IB Interest Rate Brief - Slumping yields fail to attract crowd to German auction

Not enough buyers turned up to a German bond auction today as investors feared an impending capital loss after the recent slump in yields drove borrowing costs to an all-time low. But global fixed income markets continue to push yields down during this summer lull, ever hopeful that Chairman of the Board Ben Bernanke might tip his hat in Washington to evidence lurking somewhere beneath an unturned rock indicative of an end to the current slowdown.

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Eurodollar futures - Mr. Bernanke starts two days of testimony in a twice-a-year ritual that leaves him explaining to lawmakers the health or otherwise of the U.S. economy. With a host of recent economic indicators pointing to a lessening in the pace of growth bond buyers have depressed yields in the worry that the Fed has run out of room to ease policy any further. No doubt someone will raise the question today as to whether the Fed could reduce the deposit rate paid on banks' excess reserves. Indeed newswires are buzzing with the prospect that Mr. Bernanke might raise the issue himself.

September treasury futures reached 123-10 in early trading although the contract has a narrow 10-tick trading range today, with a yield stuck at 2.91%.Eurodollar futures are also making minor gains as the curve presses lower.

European bond markets -In a sign of increasing frustration with ever-lower yields, German bond buyers failed to flock to an auction of €4 billion of 30-year bonds carrying a 3.25% coupon. While admittedly the interest rate environment looks benign, yields have fallen towards the bottom of a range of 4.92 - 3.08% during the past three years. And with economic growth accelerating during the second quarter investors are clearly reluctant to steam headlong into such low yields with at least a reasonable economic outlook ahead. Not everyone shares the view that the Eurozone will participate in a double-dip recession even if the world actually arrives at one. Only €3.764 billion of the bonds were bid for leaving the cover at 0.94 before the Bundesbank picked up the slack. The September bund contract is unchanged on the day at 128.90 ahead of Friday's stress test data. Euribor futures are five basis points higher in line with cash prices slipping in the money markets following an ECB liquidity add at a recent auction.

British gilts - Gilts managed to move ahead this morning despite continued unrest at the Bank of England where one of its policy makers argued on behalf of an end to easy money at last months MPC meeting. The minutes concluded that the prospect for inflation was not so-good-looking after the sales tax due to come into effect in 2011 is implemented. Nevertheless, in this benign period for central bank policy, September gilts added 10 ticks to 121.30 carrying a yield of 3.33%. Short sterling prices also advanced by two ticks as cash rates softened.

Japanese bonds - An index of business demand for loans fell deeper into negative territory according to Bank of Japan data spurring bond purchases at the 10-year horizon. September JGB futures rose by 12 ticks to 141.73 with the yield declining to 1.075%. The Bank's loan index has been in negative territory for four quarters. 20-year bond prices fell ahead of a ¥1.1 trillion bond auction later this week.

Canadian bills - The Bank of Canada indeed raised interest rates by a quarter point on Tuesday but fuelled expectations that little would change ahead given the challenging external environment including the impending European bankers report on the health of 91 banks. Demand for government bonds has increased following the policy statement that indicates a lesser chance of further policy adjustment. The September bond future rose a further 14 ticks midweek driving a five basis points decline in yields to 3.14%. Bill yields also implied a lower chance of further tightening falling by around five basis points.

Australian bills - Following a major slump in price on Tuesday, Aussie government bonds were bought on Wednesday slashing four basis points off borrowing costs to a 5.16% yield. A weaker Aussie dollar also created a little uncertainty over growth prospects. 90-day bill prices fell sending yields a little firmer, however.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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