Sovereign debt honeymoon comes to crashing end

Deficit worries on either side of the Atlantic continued to spook investors midweek. There’s apparently still not enough room for U.S. lawmakers to maneuver beneath an already dizzying $14.3 trillion U.S. deficit ceiling while investors looking over last week’s clever rewriting by EU leaders of how to prevent the imminent collapse of a regional sovereignty have found some flaws in the works. Stocks are sliding once again while bond prices have used the opportunity to take another leg-higher, except in the U.S. where dealers have to be satisfied with a standstill for bond yields.

Eurodollar futures – It remains hard to say whose the least unappealing battle is. The Obama versus Boehner epic continues to play out with each party leader trying repeatedly to bash his head hardest against the stone wall. Meanwhile, just when European leaders had collectively tied the knot at an EU summit last week agreeing to stand by each other for better or for worse, the newlyweds have already started bickering over the vows. Failure to agree ahead of an August 2 deadline on extending the debt ceiling will result in a potentially costly downgrade for the AAA-debt rating of the U.S. Trading in Eurodollar futures was nevertheless nonchalant and futures prices only eased by two ticks, while the yield on the 10-year treasury note stood at an unchanged 2.95% by lunchtime in New York. At the start of the week the yield rose to 3.05% as fears of default loomed.

European bond markets - German bunds surged on Wednesday after its Finance Minister Schaeuble spelled out to lawmakers the German interpretation of precisely what enhancements were agreed to in terms of the bailout fund. Investors were treated last week to news that the €440 billion fund could be used to buy bonds of debt-laden governments across the region. German Chancellor Merkel indicated following the summit that this meant under strict circumstances. It seems that the Schaeuble letter today has opened up a deep division across Europe at least in terms of revealing to investors that the marriage over which they were always skeptical over is predictably again on the rocks. The September bund future surged by more than a full point to 129.48 at the daily peak lowering the cash yield by a whopping 10-basis points to 2.64%, while yields on the region’s peripheral nations’ debt jumped by as much as spreads started to widen again. Euribor futures made gains as tensions rose around the Eurozone with implied yields slumping by seven basis points as dealers ponder how long the ECB will be able to stand by its policy of tightening monetary policy as the potential for a growth-damaging sovereign default rises.

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