IB Interest Rate - Brief Canadian rate jolt sends shudders across global bonds

Wednesday September 8, 2010

Bonds have come back off the boil as investors try to figure out whether or not the European banking system might weigh any further on the global recovery following a recent poke at its methodology. Yields slumped on the news that Europe's bankers might not have fully reported government debt on its books but as the shock wears off it seems that investors might be willing to return to business as usual. The lack of transparency in the reporting, even if were true, fails to answer the obvious question of whether or not the latest news increases the likelihood of a government default. It is hard to say at this point, however, that markets have brushed aside the report. However, firm action from the Bank of Canada quickly soured sentiment mid-morning reminding bond traders that recovery is out there - somewhere.   

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Canadian bills -Canadian bill traders face the toughest of times in reading the market's tea loves at present. Today they sold bill futures after the central bank hoisted interest rate jolt.  The Bank of Canada raised rates by a quarter point but appeared to cap further movements by admitting to a slower pace of growth on account of the uncertainty facing the U.S. economy. Further moves, it said, "would need to be carefully considered." 90-day bill prices plunged around seven basis points this morning with the front December contract slipping most. The three-month contract shed 12 basis points lifting the implied yield to 1.27% compared to today's official 1.00% setting for short rates.

European bond markets - Fears that gripped European bond markets on Tuesday haven't quite passed yet, although as U.S. equity markets reopen today there is now some notable selling across government safe havens. December German bunds have completely reversed course with the contract printing a session low of 131.30 for a 40 tick loss on the day having earlier traded higher to 132.14. The yield on the 10-year benchmark has now risen to 2.28%. One press source reports light buying of paper issued by Portugal, Ireland and Greece by various European central banks. At the same time Portugal auctioned some three and 11-year debt today. Nearly twice as many bidders than needed showed up to take advantage of a 50 basis point increase in yields compared to the previous auction in June. The bid-to-cover ratio was still lower than at the time of that last auction. Bund prices had earlier responded to a shortfall in German industrial production in July. Market forecasters had expected a gain of 1.0% but were let down by a meager 0.1% gain.

British gilts - Following the change in official Canadian rates the British debt market also gave up gains. The December gilt contract, which earlier peaked at 124.76, gave up an entire point to 123.71 where yields surged to 2.95%. Fixed income failed to respond to in-line manufacturing data reports suggesting the recovery was on track. Short sterling prices have subsequently given up five basis points across the curve.

Eurodollar futures - Treasury notes have given up early morning gains with the December contract shedding nine ticks to a session low at 124-17 where the 10-year yield stands at 2.63%. Some optimism over an extension of the latest rally for bonds is waning independently. In other words steady stock market futures are not the cause of a bond rethink today. Later in the session the Fed releases the Beige Book survey of its 12 regional members. This report will shed light on the pace of the moderate recovery with investors braced for a lack of traction in the recovery process. Any pick-up in the pace of hiring intentions coincident with Friday's bullish employment report could hurt the feelings of the bond market today. Eurodollar futures are a little softer overnight with the strip rising by four basis points in implied yield terms.

Japanese bonds -A slide of 2.2% in the Nikkei 225 stock index overnight and a rise to a 15-year high for the value of the yen against the U.S. dollar helped maintain downwards pressure on Japanese yields. The five-year yield recoiled from an eight-week peak and dropped by four basis points to 0.29%. The December 10-year JGB futures contract gained 22 ticks to stand at 141.57 where the yield dipped to 1.12%.    

Australian bills - Aussie 10-year yields were unchanged as investors watched regional stock prices melt down. On the other hand a strong report indicating heavy loan demand for housing counterbalanced equity sales, creating equilibrium for bond prices. The 10-year government yield is unchanged at 4.863%. Meanwhile 90-day bill prices were swept lower by the report with implied yields gaining by four basis points.

Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       

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