Eurozone government bonds rallied following a second successful day of auctions that removed more of the recent pressure on governments thought likely to struggle to tap investors for cash in the capital markets. Central banks in Europe kept policy unchanged as expected but a cautious Jean-Claude Trichet kept bond investors on their toes as he suggested a worsening of the inflation climate.

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European bond markets - Spain and Italy found more willing buyers for bonds stretching across a variety of maturities today than they had bonds for sale. Investors had spent days fretting that not enough patrons would show up while recent overtures from officials from China and then Japan helped smooth the passage. Italian and Spanish yields at the 10-year horizon saw double-digit declines while Belgian and Greek debt prices also rose sharply. Following the ECB's regular meeting Mr. Trichet warned that price risks may rise in the region saying that inflation rates could temporarily increase further. He was speaking on the day when a German report showed a jump in wholesale inflation with factory prices accelerated by 1.8% during December to a pace almost three-times the rate in the prior month. March German bunds have nevertheless rebounded from a session low at 124.27 inspired by Mr. Trichet's comments and recently traded at 124.58 where the yield picked up to 3.06%.

Eurodollar futures - The U.S. yield curve has responded little to a surprise increase of 35,000 in initial claims data through last weekend. Continuing claims dipped to the lowest level since October 2008 and offer some crumbs of comfort to those concerned that the recovery is slowing. March treasury note futures rallied before returning to negative territory for the session and traded recently at 120-16 to yield 3.38%. Eurodollar futures are marginally weaker on the day.

Japanese bonds - Equity prices stretched to a five-day gain for the best string of gains in seven months. The optimistic tone saw investors continue to lighten up on bonds sending the March future down eight ticks to 140.08 where yields rose to 1.19%. Data indicated a surprise decline in machinery orders through November, but the 3% decline is now old news and didn't impact the tone in fixed income today.

British gilts - The Bank of England took its foot off the neck of credit markets on Thursday and announced no change in monetary policy. While nobody predicted any change in the bank's monetary stance, the team faces a three-way split over the future course for policy in light of a tightening in the fiscal stance and stubbornly high inflation. Investors recently started the process of sharpening up the yield curve in the expectation that the bank may at some unspecified point start to think about pulling the policy chain. Gilt futures rose today sending the 10-year yield lower by one basis point to 3.62%. Short sterling futures made gains while other short ends were moving in the opposite direction with implied yields dipping four basis points are longer maturities.

Australian bills - A standstill for the employment report saw just 2,300 more employees enter the workplace in December contrasting with expected job creation of 25,000. Implied yields nevertheless jumped wiping out an earlier in the week slide as dealers priced out further monetary tightening from the Reserve Bank. Bill prices for 90-day maturities tumbled around 10 basis points sending expectations for tighter policy later in the year and beyond back on the cards.

Canadian bills - March government bond futures fell harder than treasury prices sending yields on the 10-year paper higher by a couple of basis points. The yield gap between the two duly narrowed to just 10 basis points. Bill prices fell sharply sending implied yields higher by six basis points.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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