Monday July 19, 2010

Bond prices are generally lower as investors seem a little less pessimistic towards risk to start the week. The burning question appears to be whether the notable slowing in economic activity justifies the plunge in yields.

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Eurodollar futures -A three day rally for bonds last week saw 21 basis points shaved off the cost of government borrowing as investors rushed headlong into the safety of fixed income. The 10-year note faces a weaker start today even ahead of an expected decline in home builders' confidence later this morning. September notes are a couple of ticks lower to stand at 123-04 yielding 2.95%. Meanwhile nearby Eurodollar contracts have made minor gains while contracts maturing from June 20011 onwards have declined by one or two pips.

European bond markets - Friday's rally for September bunds was remarkably suspicious. The recent recovery for the euro on account of better Eurozone data than has been the case in the U.S. put the contract in focus since it appeared to have boiled over. The market was giving plenty back until the American market caught fire as stocks wilted. Today even after a Moody's downgrade for Ireland, bunds are not in rallying mode today and the contract is 43 ticks lower at 128.73. Euribor futures are a shade lower also.

British gilts - September gilt futures are also 20 ticks lower lifting the yield two basis points to 3.35% despite evidence that the property market continues to lose momentum. A leading real estate broker indicated a 0.6% nationwide decline in home prices, exacerbated in the more expensive districts of the capital. Three times as many homes are currently offered for sale compared to the number of mortgage approvals as lending standards have risen since lenders pulled in their horns following the financial collapse. Short sterling futures have nevertheless made gains despite the repeated warning from lone Bank of England hawk Andrew Sentance who over the weekend continued to call for an exit from easy monetary conditions.

Japanese bonds - Closed for national holiday. Canadian bills - With the Canadian central bank widely expected to unleash its second interest rate increase for 2010, bill futures expiring at year end don't expect too much more this year. The December contract is now reflecting a lower yield than the several days after the government announced a record pace of jobs growth in the second quarter. The contract reached an implied yield of 1.45% in light of the 226,000 jobs gained in the April to June quarter but investors have locked into rising yields forcing them back down to 1.29% today. The contract typically trades 20 basis points above the Bank of Canada's official rate meaning that investors see the prospect of further increases as only mild for the remainder of the year. Throughout 2011 dealers currently imply a further 75 basis points of tightening with the Bank lifting rates to 2% within 18 months time.

Australian bills - Despite the call for national elections for August 21 by the new Prime minister, neither interest rates nor the exchange rate appear to have been unsettled in response. Aussie government bond yields are static at 5.10%.

Andrew Wilkinson Senior Market Analyst