Dovish comments from policymakers in Britain and a dip in Australian inflation prospects conspired to lift government bond prices midweek after yields had shied away from record lows on the theory that a U.S. economic slowdown might snowball into something bigger.

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Australian bills - The widely expected upturn in the trajectory for Australian inflation failed to appear in today's data. Instead of a half percent deterioration in the annual pace of consumer prices for the second quarter, the rate turned up marginally from 2.9% to 3.1%. The change on the quarter of 0.6% was almost only half of the projected 1% reading. Interest traders breathed a huge sigh of relief immediately pricing out any chance of a monetary policy increase at the August meeting next week. Implied yields on 90-day bills slumped by up to 16 basis points. The yield on the December 2010 contract slipped to 4.88% from 5.04% before the data release. Yields on government bonds also reflected a less bearish stance on monetary policy with that on the 10-year bond dipping six basis points to 5.198%.

British gilts - Bank of England members laid out the lower prospect of any interest rate changes for the next couple of years. Official Paul Fisher noted that inflation would be capped by the still available spare capacity in the economy as a result of the recession, while Governor King pointed to the need to maintain a foot on the monetary accelerator before the road ahead provides an easier drive. September gilt futures jumped 33 ticks to 120.06 as yields backed away from a recent peak. The two-year yield came within a short distance of carrying a 1% yield for the first time since May before buyers stepped in on the subdued economic outlook. The pound also maintained a firm position against the dollar also possibly indicating overseas money flooding into British fixed income.

European bond markets - Gains were modest for European fixed income with spreads continuing their post stress test narrowing for peripheral nations' debt. German yields eased by two basis points helping gains of 16 ticks to 127.85 for the September bund contract. Euribor futures also responded to lesser cash funding pressures with contracts shedding four or five basis points in implied yield terms. The year end December future currently implies a three-month cash rate of 1.08%. The recent one week range for yields remains volatile. Ahead of the stress test results fears of bank failure fuelled weakness to 1.18% while in the aftermath of the report the implied cash rate declined to 0.99%.

Eurodollar futures - Weakness in orders for durable goods is helping to maintain a bid for both Eurodollar futures and the September 10-year note future. The contract is only higher by four ticks at 122-14 carrying a yield of 3.04%. Investors remain reticent to plow back in to bonds given the strong showing from company earnings, which have fuelled a strong equity market performance. A dip in global tension also counters the recent plunge in yields. Later in the session the Fed will release its Beige Book - an assessment of demand and activity within the 12 Federal Reserve districts. Last time around the survey showed subdued expansion and investors will be keen to learn whether the latest reading confirms Mr. Bernanke's stark observation of unusually uncertain activity. 

Japanese bonds - A rally in stocks and a weakening of the yen relative to the dollar and euro helped deter from the appeal of fixed income. Japanese 10-year yields gained four basis points after a strong week-long rally. The yield rose to 1.075%.

Canadian bills - Spreads between 10-year U.S. and Canadian government bond yields remained at 20 basis points struggling to compress much following deterioration in U.S. consumer confidence. Firming equity and commodity prices have buoyed the Canadian dollar lately following the central bank's decision to plow ahead with its policy of slowing removing monetary stimulus. Both nation's short end futures appear to be matching gains and losses to the same extent given the Canadian economy's reliance on U.S. activity. 90-day bills of acceptance are higher by three pips on Wednesday with the year-end future implying a yield of 1.35% compared to a benchmark cash rate at the Bank of Canada of 0.75%. The contract has rallied sending its implied yield down from 1.43% two weeks ago.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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