording at Thursday’s ECB press conference indeed signaled a July rate increase, but a markdown for inflation expectations wrong-footed interest rate traders. The September German bund future screeched higher after the press conference shaving five pips off the benchmark 10-year to 3% and halving the premium above Treasuries to five basis points.
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European bond markets –Jean-Claude Trichet stuck to his scripted comments and once again talked about the need to display strong vigilance over inflation virtually guaranteeing a shift to 1.50% for the ECB’s main refinancing rate at the July meeting. However, interest rate traders dampened expectations for future rate increases when Trichet lowered the forecast range for 2012 inflation albeit by a smidgeon. The ECB now says that inflation will rise above 2.3% next year and predicts CPI will range between there and as low as 1.1% throughout the forthcoming calendar year. And while the move shaves just one-tenth of a percent off its projection, traders began to doubt the extent of future tightening sending implied yields tumbling across the euribor curve. The December contract added 4.5 basis points while the implied yield on the June 2012 contract shed 10 basis points in the fervor slipping to 2.04% at the session high. Investors also bought government bonds after an earlier selloff drove the yield on German two-year paper up five pips to 1.71% ahead of the meeting while later slumping to yield 1.61%.
Eurodollar futures – Three month Libor slipped to its lowest level since February 5, 2010 edging below the 0.25% fed funds ceiling rate set by the central bank. Abundant liquidity at the front end of the cash market and an implicit cast-iron guarantee that policy is on hold for the remainder of the year has forced the short-end of the curve lower. Eurodollar contracts surged midweek as dealers responded to the moribund state of the world’s largest economy lopping around 17 basis points off implied forward yields. The trade deficit unexpectedly narrowed in April as imports hit the rocks. Trade with jump fell by $3 billion causing some optimism that trade will benefit during the current quarter as demand rebounds. Eurodollars have subsequently pared an earlier positive start with implied yields turning a little higher after a six basis point dip ahead of today’s data. Ten-year note yields are static at 2.95% having earlier reached a year-to-date low at 2.935%.
British gilts – The yield curve is a little softer in yield terms as pressure from the continent eased following the ECB’s decision to lower its inflation projection. Short sterling futures are higher by up to four basis points while the 10-year yield shed three basis points to stand at 3.26% with the September future advancing by 30 ticks to 123.76. The trade deficit also narrowed in Britain during April as imports sagged.
Canadian bills – Canada’s big economic report is due Friday with investors now expecting a smaller gain for employment during May having already seen the sad state of the U.S. labor market. That report is due at 7am ET on Friday and will drive yield expectations accordingly. Bill futures are a little softer, albeit by one tick in advance of the reading as investors respond to events in the Eurodollar futures market where some profit-taking is sinking in after a formidable rally for fixed income prices. Dealers also sold September delivery government bond futures with the contract lower by 23 ticks at 124.71 where the 10-year cash bond yields 3.02%.
Australian bills – Weakness in the labor market iced the cake for dealers hoping that the Reserve Bank would likely end its monetary tightening. Bill futures jumped once more to price out the prospect of a further rise in official rates. The December contract at one point breached the key 5% level falling to an implied yield of 4.98%, which compares to the RBA’s 4.75% setting. Three-month Libor typically averages around 18 basis points above the central bank’s setting. Bond yields declined by a further three basis points to 5.19% following a net employment change of 7,800 new positions across the economy. The reading compares with estimated gains ahead of the report of around 25,000. The economy shed 22,000 full-time positions during May adding to a loss of 57,200 during April.
Japanese bonds – Japanese yields fell again as the September JGB future advanced by 20 ticks to 140.77 as investors remained jittery over the health of the U.S. economy and in advance of Thursday’s trade data, likely to confirm weakness. GDP data showed a sharper contraction for the economy than was thought likely with first quarter growth contracting by 1.3% compared with the three-months ending December and 3.5% over year ago data. A five-year auction of government debt carrying a 0.4% coupon met with decent demand as shown by a bid-to-cover ratio of 3.2-times.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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