Tuesday, March 9, 2010

You can almost see the headlines coming now. European politicians are crying foul over rogue derivative bets that helped derail the Greek fiscal wagon. But while the picture is there for all to see, even the German financial regulator BaFin says that there is a lack of evidence of how investors built positions using credit default swaps. The furor is likely to get louder following German Chancellor Merkel's appeal to President Obama to act now to prevent further pressure, or worse still a redux but this time with Portugal running the risk of being forced off the track.


European short futures - On the anniversary of the weakest point in the bear market for stocks, investors across the Eurozone pared their appetite for equities following a couple of less upbeat earnings reports. Germany's Angela Merkel voiced fierce concerns at a Luxembourg press conference with local Prime Minister Jean-Claude Juncker, asking for the swift implementation of measures aimed at tackling the undesirable elements of credit default swap trading. The CDS trades insure bond investors against the default of a bond issue, but there are no rules preventing investors from taking on insurance without an underlying position.

It's widely expected that Greek Prime Minister George Papandreou will address this issue with President Obama at a visit this week. Conceivably it would be possible for market villains to build a stack of positions that would benefit if a country or company defaulted. The crux of the matter, however, is whether the demand for insurance played out by rising insurance premiums, causes or accelerates default in its own right. According to BaFin, the German financial regulator, there are no signs of a build up of new positions that might have caused a run on Greece.

The urgency to implement such restrictions was put in the spotlight earlier following fears over a Fitch downgrading to debt issued by Portugal. Although its bond prices and yields were unchanged on the day, they did miss out on a sharp Eurozone bond rally, which saw core German bund yields slip from 3.18% to 3.12%. Weakness in stock indices and the shift of emphasis from Greece to Portugal helped spur a bond rally.

Portugal has already announced plans to award sub-inflation pay increases to civil servants, has delayed major infrastructure spending plans and has plans to sell €6 billion in state-owned assets as it tried to trim its budget deficit. And while the situation is less tenuous than that of Greece, investors helped widen the premium over German bunds today by six basis points to 94 basis points.

Eurodollar futures -Words from the market chief at the New York Fed have soothed money traders' fears that the Fed might lighten up on some of the debt it has purchased as part of its asset buying spree. The official picked up on previously announced measures by Fed Chairman Bernanke who indicated that at some point the Fed would seek to reduce its balance sheet. But the words today provided further groundwork on the timing and indicated that the recovery needs be more firmly established before the Fed would start to incrementally sell previously purchased securities. To do so in one big jolt would send yields at longer maturities sharply higher. Eurodollar prices are displaying enthusiasm over this communication with yields down by four basis points along the strip. June treasury note futures are paring earlier gains but are higher by four ticks at 117-01 where the 10-year yield is at 3.69%.


Canada's 90-day BA's - The rally in Canadian government bonds is petering out with yields only lower by a basis point at 3.48% as June bonds rise just five ticks to read 118.18.

British interest rate futures - Gilt prices rose pretty sharply after a well received auction of government bonds. Yields fell at the 10-year to 4.03% spurred on by comments from a Fitch Ratings spokesman who argued that the pedestrian pace of spending and revenue adjustments might put the nation's credit rating at risk. However, dealers interpreted the words as meaning that the Bank of England might need to step in to buy more government paper and depress yields artificially. Short sterling prices at further maturities rose by seven basis points. Investors were also discouraged by a reading of 17 in the balance of home surveyors reporting higher rather than lower U.K. home prices. That's the second droopy piece of housing market evidence this week - and it's only Tuesday.

Australian rate futures -Bill prices at short maturities slipped in response to a rather bullish reading of job advertisements from ANZ. The 19% jump in vacancies printed in newspapers and listed online was the strongest pace of increase in the 11-year history of the index. Still, 10-year bond prices rose enabling a two basis point decline in yields to 5.53% as the curve flattened. Speculation is still swirling that the March meeting of the RBA will deliver a quarter point rise to 4.25%.

Japan - A successful auction of 30-year maturities totaling around $6.6 billion at the highest coupon rate since August last year helped provide a positive tone to bonds on Tuesday. Yields fell to a five-week low ahead of Wednesday's Bank of Japan report on consumer prices. In line data would leave the annualized pace of decline at 1.5%.

Andrew Wilkinson