Heading towards the close of a memorable week, fixed income trading has settled down. On the one hand, the S&P downgrade triggered the most volatile market in a year and precipitated the sharpest decline for stocks in three-years. In part its move prompted the Fed to pull a new card from its sleeve as it declared at least a two-year freeze on interest rate policy. The drama also weakened investors' appetite for fresh government debt culminating in a weaker expression of interest at Thursday's auction of long bonds. But on the other hand the slide in yields on account of this week's action did save the taxpayer more than $600 million a year in interest costs. Whether the fall in the cost of borrowing will invigorate consumer and corporate demand for loans is another question.
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Eurodollar futures – And according to a plunge in the University of Michigan’s consumer confidence reading, that’s not likely to happen anytime soon. To find a lower value for the headline reading of 54.9 one has to look all the way back to May 1980. The decline was much heavier than forecast and goes head-to-head with an earlier gasoline-fuelled increase in retail sales last month. Consumers were less likely to purchase a big ticket item with that index gauge slipping from 75.8 to 69.3. In itself that speaks volumes over the current state of the economy. But the forward looking expectations gauge predicts things are likely to worsen, which isn’t being reflected in a gain for equities on Friday. The expectations gauge slid from 56.0 to 45.7 and helped propel the Treasury market after it fell on Thursday. The 10-year yield declined by 10 basis points to 2.23% to end a week during which both two-and-10-year government yields fell to record lows.
European bond markets – French government bonds typically trade at a premium to German bunds by anywhere from 20-40 basis points. This week’s rumor-and-panic-driven trading that decimated Gallic bankers’ share valuations also dramatically widened the French premium to 90 basis points. Dealers sold French bonds for fear that S&P was on the cusp of matching its treatment of the United States with a ratings downgrade across the Atlantic. The bond spread has subsequently narrowed to 64 basis points and its calmest in two weeks. Further bad news for the domestic economy on Friday, however, as second-quarter growth came to an unexpected standstill. German bunds looked soggy on Friday after the powerful rally caused a plunge in yields during the week. The 10-year yield added three basis points to end the week at 2.34%.
British gilts – Without a catalyst for more pressure on stocks it’s hard to see how the short sterling futures strip can maintain its buoyancy. With that in mind investors sold short sterling futures lifting implied yields by as much as five basis points, which means that the March contract is heading for a weekly loss of four basis points after earlier rising by nine pips in the heat of the panic. But still the ironing out of the front of the yield curve still has indicated three-month cash prices marginally lower than the front –month future by five basis points. Gilt futures prices tumbled by 40 ticks to 128.35 to yield 2.52%.
Japanese bonds – Japanese government bond trading was once again confined to a narrow range with little activity to spur a further decline below 1% while mild selling pressure caused yields to gain a single pip to end the week at 1.038%. Industrial production repeated its May performance and rose by 3.8% in June as the economy continues to feel the benefit of a fiscally-induced rebound in the economy after the March disasters.
Australian bills –After a strong run for bill futures this week some profit-taking was called for as equity investors also breathed a sigh of relief in light of Thursday’s strong North American performance. The lowest point along the yield curve implied by the bill strip remains at the March expiration, which currently claims that the central bank is due to cut its benchmark to 3.75% or 1% below its present position.
Canadian bills – There was a little pressure on the front end of the Canadian bills of acceptance strip while contracts expiring more than a year forward made minor gains. The message was mixed on account of the conflicting nature of economic reports from the U.S. where retail sales grew but consumer confidence plunged. The spread between U.S. and Canadian government bonds widened by five basis points as treasury futures accelerated to leave Canada at a premium of 18 basis points with Canadian bonds yielding 2.41%.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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