Wednesday, May 19, 2010

U.S. treasury notes are trading between gains and losses while euro-area government bonds are higher. Yields are responding to the news from Germany where regulators banned certain types of short sales, but the impact is changing as the day wears on. Initially the defensive measure appeared far-more damaging to already fragile sentiment and raised concerns that government efforts were flailing in the face of failure. The euro reached its weakest point since April 2006 reflecting added market anxiety, but has subsequently rallied back to positive territory for the day. The reduction of perceived risk is lessening demand for the safety of U.S. government securities, while the confusion surrounding dealings in European government debt is creating a bid over there.

European bond markets - An auction of 10-year German debt was oversubscribed, but the agency held back one quarter of the issue today. The fact that yields had slumped to 2.78% this morning made the offering unappealing while the financial watchdog's ban on short sales of specific instruments left dealers wondering how to hedge new issues. Euribor futures shed two basis points as cash markets edged higher.

Eurodollar futures - Eurodollar futures are virtually flat and there was little excitement from the consumer prices report, which showed the first minor drop since March 2009. Heavier losses indicated by equity index futures markets didn't pan out quite as badly as the euro rebounded into the black after a rocky start. The June note future has also rebounded from earlier weakness to 120-01 before yields resumed a downward tack to 3.34%.

British gilt -Gilt prices more than recovered from inflation-inspired losses a day earlier. The 10-year yield has slumped by eight basis points to 3.66% as dealers respond to Germany's plans to scupper short-selling of swaps tied to European government bonds. Short sterling prices also rallied at deferred maturities with implied yields down by six basis points in the 2011 strip. Dealers were also encouraged by the contents of the minutes from the recent Monetary Policy Committee meeting at which members voted uniformly to leave rates and the Bank's bond-purchase plan unchanged.

Canadian bills - Yields at the 10-year region moved to a five basis point premium following a thumping Tuesday rally for U.S. debt. The European drama helped Canadian bond prices shed a further basis point in yield to 3.39% this morning, while weakness in oil and gold prices is a strand of evidence that the Bank of Canada will have to mull when it decides on whether to shift rates in June. Dealers bought 90-day bills driving down implied yields by four basis points.

Australian bills - Given the timing of the German decision to ban certain types of speculation in government bond markets and its impact on the euro, stock markets continued to slump into the Pacific time zone. The dive out of the Aussie dollar back into the Japanese yen coupled with fears for the sustainability of global recovery saw dealers price out further monetary tightening. Bill prices jumped by one quarter of one per cent. Buyers of government 10-year bonds sent yields down by seven basis points to 5.42%. to ice the bearish cake today, an index of consumer confidence slumped by the greatest amount in 19 months indicating success for the RBA's recent policy moves.

Japanese bonds -Eurozone woes continued to filter through to demand for Japanese government debt with the five-year bond falling in yield terms to its lowest point in five months. The 10-year JGB future rallied to a two-month high and closed with a 27 tick gain to 140.12. The yield pushed back down to 1.275%.

Andrew Wilkinson Senior Market Analyst