Bonds were shaken out of bed on Monday morning as dealers adopted a much more upbeat view on the prospects for the global economy in the event that the Federal Reserve decides to take a third stab at stimulating the economy through open market purchases of government bonds. Friday's speech from Chairman at the Fed Ben Bernanke is the week's big event and dealers have already determined that the world economy is so bad and the U.S. economy is so dire that nothing less than a third round of quantitative easing is in the air.



Eurodollar futures - Stocks jumped and bonds fell in anticipation of reduced volatility resulting from Friday's delivery. The Fed's first two rounds of quantitative easing delivered a combined $2.3 trillion in purchases but breathed life back into an ailing economy. They also fed the inflation dragon, which turned around and unleashed a mighty fireball at the central bank's rear leading many to conclude that the economy couldn't afford a further round of stimulus. Yields on benchmark U.S. debt fell to a record low last week reaching 1.9735% before fear subsided and note prices stabilized. Many believe that the market is now pricing in the strong hint of quantitative easing to be announced Friday and that yields have possibly overshot the mark. The September treasury note future fell by a half point as equity index futures roared on Monday adding six basis points to the 10-year yield at 2.12%.

European bond markets - German bund prices, which had fallen earlier and in line with treasury futures, staged a strong recovery on Monday limiting losses and preventing a move away from a record low last week. The euro came under mid-morning selling pressure in New York as a gain for U.S. equities faded and removed much of the day's badly needed confidence. German debt prices consequently picked up steam to reach 135.18 and although still lower on the day rebounded from 134.74. The early part of the European session saw bunds climb before rejecting the day's high at 135.84.

British gilts - September gilt futures are similarly staging a late-in-the-day rebound having rejected 129.01 trading up to 129.34 recently. The 10-year yield nevertheless added a basis point to 2.40%. Britain's short-end futures were mixed with early losses for short sterling giving way to contract gains later in the session. Front month contracts were lower by a couple of basis points as several currency Libors rose at the margin.

Japanese bonds - Japanese yields remained at a nine-month low of 0.97% as the Nikkei wilted by a further 1% in Tokyo while government and central bank officials remained idle onlookers only expressing their concerns verbally over the strength of the yen. Domestic data was buoyant with July supermarket sales increasing by 2.1% year-on-year after a softer June increase of 0.1%.

Australian bills - Equity prices finished on the day's low but the decline was mild relative to recent slides in the benchmark index. Bond and bill yields nevertheless declined after a major rally in fixed income prices recently. The 10-year government bond yield rose by five basis points to close at 4.31% and still around half of one percent below the Reserve Bank's current short rate. Some profit taking on bill futures lifted yields between two-and-10 basis points on the day but keeping the entire shorter-dated yield curve well and truly in rate cutting territory.

Canadian bills - The more buoyant tone for stocks at the start of the week and in anticipation of Friday's central bank conference weighed on bill prices in Montreal. Interest rate traders recognize that although the Bank of Canada would truly love to normalize its still accommodative monetary stance, it remains at the hostage of the U.S. economy. And while inflationary pressures remain muted the central bank would prefer to get back to business as usual by raising rates. Bill futures slipped just a couple of basis points while the 10-year government bond future lost 22 ticks to 132.38 lifting the yield by two basis points to 2.32%.

Andrew Wilkinson

Senior Market Analyst       

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