Tuesday, April 27, 2010

A strong indication from German Chancellor Merkel that she intends to refrain from swilling German taxpayers' money down the drains of Athens created a powerful bid for fixed income as risk adverse plays saw investors favor bonds. Meanwhile Greek and peripheral European government bonds thumped to the floor as investors interpreted a growing number of comments surrounding the plausibility of debt restructuring as limited not solely to Greece. The turmoil appears to be signaling a new phase of the crisis forcing a wedge into the chasm and prizing yield spreads to widen.

European bond markets - Strains on European fixed income were evident on Tuesday after Ms. Merkel reiterated her advice telling Athens to do its homework on fiscal rectitude. I have to admit it, but I thought Greece had been pretty successful in so doing to most the satisfaction of most authorities. That said, investors are starting to wonder just what the German end-game is here in deploying delaying tactics in order to keep the money off the table.

The fallout is pretty far-reaching and has torpedoed the maturity curves of so-called peripheral Europe. Greek yields are hovering around 12-year highs again this morning. Meanwhile the surge in Portuguese yields is dramatic as investors once again play the contagion card. The fear for slow-growing Portugal with its hefty debt burden is that if the situation for Greece worsens in that it doesn't receive timely financial relief, contagion would be transmitted automatically as investors are forced to terminate their holdings at any price. Two-year yields surged by 77 basis points to 4.73% while 10-year yields jumped by half as much to 5.58%. Irish two-year paper added almost a half of one percent to yield 3.40%, while Italian paper rose in yield terms by 22 basis points to 1.68%. Spain's two-year yield rose by 17 basis points to 2.08%.

Market data played second fiddle today. French consumer confidence fell and failed to match the increase in the German reading. Meanwhile import prices for March almost doubled on a year-over-year basis from 2.6% in February to 5%. Typically such news would have escalated inflation worries and sent German debt prices lower. However, German paper is very much in demand today with yields falling four basis points to 0.83% at the two-year and by three basis points to 3.01% at the 10-year.

Eurodollar futures - As the fear of contagion hovers over Europe it's providing respite for U.S. bonds where the market has to yet again digest another slew of issuance from the U.S. Treasury. This week it is looking for fixed income buyers to swallow $129 billion in paper issuance. Ahead of data from the Conference Board likely to maintain a rise in consumer confidence, the 10-year yield has slipped to 3.75% this morning. June t-notes are near an intraday high of 117-06. Deferred Eurodollar maturities have also added five basis points from the March expiration onwards as the belly of the yield curve continues to flatten.

Japanese bonds - Japanese government debt prices closed at the session highs meaning a gain of 26 ticks for the June JGB contract where the yield slipped to 1.295%. The potential for a rise in yields came after a Nikkei news story predicted the Bank of Japan would firm its inflation profile to at least flat from deflation when it reports on Friday. However, regional stock market weakness and a bid to the yen on safe haven flows easily countered that argument.

British gilt - June gilts prices are joining the European bond rally for now at least. The 10-year yield eased three basis points to stand at 3.96% while short sterling futures also reacted positively along the curve to the prospect that contagion would harness any signs of Eurozone growth and help maintain low interest rates for longer.

Australian bills -The Australian yield curve once again erred on the side of caution rather than paying attention to producer price inflation. Weaker commodity prices in Asia and a slip that sent the Chinese benchmark index to a six month low outweighed a 1% quarter-on-quarter rise in producer prices. Wednesday data will reveal the consumer price index for the first quarter and is expected to rise from 2.1% to 2.8%. Aussie two-year yields fell by four basis points to yield 4.96% while the 10-year eased a little more to 5.77%.

Canadian bills - Canadian government bonds are a big mover today with June futures rallying 37 ticks to 117.15 where the yield has slipped three basis points to 3.63%. Bill futures are also matching gains in Eurodollars and have risen by a similar amount from June 2011 outwards.

Andrew Wilkinson

Senior Market Analyst