Tuesday, May 4, 2010

Government yields slumped on Tuesday as investor optimism cratered to dust for fears that the weekend agreement won't be big enough to prevent default among weaker sovereign nations. Bond prices in Greece, Spain and Portugal gave back gains made in the aftermath of the weekend agreement among the EU to provide €110 billion in aid to Greece. Yet as the dust settles investors are growing concerned that the price to pay by the people of Greece might prove to be unacceptable leaving a question mark over the sizeable package from across the Eurozone.

European bond markets - Greek bonds erased gains sending the 10-year yield higher by 27 basis points while the German yields declined by 10 basis points. Once again widening curve spreads and a rise in the cost of insuring riskier bonds marred investor appetite putting global recovery in second place behind the seemingly endless theme of risk aversion.

Eurodollar futures - The safety of the dollar and by extension U.S. treasuries was firmly evidenced on Tuesday by the three-quarter point rally in 10-year notes that dragged yields down to 3.61%. Eurodollar futures contracts expiring from 2011 onwards made gains of five basis points and more as investors wrestled with the notion that central bank tightening might be eternally postponed.

Canadian bills - Despite being braced for a June interest rate rise, dealers found the allure of Canadian bonds too much and sent prices sharply higher. The June government bond contract rose by 83 basis points to 118.57 where it carried a yield of 3.56% and lower in-line with the drop in U.S. yields. Far-dated bill futures surged by as much as 13 basis points.

Australian bills -The RBA raised rates and stated that consumers now face an around average cost of borrowing. It sounds and looks like a pause in policy and very possibly is one for the next several months. However, the central bank also stated that recent inflationary pressures are less likely to ease as earlier thought and will now remain in the upper half of its central target range, which means that even a marginal deterioration down the line will result in rising expectations for further monetary tightening.

But in the immediate aftermath of the decision and reversion to a neutral policy stance, investors reacted by buying bills and bonds. 90-day bill futures added up to 11 basis points at maturities beyond next March, while a weaker manufacturing survey surrounding the Chinese economy added to a risk-averse tone allowing bond yields to slip by four basis points to 5.73%.

British gilt - Investors remain braced for Thursday's national election and onlookers expect a tight race. Gilts continue to find favor as risk aversion steps up and the June contract has risen by 61 ticks to 116.55 sending yields lower to 3.83%. Deferred short sterling futures are also in rally mode in-line with global short-ends. The strip beyond June 2011 maturity is higher by 11 basis points.

Japanese bonds - Japanese markets are closed.

Andrew Wilkinson Senior Market Analyst