Friday FX Interest Rate Monitor: Quiet Yields

by: Interactive Brokers

It’s difficult to strip out the various macro-forces driving bond prices to see what the heaviest influences really are today. The drop in conviction that global recovery will remain intact has equity prices approaching a 5% drop on the week. In turn that lack of conviction stems from the potential for weaker growth in China if the authorities follow through to raise interest rates. The loss of investor and business confidence across Europe as the question of budget deficits reaches boiling point is also partially responsible for the drop in equity valuations and the jump into the safety of government debt.

It’s awkward to determine with any conviction what impact the Obama proposal to curb bankers’ risky bets is having on fixed income in light of today’s drop in the S&P 500 index. One line of thought says that bankers will be forced to drop leveraged positions and move permanently to the sidelines, while others correctly ascertain that passage through Congress remains a challenge in a week when the Democrats lost their Senate majority. This week bond markets are set to close higher for a third week straight, although today yields are slightly higher. In other words there is a lack of conviction after U.S. 10-year notes rose to the highest in a month sending the yield down to 3.57%. Earlier this month yields peaked at 3.91%.

Next week the U.S. treasury will auction $44 billion two-year notes, $42 billion five years and $32 billion in seven-year debt to bring the grand total to $118 billion for the week. Supply will continue to figure in the demand for bonds throughout 2010.

Eurodollar futures – Treasury prices are trading either side of unchanged today and carry a 3.62% yields while Eurodollar futures are creeping higher. The year-end December contract has finally reached its contract high at 98.96 to imply a three-month cash Libor of 1.04% at the end of 2010.

British interest rate futures – Further evidence of economic stagnation was apparent in a retail sales reading for December, which disappointed investors. The weakest reading for monthly sales growth in two years for the key retailing month left analysts scratching their heads, but acted to send interest rate expectations lower. Short sterling rallied about 8 basis points in the deferred contracts from December 2010 expirations outwards. That contract, which closed last week at 98.345 (1.655%) closed this week at 98.42 (1.58%) but took a detour thanks to a midweek inflation shocker all the way to 98.165 (1.835%). Meanwhile March gilt prices are 17 ticks higher at 115.55 to yield 3.91%.

European short futures – March bunds rallied 18 ticks to 123.33 in March as a Greek official confirmed that the government would soon launch €3 billion bonds with maturities of between five and 10 years. The spread above German 10 year maturities continued to widen to 306 basis points to a 12 year high. Euribor futures added three basis points.

Australian rate futures –Aussie bond prices surged to deliver a 10 basis point dump in 10 year yields to 5.41% as Asian stock prices slid. Bill prices jumped between 6-8 basis points.

Canada’s 90-day BAs – A larger than forecast drop in December retail sales hurt the Canadian dollar and commodity prices despite an upward revision to the November data. Bill prices rose a tiny amount while the 10-year yield is flat at 3.39%.

Japan – Japanese bond futures expiring in March rose as stocks slipped 2.6% overnight in Tokyo. Demand for fixed income in the face of a potential global slowdown drove down the yield to 1.31%.