Wednesday, March 17, 2010

On St. Patrick's Day 2009, fixed income investors didn't yet realize that 10-year treasury yields were starting an ascent that would lift them from 2.5% to 4% before Memorial Day. The prior week's capitulation for equity prices maintained upwards pressure on fixed income investments as safe haven buyers balked at other asset classes. One year on the Fed is still describing a fairly weak economic recovery. Tuesday's FOMC statement has enhanced risk appetite while leaving the door wide open to a long period of low interest rates. However, the main beneficiaries of those words from the Fed appear to be the European markets and not that of the U.S.


Eurodollar futures -The 10-year yield is barely changed on Wednesday at 3.64% despite the Fed's argument that the quality of the U.S. recovery means an exceptionally low period for interest rates. In addition to that today's producer prices report for February came in below forecast, bolstering the Fed's position, yet failing to materially provide more demand for notes. In the aftermath of the Fed's decision Eurodollar futures made gains of around six or seven basis points as dealers priced in a lower for longer attitude. Again, there is no follow-through buying today and futures are in the red by a minimal amount admittedly, but my point remains the same: Some disappointment exists, and if that's not the case, there is some distrust of the Fed's ability to maintain low interest rates for an extended period.

European short futures - Euribor futures rallied about the same degree as did Eurodollar futures as dealers bought into the easy money argument. But German yields have slipped sharply once again and are easily outpacing those of treasuries It would be easy to blame the move on a decline in data for Eurozone industrial production released earlier, but that data describes the performance in January and is of lesser importance. German yields dropped four basis points to 3.10% compared to just a one basis point decline in the U.S. 10-year yield to 3.64%.

Australian rate futures - Aussie bills declined after the local dollar surged on the improved outlook for risk appetite overnight. A robust 15% gain for local housing starts also plays right into the Reserve Bank's corner as a reason to keep inching towards rate normalization. Yields at the 10-year gained by three basis points to 5.65% while bills lost three basis points.


Canada's 90-day BA's - A stronger Canadian dollar continues to act as a barometer for global economic recovery. The pace of growth may be fragile according to the Fed, but the Canadian's are first in line on the food chain, benefitting from rising demand for crude oil and other natural resources. Bets are stepping up that the Canadian yield structure will reside sharply above that of the U.S. by year end. The December contract currently implies a year end cash rate of 1.48% compared to an implied U.S. yield of 0.79%.

British interest rate futures - Short sterling futures gained sending implied yields three basis points lower, while gilt futures gained sending the yield at the 10-year lower by 2 basis points to 3.99%. Minutes from the recent Bank of England meeting saw consensus reached on policy matters. Each member voted in favor of maintaining the bond purchase program where it is - closed until further notice. Interest rate traders jumped on the same bandwagon set in motion on Tuesday when the Fed argued that rates would remain unchanged for longer. However, a bullish employment report showed a 32,300 decline in the number of jobless claimants for February against an expected rise of 6,000. Still, money markets are wiser than to believe that this single piece of data would be enough to provide anything other than relief at the next Bank meeting.

Japan - Japanese bond prices declined with yields rising after the Bank of Japan doubled its own bond purchase program. In agreeing to a repeat performance for its ¥21 trillion war chest, the decision drove a wedge between its board members with two voting against the measure. Bond prices fell because investors realize that if this was a hard decision to make today under intense government pressure to help combat deflation, it likely signals the last time the board will come to a consensus decision to do so. As such today's move marks the beginning of the end of quantitative easing. Governor Shirakawa noted that the economy was overshooting the Bank of Japan's forecast and was keen to announce that the three-month loan process was not designed to weaken the currency. Ten-year note yields rose to 1.34% while two-year note prices surged to a four-year high earlier sending the yield to 0.14%, which is about where the fed funds rate stands at present.

Andrew Wilkinson