The widening of premiums to euro-area record highs commanded by investors willing to hold Italian and Spanish government bonds speaks volumes as confidence in leaders’ abilities to solve the Eurozone crisis comes crashing down on the Empire of Debt. Faith in central bankers’ and political leaders’ ability to cut through the jungle of budget deficits sank to its lowest point yet as speculators recognize that if the sovereign debt crisis is spreading to a nation the size of Italy then a new and larger bailout fund is required.
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European bond markets –Heading towards the close of trading for European bonds, investors are in no mood to change course as the European sovereign debt crisis deepens. German bonds have surged while peripheral nations’ bonds slumped forcing yields in opposing directions and causing spread differentials to widen to the widest since the single currency was launched 12 years ago. The rumor mill churned out several worrisome stories over the weekend, each of which sparked renewed concerns that a sovereign debt crisis is increasingly likely to happen and that a rescue plan requires deeper pockets than the current €740 billion bailout fund. Germany’s Handelsblatt newspaper claimed that the ECB had approached several key banks in recent days urging them to apply to act as advisors in the event of default somewhere within the region. German Finance Chief Wolfgang Schaeuble is busy trying to douse the fire sparked by Die Welt, which claimed that discussions to double the rescue fund to €1.5 trillion are underway so that in the event that the crisis inflicts turmoil on Italy the authorities will be able to fight it. The FT said that authorities are close to accepting a partial Greek default in order to progress to a more permanent solution. German bunds surged with the yield sliding by 15 basis points to a seven-month low at 2.67%. Implied yields on shorter-dated cash slid by an equal amount and moved contrary to the central bank’s move towards policy tightening.
British gilts – The British yield curve flattened with a mirror-image shift in rate expectations to that seen ahead of the Greek vote. Short-dated yields rose on escalating liquidity fears while deferred short sterling futures rose sending yields lower by up to 12 basis points and widening some spreads from the front of the curve to the back by 15 basis points. September gilt futures soared by 120 ticks sending the yield 11 basis points lower to 3.08%. The path for yields on Monday is littered with potholes en route. The variety of unfolding scenarios generated by weekend press reports all point to the same worrisome conclusion that so many investors had thought likely, that a sovereign default is more plausible than ever before. In addition the domestic yield curve was further pressured by a BRC report for June showing like-for-like store sales fell by 1.4% last month for a further contraction.
Eurodollar futures – At the end of May the September 2011/September 2012 calendar spread was trading at around 60 basis points. With two more employment reports under their belt traders have flattened the yield curve on the view that global fears among investors are worsening and that the Fed’s hopes for second-half growth resurgence might be premature. The gap between the two contracts narrowed to 30-basis points Monday as liquidity fears resurfaced in Europe. Italian authorities moved to stem short-selling after the local market slid with banking shares hit hard. Investors dumped shares of local banks most exposed to Italian government debt. Italy has €1.9 trillion of paper outstanding and more than the German level of €1.1 trillion. Bond traders took no chances that rising funding costs at forthcoming auctions could accelerate the crisis and sold Italian bonds. Fears that the crisis might create a liquidity crisis in the cash market saw front month Eurodollars fall as implied yields for September rose to 0.5% or twice the level where three-month dollar Libor recently traded. The yield on September notes dipped to 2.96% as concerns mounted over global economic health.
Canadian bills –Canada doesn’t suffer from the same liquidity pressures as does the United States when it comes to banks scrambling for cash. Implied yields declined across the bill curve with BAX contracts rising from two pips at the near-end to 12 basis points at expirations one-year forward and beyond. Canadian government bonds rose neatly albeit at a lesser pace than benchmark treasuries. The September bond future advanced by one-half point shaving four basis points off the 10-year cost of borrowing to 2.92%. The yield premium enjoyed by the Canadian government narrowed to just three basis points on Monday.
Japanese bonds –Asian stocks were destined to slide on Monday, assured by weak June employment report that shocked U.S. bond investors on Friday. The MSCI Asia Pacific index declined by 1% while pressure on the euro currency cleared the way for fresh hurdles for European traders. Adding to pressures was worse-than-forecast Chinese inflation. A weekend report showed that consumer prices advanced during June by 6.4% setting off a second-wave of monetary tightening fears for the world’s second largest nation. Investors ignored a healthy rise in machine tool orders last month further supporting hopes for domestic recovery. The year-on-year pace picked up to 53.3% while a separate reading of consumer confidence rose ahead of the previous month. The yield on Japan’s 10-year benchmark slid to 1.135% as the September JGB future advanced by 55 ticks to 141.13.
Australian bills – No matter how divided Aussie money traders remain over the next likely move from the Reserve Bank of Australia, the current drive towards easier monetary policy around the world has taken hold in the local market. Bill futures surged overnight with implied yields sliding close to 20 basis points. Investors responded to resurgent fears of Chinese monetary tightening by concluding that if that eventuality plays out, regional growth would slow and deliver the desired slowdown in inflation too. Money traders also bought bill futures in response to the weakness shown in the June payroll data on Friday. It’s hard work for Australian economy bulls who are having to swallow declining yields at a time when certain reports are pointing to an otherwise healthy domestic economy. Home loan data for May showed a healthy 4.4% increase, the second such pace of gain. Government bond yields crashed 15 basis points lower to 5.02% matching the lowest seen just ahead of the recent Greek vote.
Andrew Wilkinson is a Senior market Analyst at Interactive Brokers LLC
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