German bunds were inching towards a fresh high ahead of the weekend as concerns remained elevated that Greek Prime Minister faces an insurmountable hurdle next week as he presents a €78 billion austerity package to Parliament, without the passage of which would leave his nation on the brink of default and the first in the short history of the Eurozone area. Bank of England Governor Mervyn King commenting in the central bank’s financial stability review warned that throwing money at Greece was not a solution, highlighting the challenge faced by European leaders as they attempt to keep the eels in the bucket. But Europe’s drama didn’t stop in Athens after Moody’s sent Italian banking shares in to a tailspin as it warned over a potential downgrade as risks and borrowing costs were likely to rise.
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European bond markets – The September bund contract spent much of the day in the doghouse after a German IFO business confidence reading shocked investors by improving on the prior reading at a time when most data reports can be used to compile a dossier confirming economic slowdown. Shortly after the start of electronic trading bunds eased as equity prices recovered setting a poor tone for fixed income trading. The IFO measure just affirmed the mood and sent the September future to 126.73 at its lowest point. However, a slide in Italian banking shares following a Moody’s warning that they could be vulnerable to a downgrade as sovereign risks rise in Europe shook investors whose glare was cast purely on events in Athens. This week’s confidence vote for Papandreou was hardly a slam-dunk given the finely balanced margin of victory. Next week’s passage of deep austerity measures is far from guaranteed and has accelerated the demand for German paper. The 10-year yield eased by two more basis points late in the day as the contract set off fresh highs at 127.31.
Eurodollar futures – The 10-year yield spread between German and U.S. denominated debt accordingly widened to seven basis points as the core European bund saw accelerated demand. Treasuries faced a mild hurdle, however, in the form of a stronger than expected reading for May’s durable goods report where orders advanced by 1.9% while an April decline was massaged higher. Curiously the early advance for stocks has simply vanished following nervous European stock benchmarks lower. The September Treasury note future is three ticks higher with the benchmark yield stable at around 2.91% although the yield dip hasn’t extended to Eurodollar futures just yet with the strip lower in price by one tick.
British gilts –With little fresh impetus for investors to price out any change to policy settings, short sterling futures are unchanged heading into the weekend. The June 2012 expiration advanced during the week shaving five basis points off the implied yield one-year forward. Rate expectations were further desensitized following the release of minutes that revealed the Bank of England was considering additional bond purchases in light of an unexpected downturn in domestic demand. The September gilt future is marginally higher at 122.38 today having rebounded from significant weakness earlier in the day to a session low at 121.89. The yield on the benchmark 10-year gilt is unchanged at 3.15%.
Canadian bills – Bill futures are once again back within an ace of last week’s highs regardless of the firmer U.S. durable goods orders. Dealers have been dismissive of the likelihood of further bank of Canada monetary tightening and gradually lending into the yield curve pushing implied yields lower as the price of bills of acceptance (BAX) futures contracts rises. And as liquidity issues are weighing on front-month Eurodollars contracts, the spread between the two curves closing faster than expected. During the last week December Eurodollar futures have shed 10 basis points as European investors bid up dollar borrowing costs in order to swap the proceeds into euro deposits. At the same time dealers recognizing the slimmer chance of a policy change from the Bank of Canada have driven the price of the December bill higher by 15 basis points. The spread between the two has narrowed ridiculously to 90 basis points as a result while the current three-month cash differential stands at 93 pips.
Australian bills – Futures traders now predict that the Reserve Bank will be inactive through the end of 2012 according to implied yields on bill futures. The December 2012 contract closed the week at 95.00 and just 25 basis points above the current short-term cash rate of 4.75%. The market currently feels that the central bank has abandoned its policy weapons in an attempt to fight inflation that stems purely from the biggest investment in the mining sector in a century. The Bank’s recent minutes also hinted that policy prudence was likely required in consideration of the mounting European debt crisis. Government bond yields rose by three basis points to 5.07% at the weekend.
Japanese bonds – The Japanese yield curve eased again sending cash yields at the two-and-10-year maturities to the lowest since November. There was no economic data for investors to trade off into the weekend but the relative safety of fixed income remained a key theme ahead of next week’s vote in Athens.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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