Thursday, April 1, 2010

Bond bears sat on U.S. treasury prices on Thursday after U.S. initial claims data revealed a 6,000 decline in weekly jobless data to 439,000. The number of continuing claims rose a little further confusing the importance of the series ahead of Friday's March employment report. Bond markets will be open for a shortened session in the U.S. while equity markets face a day of rest for Easter, while European traders will be absent until Tuesday.

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European bond markets retained a bid even as Greek bond prices firmed easing pressure at least at the 10-year maturity. Eurozone manufacturing data released earlier continued to indicate a healthy pace of expansion, while the reading of German data also impressed with a hearty reading.

Yet traders are reticent to let go of the life raft offered by core German bunds, where yields close to record lows indicate that a worsening of the sovereign debt crisis lurks somewhere in the background. The unspecified agreement agreed recently in which EU members agreed to provide financial aid to Greece in conjunction with aid from the IMF has created something of a Pandora's Box. The positioning by the parties as lenders of last resort has failed to quell speculation that Greece can sell enough debt to by pass forthcoming bond maturities. If it can't raise enough buyers for bonds at still elevated yields more than 3% above comparable German maturities it might default. We now know that under such circumstances the EU-IMF should step in. But the very presence of this tag team is meant to convince speculators that a default will be prevented.

Simply put, the 340 basis point yield premium over German bunds tells us that the present course of action isn't working. Speculators seem intent on finding out what's inside Pandora's Box, and the real danger is that if they force a default that lasts a virtual nano-second forcing an EU-IMF purchase of the remaining portion of unsold debt, the panic ought to subside immediately taking away the supply of Greek debt and forcing the spread to collapse. Wishful thinking? We'll only know it when we see it.

Japanese bonds rallied to begin the quarter as dealers took advantage of a four-month high for yields at 1.40%. The less pessimistic tone to the quarterly Tankan report was anticipated by investors and was not overtly bullish and didn't sugar-coat the recovery, at least not enough to spark higher yields instead. The Nikkei index rose to an 18-month closing high.

British gilt prices surged as optimism grew surrounding the likelihood of a majority government at the summer election. The Prime Minister has to give at least one month's notice for a general election that has to be held by June, but is widely expected to be held on May 6, which means his deadline for such timing is next Tuesday. A Metro-Harris opinion poll revealed a 10% lead for the opposition Conservative party that would be enough to give them an overall majority government in the summer. June gilt prices rose 26 ticks to 115.01.

Andrew Wilkinson

Senior Market Analyst