A further sizeable flattening in global yield structures is underway as equity markets around the world sink over geopolitical fears coupled with fears that banking reform in Spain is either late or the tip of the iceberg. During the past several days while government bond yields have slumped as investors seek the safety of fixed income bearing assets, rising perceived counterparty risks have resurfaced causing volatility at the short-end of most yield curves. This regressive step takes the world back to the liquidity crisis days prior to the collapse of Lehman Brothers during which stage of that crisis, banks stopped lending to each other for fear of failure. Back in those bad old days banks were concerned with what counterparts might be holding on their balance sheets. Have we learned nothing after two years?
European bond markets - An IMF report supported the recent budget cuts in Spain, but said that it feared consolidation in the banking sector was well behind schedule. This is possibly why the Bank of Spain welded four savings banks together on Monday to help bolster their asset base and make the system less fragile. The positive move has kicked off a purple patch in which banks are coming under further pressure, with the fear being that restraining bank lending will further prevent a recovery from gaining traction. German bunds are bid and the June contract is 69 ticks higher at 129.30. That's another contract high as risks escalate. The yield slipped to 2.66% and to put that in perspective, the lowest point reached at the start of January 2009 as global fears accelerated, 10-year bund yields fell to 2.85%. The focus on European risks and further spillover has worsened the situation so it would appear. While an ECB rate cut is a clear possibility over the summer, shorter-dated euribor contracts are not predicting such an outcome. Since last week when the December contract peaked at 99.13 (0.87% yield) the dash-for-cash that has pushed Libor settings higher, has seen the contract slip to 98.85 (1.15%).
British gilt -Short sterling prices have felt a less dramatic although still significant downdraft adding 15 basis points in yield in a week. The December contract is currently unchanged at 98.85 (implied yield 1.15%). Far-dated futures prices have added around six ticks as they seem to be fighting off a looming liquidity crisis. Perhaps the market expects the failsafe to be an expansion of the Bank of England's bond-purchase program, which it noted as recently as last week that it could reintroduce. 10-year gilt yields slumped lower by a further eight basis points today to read 3.46%. Earlier in the morning Adam Posen, MPC policymaker warned that the external environment would remain a stumbling block to Britain's recovery.
Eurodollar futures - Eurodollar futures at the December expiration have now dropped forty basis points in less than two weeks. As demand for cash grows it's the dollar funding market that is feeling the greatest strain as Libor prices head higher. The contract is five ticks weaker this morning at 98.88 and carries an implied yield of 1.12% and compares to an average fed funds target rate of exactly 1% lower. The June 10-year note future carries a yield of 3.11% this morning, lower by eight basis points on Monday's session as the flight to quality steps up a gear. In the aftermath of the Lehman's crisis the 10-year yield reached 2%.
Canadian bills - Canadian 10-year yields also slumped on Tuesday as the June government bond futures contract roared 122 ticks higher at its best point of the day to 121.78. Yields in Canada slipped a massive 16 basis points to 3.20% this morning while that frequently watched Canada over U.S. widened to nine basis points. Ahead of next week's Bank of Canada meeting dealers are questioning whether it would be a mistake to raise rates at the Bank of Canada and as such have pushed 90-day bill prices higher by as much as 12 basis points.
Australian bills - More Asian stock market declines and depressing geopolitical news from Korea weighed on a variety of factors that would seal the case on further Reserve Bank policy actions. A weaker local dollar and slumping commodity prices infer weakening economic activity ahead. Aussie 10-year yields declined by eight basis points to 5.25% while bill prices surged by 17 basis points at deferred expirations.
Japanese bonds - Yields fell in sympathy with a global flight to safety and Japanese yields drooped by a further four basis points to 1.204%. Regional stock markets faced approximate declines of 3%.
Andrew Wilkinson Senior Market Analyst