Yields sink as European tensions feed U.S. slowdown

Credit market participants continue to lower monetary tightening expectations at the end of a week in which further disenchantment surfaced over the health of the global economy. Inflation expectations also moved to a less threatening trajectory helping massage longer-dated yields further downwards.

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European bond markets –New highs for the September German bund contract as risk aversion resurfaces with flashpoints glowing red across the periphery. Portuguese benchmark government debt prices slumped sending the 10-year yield ever higher. ECB Vice President Vitor Constancio said it was not for the central bank to resolve Greece’s debt crisis and reminded us that it wasn’t the ECB that had dragged private bondholders into the discussions. President Trichet said that the central bank had no intention of rolling over its maturing Greek bonds sparking weakness in the euro and demand for German paper. The September bund contract also responded earlier in the day to steady consumer and producer prices in Europe’s largest economy during April. Euribor futures continue to rally sending implied yields lower in the wake of a softer tone toward inflation at Thursday’s ECB meeting.

British gilts – Woefully abysmal manufacturing and industrial production data reinforced the slowdown within a cash-strapped British economy. The September gilt future added a half-point and reached new contract high at 121.29 as the yield slumped to 3.21%. The two-year yield fell to its lowest for 2011. On Thursday the central bank announced unchanged rates and so far the doves on the committee appear vindicated. Short-term yields fell again as the curve flattened further with nearby contracts gaining three basis points and deferred contracts adding six pips.

Eurodollar futures – Eurodollar contracts gained by increasing amounts across the maturity spectrum with the curve continuing its flattening process. One week ago a huge block trade in the NYSE Liffe Eurodollar futures involving 30,000 September 2011/2012 spreads went through at 46 basis points. After a week of flattening, the calendar spread has narrowed by a further seven basis points to 39 points. The yield curve plotting the gradient of the curve across that time frame has not been this flat since the market responded to the announcement of the Fed’s second wave of quantitative easing in early November. The one-year calendar spread narrowed to 30 basis points at that time. The 10-year yield shed five basis points to 2.945% and is closing in on an earlier in the week low for the year ahead of reports next week expected to show a slowing in retail spending and consumer prices for May.

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