Tension within the Eurozone rose to boiling point on Thursday after German insistence that Greek bondholders must share the burden of failure was countered by comments from an ECB member stating that Europe’s emergency fund should be doubled under such circumstances. The failed negotiations will begin again over the weekend with EU monetary commissioner Olli Rehn saying that his “close contact” with the IMF leaves him assured that Greece will soon receive its next round of aid to the tune of €12billion. His optimism seems to have taken the edge off demand for Treasury securities but not before two-year yields fell to a record low while those at the 10-year matched year-to-date lows.
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European bond markets – Money markets are also facing increased pressures from European banks wanting to raise both euro and dollar-denominated funds. Pressure at the front end of the curve was evident as overnight lending costs in euros rose for the first time in four days with counterparty risks clearly evident. Meanwhile the premium paid to buy dollars and convert them back in to euros also rose causing a drain on U.S. liquidity. The growing crisis saw Greek Prime Minister Papandreou’s hold on power slip reducing the likelihood of a safe passage of fresh austerity measures through an increasingly hostile Parliament. Of course the passage of which is a pre-requisite for the next installment from the IMF. German yields eased by one basis point to 2.93% as the 10-year bund future jumped to 126.62, while euribor futures rose by four basis points.
Eurodollar futures – I noted the hint of pressure in yesterday’s commentary in September and December Eurodollar expirations, which as noted above, worsened on account of demand for liquidity regardless of origin in European cash markets. The implied yield on the December contract rose from 0.40% at the start of the week to 0.49% at the height of market desperation on Thursday. Eurodollars also faced some pressure following better reports on employment and housing. Initial claims fell by 16,000 to 414,000 while new housing starts rose by 3.5% from an upwardly revised base for April. Permits issued to build new homes also jumped by 8.7% after builders were hindered by flooding during the spring. Rising yields were later tempered by a shock contraction in Philadelphia area manufacturing. The Philly Fed index of activity was predicted to rise in June from 3.9 but came in at minus 7.7. The September contract opened stronger and put in a fresh contract high at 124-16 before gains were pared to 123-29.
British gilts – The yield curve continued to flatten with short sterling futures expiring in this calendar year remained unchanged while sharp gains of up to eight basis points were seen at deferred maturities. Weakness in U.K. retail sales during May was blamed on high fuel costs and worries over employment prospects. Don’t forget that Wednesday’s jobs report showed not only dismal annualized wage growth of 1.8% for the three months ending April, but also the sharpest gain in jobless claims in two years. Interest rate futures are increasingly pointing to a lack of policy action from the Bank of England with expectations for the first move appearing to shift to about one year from now. Gilt yields joined the rally with an advance of 68 ticks in the September contract erasing four pips leaving the benchmark yielding 3.19%.
Canadian bills – Canadian bill prices surged with the implied yield on the December contract at one point falling to 1.37% in the heat of the moment on Thursday. The sustained gains for Canadian credit were directly opposed to the fall in Eurodollar futures meaning that the two curves compressed substantially. The spread between the year-end contracts north and south of the border closed Wednesday at 100 basis points and today has breached that level for the first time since October. The calendar spread narrowed to 88 basis points during the melee. Deferred bill futures advanced harder shaving six basis points off the yield. Government bond yields in Canada are unchanged ahead of lunchtime with the 10-year yield marginally below comparable U.S. debt at 2.94%.
Australian bills – Aussie bill prices wrote-off Wednesday’s threat of further monetary action and rallied sharply. A 12 basis point slide in implied yields came in defiance of Governor Stevens’ delivery in Brisbane midweek in which he said inflation risks were only likely to accelerate over the next few years raising the chances of resumption of monetary tightening. The 10-year bond yield slid by four basis points as Pacific investors realized that monetary tightening was becoming an obsolete threat as sovereign issued weighed heavier.
Japanese bonds – Spurred on by a midweek rally in U.S. treasuries on account of growing weakness in the Greek government and consequent rise in default fears, Japanese bonds jumped again overnight sending the benchmark yield lower by five basis points to 1.105%.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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