Bond spreads blow-out as focus turns from Athens

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%.

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