Friday, May 7, 2010

The challenge today is to attempt to gauge the true direction for bond markets after a series of unfortunate events. The collapse of confidence that caused a rip in the hold of the USS Titanic saw global yields plunge to multi-month lows. This morning bond markets are weaker, but surprisingly not that much that we could quickly conclude that Thursday's excessive volatility was overdone. Yields remain surprisingly low given the huge North American employment reports confirming recovery.

Eurodollar futures -June treasury futures spiked to 121-03 on Thursday, at which point the intraday yield slumped to 3.26%. Once the panic had stopped and stories emerged of erroneous trading, stocks recovered and bonds pared gains. The June contract this morning reeled to 118-28 in the aftermath of the 290,000 employment report lifting yields back up to 3.53%. The failure of panic to fully dissipate has left yields standing at 3.39%. The intraday yield range on the 10-year was a massive 32 basis points.

The jobs report was massive. I say this given the strong back revision on the March data lifting the number of jobs created from 162,000 to 230,000. And so for the first four months of this year the U.S. economy has an average job creation record of 143,000 new positions. The shine is partially removed with an overall increase in the official rate of employment from 9.8% to 9.9%, but this is due to far more people coming into the labor force. The muted sell off in both bonds and Eurodollars indicates to me that money markets are far from convinced that today's otherwise bullish report is enough to alter the course of Fed policy given external threats to the rest of the world.

Canadian bills - Canadian bills did respond to a shockingly strong employment report this morning in which 108,700 jobs were created during April. The report sent 90-day bill prices reeling by up to nine basis points at deferred maturities. The benchmark 10-year government yield rose by five basis points to 3.51% after the news with the June future now down 69 ticks at 119.25.

European bond markets - During this week's financial market violence, money traders raised the question over a future ECB monetary policy ease. The March euribor contract reached a mania high on Thursday at 99.05 (yield of 0.95%) having closed the previous week trading at 98.83 (yield 1.17%). As recently as mid-March the contract implied the next move would be a rate increase from the ECB to 1.5%. This is first hand evidence of the impact of fiscal strain and the propensity for a double-dip recession gripping the region.

June bunds traded at a fresh contract high on Thursday at 127.99 before easing on Friday to 127.30 where the contract remains higher on the session heading into the weekend.

Australian bills -Because the Thursday drama happened before the Australian markets were even awake, yields played catch-up to end the week with Australian 90-day bills reacting strongly with a 15 basis point slump in yields. Earlier in the week the RBA indicated it was at the end of its initial phase of monetary policy tightening by raising rates to 4.5%. The ensuing threats to global growth have caused investors to bet against any near-term resumption in RBA tightening. Government bond yields shed seven basis points to close the week at 5.45%.

British gilt - British yields are under the cosh on Friday as the country enters a weekend of political horse-trading after a strong opposition showing was insufficient to allow leader David Cameron to immediately dislodge Prime Minister Gordon Brown. The state of flux immediately sent up a red flag in terms of Britain's fiscal position with dealers drawing the prompt although likely inaccurate conclusion that the stalemate would extend to the same for deficit negotiations. June gilt yields rose by eight basis points but remain lower than at the start of the week despite pressure on the British pound. June gilts yield 3.87% and are trading in London at 116.78.

Japanese bonds - A rally in Japanese bond prices wilted during the day as the response to what had occurred in North America became more transparent. Bond futures closed only four ticks higher while cash yields rose by one basis point to 1.264%..

Andrew Wilkinson Senior Market Analyst