Stress-testing of the euro currency performed this week came to a tidy end with an entourage of French ministers getting a free-trip to Berlin thrown into the bargain. For all of the bravado and apparent brinksmanship, Germany appears to have backed down in its demands for private investors holding Greek bonds to share financial burden of a financial restructuring. Instead Ms. Merkel claims that it would be sufficient to have debt holders volunteer to roll over maturing debt. The so called Vienna Initiative, which avoids railroading unwilling investors to defer repayment or shut up, might be just another attempt at kicking the can down the road until 2013 when the European Stability Plan kicks in.
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European bond markets – Nevertheless the yield curve rose in response to the appearance at a Berlin press conference involving Franco-German leaders. Chancellor Merkel said that a Vienna Initiative, used to assist Eastern European banks during the 2009 crisis, would be a “good basis” for lining up existing bond holders to voluntarily help Greece through its fiscal crisis. She also confirmed that any political resolution should also be worked out with the ECB so that there is no basis for ongoing dispute. We await the response of the central bank to today’s developments. Meanwhile Greek two-year yields approved the news and retreated from above 30% yesterday, while German yields rose at the 10-year by four basis points to match U.S. treasury yields at 2.95%.
Eurodollar futures – The kneejerk response to Friday’s Berlin press conference was clinical with investors selling the dollar and government bonds. However, the bond market reaction has calmed as investors recognize that on top of the danger of a sovereign default in Europe, there remains the sticky problem of global slowdown. Thursday’s pressure on short-dated Eurodollar futures reversed with three-tick gains at the first four contracts while deferred contracts fell by as much. September Treasury futures fell to 123-18 before rebounding somewhat to trade at 123-24.
British gilts –Short sterling futures also saw a mixed reaction to the alleviation of pressure on the continent. Nearby maturities gained while deferred contracts dipped sending implied yields marginally higher as the yield curve steepened. Investors remain increasingly comfortable with the view that the Bank of England remains a long way from lifting monetary policy. The 10-year gilt yield added two basis points to stand at 3.19%.
Canadian bills – Thursday’s optimism over steady yields came in for a setback heading in to the weekend as Canadian bill prices reversed some of the prior day’s surge. The December contract is lower by three basis points but remains toward the top of the weekly range at 98.57 to imply a year-end three-month cash Libor of 1.43%. A weaker tone to credit was backed by a smaller than forecast dip in wholesale sales during April when sales dipped 0.1% or one-third of an anticipated fall. The stall in March data was also revised upward to reflect a less negative performance. Government bond yields added two basis points at the 10-year maturity to stand at 2.94%.
Australian bills – Aussie bills slid by seven basis points as the confusing week drew to a close. Dealers are responding to conflicting signs of economic weakness, bolstered by a stressful European picture while the head at the RBA this week appeared to threaten the market with a resumption of monetary tightening later in the year on account of rising inflation.
Japanese bonds – Japanese yields stood still as the yen strengthened and data pointed to lower consumer activity. The yield at the 10-year bond remained at 1.11% after department store activity for May fell by 2.4% nationwide and a deeper 4.3% in Tokyo in a further sign of economic weakness.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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