After an aggressive bout of risk aversion this week, Friday's trading was more subdued. But the scars left across the landscape remained there for all to see. Global government bond yields moved decisively lower for a second week as equity investors dug an early grave figuring that the plunge in valuations signaled a move to a lower growth trajectory rather than greater value. The loss of confidence with policymakers' response is adding to real data that has again this week created gasps across Wall Street's dealing rooms. The resulting official growth downgrades by major investment bankers lends its seal of approval to the bearish tone.

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Eurodollar futures - With the 30-year long bond yielding 3.38% representing a 34 basis point slump on the week in response to growing financial market stresses, you have to look back to December 2008 to find a time when yields plunged deeper. At the heart of the financial crisis during that time the yield on the long bond dropped like a stone falling 49 basis points in a single week. This week the 10-year yield reached a record low at 1.9735% and looks set to end the week with a gain of 15 pips at a close at around its current 2.09%. Output expectations are currently very much under the microscope with reports of the fastest contraction in Philadelphia-area manufacturing in two years contributing to economists' downgrade for growth. However, the current bout of reevaluation still seems at odds with official projections. Take Cleveland Fed Chief Sandra Pianalto for example. In a recent speech she said she'd voted in favor of additional support to the recovery by agreeing to the change in wording of the Fed's statement when the FOMC said that the environment called for the current stance at virtually zero. In the cold light of day Ms. Pianalto's 2% prediction for 2011 now looks ambitious while 3% in 2012 and 2013 look like equally tall orders. I'm not entirely sure that if such rosy projections were likely the Fed would have needed to offer investors another crumb of comfort.

European bond markets - Greece emerged from its moribund role again on Friday after speculation grew that the recently agreed upon bailout packages would face new stress if other nations sought to follow a Finnish precedent. Finnish lawmakers agreed with Athens that if Finland agreed to provide new loans it must first receive 20% collateral which it would invest in AAA-rated bonds. Imagine if all other nations demanded the same. Worries for a further collapse in already fragile investor confidence sent the yield on Greek debt skyrocketing to end the week. And while bond markets appeared to calm on Friday there were reports that the ECB was once again intervening to steady Italian government bonds. The down but no out appearance of European equities on Friday also dampened enthusiasm for German debt where the 10-year bund yield rose by two basis points to 2.10%. Nevertheless, yields ended the week 23 basis points down. Talk of a joint euro bond issuance mechanism aimed at strengthening the fiscal discipline of its members seemed to excite investors Friday, despite German opposition to such a move. On Thursday Chancellor Merkel explained that this is no solution for the euro-area's problems. Under such a mechanism a single blended borrowing rate would emerge in the form of a hybrid yield of the 17-member nations. That would lower the cost of borrowing for some and increase it for others. According to Bloomberg data that would mean an increase in German borrowing costs of €47 billion and would be a very bitter pill for Berlin to swallow.

British gilts - September gilt futures looked fatigued at the end of the week in which the 10-year yield reached a record low and closed at 2.39%. The September contract was 69 ticks lower on the day. That move helped drag short sterling futures lower by nine basis points too. The slide in yields is justified in a fiscally-austere and growth-deprived environment although the pace of decline is clearly under scrutiny with participants finding any excuse to take profits.

Japanese bonds - Japanese yields reached their lowest since November by touching 0.97% after the Nikkei 225 benchmark equity index lost a further 2.5% overnight. Fears for Asia's regional manufacturing economies hardened during a week of worries for U.S. and European economies where recession looks closer than ever. The 10-year yield closed at 0.979% with the September JGB future adding 13 ticks at 142.74.

Australian bills - Fixed income investors are currently comfortable sitting on the monetary easing side of the fence for now at least. The incessant selling that dogged the region's stock benchmarks this week failed to abate in time for bearish investors to change their minds. Bill prices closed the week expecting a full 1% off rates within six months with many expecting an October-time move. Government bond prices powered ahead depressing the benchmark yield to its lowest level at 4.23% since March 2009 when global stock benchmarks performed a selling finale marking the onset of a new bull market.

Canadian bills - Bill prices slipped just a couple of basis points at the end of the week although they responded more to signs of stability in stocks than they did to a muted inflation report earlier in the day. Consumer prices rose just 0.2% in July but reversed a 0.7% decline in June. On the Bank of Canada's preferred core gauge the annual pace of increase of 1.6% was a step up from the 1.3% reading in June. But with the currently elevated reading of risk aversion in the air, the Bank of Canada is unlikely to be in any mood to shake-off its currently loose state of policy. The government bond future expiring September was the only major bond market that advanced Friday although the 10-year yield rose by two pips to 2.31%.

Andrew Wilkinson

Senior Market Analyst       

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