Government fixed income prices took-off again midweek jet-fuelled by growing concerns over the European debt crisis, with official discussions seemingly running up against roadblocks at every avenue. Bond prices accelerated after a cooler reading of the health of the U.S. service sector, while the demand for safer assets was providing a tailwind following an increase in official Chinese interest rates culminating in a self-evident sell-off in riskier assets.
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European bond markets – Several plans to swap, roll or back Greek bonds with guaranteed collateral have run up against some form of objection at some juncture on the basis that such proposals would likely culminate in a sovereign default. Exhausted by events surrounding Athens, capital markets today deflected the attention of European officials after Moody’s cut Portuguese debt ratings to junk raising fresh threats to the crisis. Capital markets were clinical in dealing with the fallout sending yields rocketing on peripheral nations’ bonds for fear of further widespread contagion. Italian and Spanish bond prices slumped forcing benchmark yields up at a double-digit pace as speculators traded them in for the safer bet of German bunds. The spread between yields widened by 20 basis points throughout the session as investors took no chances. Adding insult to injury the ECB has signaled that it will raise short-term interest rates by about as much in an effort to contain inflation. Euribor futures rose in defiance almost daring the ECB to make such a bold move in the face of growing financial market uncertainty.
Eurodollar futures – Eurodollar contracts face a rerun of last week’s events when the escalation of the European debt crisis put pressure on the front end of the cash curve in a dash-for-cash among European bankers at a time when credit worthiness is paramount. As lenders become picky over whom they lend to, banks with a shortfall tend to stretch out along the short-dated yield curve to plug the gap and in the process push up Libor – the benchmark standard for cash borrowing. The front three Eurodollar contracts imply slightly higher yields on Wednesday at a time when growing uncertainty has pushed lower the reading of implied yields on further forward contracts. An index of service sector companies also fell as was predicted but further soured the appetite for risk as investors are reminded that the vast majority of the economy is entrenched in a cooling off period at the very least. The September Treasury future contract made gains of about one-half point pushing the yield lower by four basis points to 3.08%.
Japanese bonds –JGBs were barely changed on Wednesday ahead of a reading on Thursday of machinery orders. Prime Minister Kan warned over the likely flood of bonds needed to finance rebuilding efforts following Japan’s earthquake. The September JGB future dipped by five pips to 140.73 to yield 1.17%. Data used to compile coincident and leading indices from May both proved that economic conditions improved at the time.
Australian bills – Bill prices advanced on the Sydney Futures Exchange a day ahead of a key employment report that will provide the latest reading of the health of the Australian economy. Economists are expecting a net change of 15,000 new positions for June. The escalating European crisis, however, grabbed more attention ahead of the report and helped allay fears that the RBA was even close to a further monetary tightening. Dealers second-guessing the report figure that even if employers added to job openings last month, the lack of light at the end of the debt tunnel in Europe is likely to exert stronger pressure on the central bank to stay “prudent” and keep rates stable.
Canadian bills – The Canadian curve continued its attempt to flatten as concerns over the ailing sovereign health of Europe’s periphery grew. The softer tone to yields driven by the debt crisis was reinforced by weakness in the U.S. ISM non-manufacturing survey where the headline reading of 53.3 was marginally lower than expectations and marked a dip from 54.6 in May. The slowing U.S. economy, albeit possibly in passing response to a slump in Japanese output following the earthquake, still plays out as a negative for the health of the Canadian economy. Bill prices advanced by six basis points with the September 2011/September 2012 calendar spread narrowing by as much in the session as rate expectations continue to edge lower.
British gilts –Gilt futures added almost one full point on Wednesday shaving seven basis points off the benchmark 10-year yield as European woes mounted. An earlier report from the BRC depicting the fastest pace of rising retail costs had zero impact on monetary policy expectations in the face of growing concerns over a possible sovereign default was closer than feared on the horizon. Short sterling futures rose by up to double-digits at deferred expirations while, as with Eurodollars, prices underperformed at nearby maturities on liquidity fears. The September gilt future recently traded at 121.45.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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