Monday November 30, 2009

10-year U.S. treasury yields slipped from around 3.36% last Monday to 3.18% following the announcement from Dubai World suggesting strongly that it was buckling under the strain of $59 billion debt as the flashy emirate state partied on after the global economy crashed. As the emirates got back to work over the weekend, two of its central banks rose to the occasion and agreed to stand behind borrowers likely to suffer in the event of debt default. In addition the central bank of Abu Dhabi offered preferential borrowing facilities to local banks in order to calm any ensuing demand for liquidity.

The following chart depicts the change in the term structure of the Eurodollar curve between the start of November and last Friday as the Gulf situation escalated. The yield on the September 2010 expiration Eurodollar future has slipped 40 basis points. Admittedly most of that movement has occurred at the suggestion of weaker domestic U.S. data, and was boosted by a setback in equity prices as investors fretted about whether the rally dating back to March was self-feeding optimism about the recovery.


Last week's panic was responsible for the last 10 basis points or one quarter of that rally with the September future falling to a yield low of 0.715%. At the start of November the market view on its future yield stood at 1.19%. As Eurodollars continue to push lower you can see the steeper nature of the yield curve as that of the 10-year declines but less markedly so.

Eurodollar futures are simply marking time at this point. The flat-line for S&P 500 index futures ahead of market trading indicates a steadier state of affairs for the global economy, but still represents a cautious tone. Euros are up between one and two ticks along the shorter end of the curve, although significantly off last week's peak. Indeed on a net basis, the September contract is only three basis points higher since pre-crisis news broke and should the situation blow over one might expect a little nudge lower in the U.S. strip indicating less bullishness surrounding the interest rate complex. Don't forget that we have non-farm payrolls due at the end of the week and the current expectation is for a net loss of 120,000 jobs.

While this will undoubtedly increase the rate of unemployment investors will be possibly be treated to the smallest pace of decline in many months. Llast week's initial jobless claims reading of about 453,000 claimants supports the position that November's job report could be a bullish sign for growth. Remember that on account of population growth it is estimated that the U.S. economy needs to generate 150,000 just to maintain a stand still in the unemployment rate.

The December 10-year note is lower by 3/32 with a yield of 3.24%. If news from Dubai is off the radar by Wednesday, one might expect yields to reenter the 3.30 - 3.40% range ahead of Friday.

The front end of the European interest rate futures curve is marginally lower and remains unphased by gyrations in the U.S. rate complex during the month. Indeed, the softer tone to global rate expectations during November has left its hallmark on European rates. The March 2010 contract currently yielding 0.91% has declined from an early November yield at 0.96%, but remains significantly off its mid-month peak at 0.78%. The harsher tone from the ECB surrounding a move away from emergency liquidity measures has sparked a wave of selling punctuated only by a 10 basis point Dubai-rally. Unlike its U.S. counterpart, euribor can't maintain its gains and the spread between the two contracts has moved from about 42 basis points to 51 basis points. This indicates greater prospects for a Eurozone recovery and a fear that the ECB might tighten faster than the Fed.

British rate futures rose a net seven basis points during November, indicating lower yields, but remain at least 12 basis points beneath the high sparked by the Bank of England's more cautious tone mid-month. The March 2010 expiration carries a 0.75% yield today and is just a shade higher price wise after data showed weakening consumer confidence according to a Gfk NOP poll. There was a net decline in the number of consumers that believed now is the right time to make a major purchase. Consumer credit fell at the highest rate on record or at least since data was first compiled in 1993 according to Bank of England data released today. The report also showed the strongest level of mortgage lending approvals in a year-and-a-half.

Australian rate futures - The March contract lost eight basis points sending yields higher at the start of the week in which fear began to subside in terms of the potential fallout from Dubai World. The activities of Gulf central banks soothed the nerves of investors who feared a worst case plunge in global liquidity causing net liquidation of risky positions. Last week as fears first surfaced from the emirates, the Australian dollar plunged and implied interest rates slid 20 basis points as investors dealt on the belief that there was no way on earth the RBA would raise rates within days of the emergent crisis. Proving that Monday is a different day altogether, investors sold 90-day bill futures on the Sydney Futures Exchange for fear that Tuesday will indeed a further 25 basis point rise out of the central bank. Compared to last Wednesday's yield on the March contract at 4.3% during the blood-rush to the head, the yield at the same maturity has risen to 4.48% on the eve of the monetary meeting. The yield on the benchmark 10-year government bond rose three basis points to stand at 5.23%.

Canadian 90-day bills of acceptance (BA's) continue to oscillate in a ridiculously narrow range. The March contract is unchanged carrying a yield of 0.48% following government data showing the first reading of net-positive growth for the first time in four quarters. The 0.4% rise was less than the expected 1% gain for the quarter ending September, but received some respite from a downward revision to the previously recorded 3.4% shrinkage. BA yields are about 10 basis points lower on the month. Meanwhile the 10-year yields is a little lower at 3.2% as Canadian bonds rally.

Andrew Wilkinson

Senior Market Analyst