Fixed income buyers are dragging their heels midweek as investors mull the prospects for a rosier outcome from a two-day meeting of European finance ministers. In North America the perceived need to the safety of government paper is becoming overlooked and allowing yields to rise as inflationary arguments around the world swirl. However, weakness in equity prices, albeit following a strong start to the year, saw buyers resurface by mid-morning in New York.

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European bond markets - A German newspaper article claimed that discussions were under way that would enable Greece to use bailout funds to restructure its debt. Both nations denied the story, but yields rose in response to the prospect of any possible damage to investors from a so-called haircut. March bunds have recovered from earlier losses to 123.86 to stand higher on the day at 124.25 after several ECB members attempted to push back against a hawkish tone set last week by Trichet and Weber. Even Mr. Weber admitted late in the day that he still expects medium-term inflation to be below the 2% target. Shorter-dated euribor futures rallied as investors bought contracts to drive implied yields lower.     

Eurodollar futures - Eurodollar futures climbed by around three basis points following a weaker than hoped for reading for housing starts in December. A decline of 4.3% between months was further confused by a strong reading of building permits, a common indicator of future construction activity. Nevertheless investors responded negatively to the downturn in output seeing the time to recovery lengthening. March note futures have recovered from a lackluster start putting in a low at 120-10 before rallying three ticks on the day to 120-23. The curve nevertheless continues its steepening process as inflationary fears around the world grab the headlines and investors continue to assess the potential for an ultimate change in stance at the Fed. The gradient of the two-to-30-year edged further towards record territory of almost 4% or 400 basis points on Wednesday.

Japanese bonds - A third day of rising stock indices around Asia and the prospect of an imminent 20-year government bond auction deterred fixed income buyers on Wednesday sending the 10-year yield higher by five basis points to 1.255%. The March JGB future slid 44 ticks to close at 139.31 ahead of an auction of ¥1.1 trillion in 20-year paper later in the week. A service sector index for November revealed a stronger level of activity than was forecast also sparking economic confidence.    

British gilts - Gilt prices have reversed earlier losses inspired by an unexpected dip of 4,100 in the jobless claims for December. The unemployment rate remained unchanged at 4.5%. Investors and lawmakers remain concerned by the tenth straight reading of above target inflation. The March contract has risen from a session low at 117.07 to trade 23 ticks up on the day at 117.36. Short sterling futures made gains of eight ticks as implied yields slid in response to gains at the European short end.

Australian bills - Government bond yields jumped by five basis points while bill futures saw accelerating losses of four basis points from September expirations outwards despite a sharp drop in consumer confidence. A Westpac report showing weaker consumer confidence was probably driven by the impact of flooding, while investors remain optimistic over the strength of economic activity in the nation's biggest trading partner. On Thursday China is scheduled to release key GDP data amongst others likely to prove the world's number two continues to expand at a near double-digit clip.

Canadian bills - The Bank of Canada pretty much announced yesterday that monetary policy is firmly on hold despite the growing likelihood that North American activity is rebounding. Investors today favored U.S. debt over Canadian at the 10-year horizon forcing the yield premium to narrow to just six basis points with domestic bonds yielding 3.29%. Short-dated bills continued to rally sending implied yields lower by three pips.

Andrew Wilkinson                                                                    

Senior Market Analyst