Monday, May 10, 2010

The EU's original €20 billion offer of aid to Greece now looks like a speck of dust after the weekend announcement of a €750 billion package, which leaders will be hoping will cut to the heart of the problem. There is a clear parallel between this weekend's package and that devised after Lehman's collapse. Just as at that time, today's initiative sees global central banks agree to the provision of a currency-swap line designed to quell the demand for dollars that happens when counterparty risks arise. The unlimited nature of dollar supply through this mechanism coupled with a pan-European government and private bond buying spree should allow the ECB to fulfill its aim of trying to return those markets once again to a healthy and liquid state.

European bond markets - Core European government bonds are markedly lower as a result of the coordinated plan. European central banks stepped up to implement bond purchases in those markets suffering from stress over the recent weeks. The resulting coincident flight to quality lifted prices of bonds perceived as safe havens due to investors' concerns that fiscal austerity might lend itself to a double-dip slowdown. Slumping stock prices drove home that point last week and accelerated sliding yields.

The divergent fortunes of those bond issued by different European governments manifested itself in an explosion of spreads between yields of varying qualities. In the mania sometime last week, the premium demanded by investors buying Greek bonds relative to German bunds exploded to almost 1000 basis points.

Today the differential has collapsed to 343 basis points while the Portuguese spread narrowed to 200 basis points from 350, while gains for Spanish government bonds reduced that premium from 173 to 94 basis points.

Euribor futures also jumped at the European short end as the perception of ultra-liquid cash markets created a buying opportunity. And of course the potential for an interest rate cut can't be ignored to coincide with what the ECB announced over the weekend.

British gilt - The British yield curve also reacted hugely to not only the Eurozone response to the sovereign debt crisis, but also to what's increasingly looking like the formation of a majority government in Britain. Short sterling prices jumped by about a quarter of a percent in a massive slide in short term yields. Meanwhile the longer end of the curve saw yields jump by 10 basis points to 3.92%. The resulting yield curve gradient steepened dramatically as a result.

Eurodollar futures -June notes are down by more than a full point at 118-21 sending yields up to 3.57% for a 15 basis point rise. There is no disappointment associated with today's selling, which is simply an unwind of the fear bid backing U.S. government fixed income during the rising pressure of last week. The coordinated global intervention is also playing out in shorter-dated Eurodollars, which have surged around 15 basis points at the nearest two contracts. June expiration Eurodollar futures are trading at an implied yield of 0.47% compared to a gloomy 0.83% in trading last Thursday. The yield does, however, have some way to drop to reach its all-time low of 0.33% seen at the start of March.

Canadian bills - Returning risk appetite is good for the Canadian dollar, but now helps put the prospects for Canadian central bank policy under the spotlight. And all in the space of just a couple of days so it seems. Bill prices are lower by more than 10 basis points across the curve, unlike in the Eurodollar complex. Don't forget that in the unfolding carnage last week, Canadian employment data proved a surging gain across all industries in its employment report. That slipped under the radar as fears gripped the market. Government bond prices slumped 116 ticks to 118.15 in the June contract this morning as the 10-year yield jumped by nine basis points to 3.58%. During the recent turmoil declining U.S. yields have slipped beneath comparable Canadian yields.

Australian bills -Australian yields traded in a similar fashion with cash rates getting back on a rising track via 90-day bills, whose prices slipped between six and 20 basis points. The long-end was far more vulnerable to a rejuvenation of risk appetite with 10-year yields jumping by 10 basis points to 5.53%.

Japanese bonds - Surging regional equity prices and a first-opportunity for Asian investors to digest the impact of the coordinated package resulted in a drift higher in Japanese yields to 1.294%. June JGB futures slid 27 ticks to 139.64.

Andrew Wilkinson Senior Market Analyst