Government bond trading was buffeted by opposing forces midweek. The recent dashing of expectations evident in most economic reports during the last month has hardly healed. Pressure on yields remains to the downside but the growing hopes for a further reappraisal of the Fed's balance sheet is boosting expectations that the recent spate of weaker data will soon be countered by remedial action of some sort. Global short ends are already low and curves have flattened about as far as they can without aggressive central bank action or without the market begging for it on account of weaker data.

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Eurodollar futures - Treasury traders also had to deal with conflicting economic data on Wednesday. The ADP private employment assessment showed a tepid 91,000 additional jobs were created in August while July data was pushed lower. The official government report on Friday is predicted to deliver fresh hiring of just 75,000 for August, which is exactly half of the golden number that we keep the unemployment rate from rising. However, a July report showed factory orders advanced by 2.4% and above the expected pace while the June contraction of 0.8% was halved. The Milwaukee-area NAPM index reading confounded expectations of a dip by rising from 57.6 to 58.3 indicating greater expansion. September futures shed about a half-point on the news with equity markets forging ahead sharply as investors took the tonic and still anticipate further maneuvers from the Fed.

European bond markets - Firmer data points from the U.S. stepped up pressure on German bunds, where the need for safety had been earlier lessened by a 26th monthly drop in German unemployment. The domestic economy created 8,000 more jobs in August and enough to maintain a 7% rate of unemployment. Eurozone-wide the reading remained stuck at 10% for July. Germany approved new measures resulting in a wider share of that nation's loan guarantees through the EFSF. The approval means wider bond-purchases across deficit nations around the region, whose governments are struggling to keep a lid on borrowing costs when interest rates are already low. September bunds traded down to 134.64 driving the yield up to 2.18%.

British gilts - Gilt yields added four basis points with the 10-year benchmark rising to 2.54%. The September futures contract shed 55 ticks during the London afternoon to trade at 128.25. Gilts were unfazed by a weaker GfK consumer confidence report given the bigger picture downdraft for bond prices midweek. Short sterling futures appear to be finishing an otherwise bullish session at the day's worst levels. The December contract earlier rose to an intraday high 99.04 before turning lower on the day to imply a 1% three-month Libor at the end of the year. Over the last two weeks the short end has surrendered more than 25 basis points as equity prices recovered.

Japanese bonds - Japan's benchmark yield rose by two basis points after a report showed industrial production advanced by less than half its expected advance during July. Loans extended by discount corporations and other lenders fell by 1.6% compared to July 2010 while vehicle production narrowed its annual pace of decline to 8.9% from a previous 13.9%. The September JGB futures contract lost 10 basis points to 142.38 lifting its yield to 1.024%.

Australian bills - Bond yields were static in Australia with the benchmark 1-0year yields remaining unchanged at 4.40%. Bill futures dipped by a further two basis points as easing hopes from the RBA were tested. The market still nevertheless implies a series of rate reductions.

Canadian bills - A drop in energy exports along with an overall lack of appetite for Canadian output tipped the economy into a contraction during the second quarter according to a government report released midweek. The premium for benchmark government bonds over U.S. treasuries nevertheless widened to 24 basis points as a separate monthly reading for output during June rose by twice the expected pace. Government bond futures shed 23 ticks to trade at 131.49 lifting the 10-year yield to 2.41%.

Andrew Wilkinson

Senior Market Analyst       

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