Tuesday, March 16, 2010

According to implied yields on short-dated fed funds futures there is an 84% likelihood that the Fed will leave interest rates unchanged when it announces its latest perspective on Tuesday afternoon. Bond yields are dripping ever so slightly lower in the hope that the Fed won't remove the expression from the wording that means official short-term rates are likely to remain unchanged through the summer. However, one cannot doubt that there will likely be a vigorous discussion within those Washington walls about when the Fed needs to remove its bond with a an extended period of low interest rates. You can bet your bottom dollar that many what-if statements will be tossed between hawks and doves today. The bottom line for policy makers has become if not now, when?


Eurodollar futures -Trading volume remains brisk but Eurodollar futures remain largely unchanged ahead of the Fed. June treasury note futures have risen by 7/32 to 117-03 pushing the 10-year yield to its lowest in a week at 3.67%. But one has to wonder just how overtly dovish the Fed's statement would need to be in order to send yields lower still. Weakness in data for housing starts this morning argues that yields could indeed slip further on account of the challenges facing the home construction sector, yet subtle changes in the wording of what the Fed has to say could unseat bond yields.

Australian rate futures -Aussie bills responded well to the latest batch of monetary policy insight in the form of the minutes from the Reserve Bank's March meeting. Having lifted short-dated interest rates to 4% at the time of that meeting the minutes didn't sway investors to any change of heart over the anticipated pace of monetary tightening in the coming months. There remains a lack of conviction over an April interest rate increase and today's minutes failed to deliver a sense of urgency over further moves. As such, bill futures regained some lost ground of late and rallied six basis points across the strip. Currently the futures market sees the rate cycle topping out at about 6% about two years from now. Bills from March 2012 expirations onwards imply a yield of 5.88% consistent with a curve flattening typical of the end of a cycle.


Canada's 90-day BA's - A rally in the Canadian dollar is an implicit tightening in monetary policy. However, the rise in the dollar is brought on by growing delight in the prospects for the domestic economy, which is boosted in part from stability to its largest trading partner south of the border and partly by growing demand for crude oil as the rest of the world gently boosts output. These influences on the Canadian dollar are helping depress interest rate futures on account of a growing sense that the Bank of Canada will be in good shape to start lifting official monetary policy in the second half of the year. However, the price of 10-year government bond rose easing the yield to 3.46%.

European short futures - Moody's has apparently removed Greece from being on watch, which probably means that the recent budget has produced enough of a safety valve to allow some of the steam out of the pressure cooker. June bunds rallied on the news and are at pushing on the day's high at 112.92 ahead of the close. Euribor futures are higher despite a positive out turn for the ZEW sentiment index, which earlier unseated fixed income.

British interest rate futures - Short sterling futures are lackluster as the pound rallies against a weaker dollar. Gilt yields slipped despite news of a draft report from the EC suggesting that the British government must address its deficit more so than it has already done. June gilts rose 29 ticks to 114.55 where the yield is 1.01%.

Japan - Demand for a 20-year auction attracted 3.49 bids for each available bond today, which kept bond prices higher as fixed income demand remains its appeal into the fiscal year end through March. The market is patiently awaiting the outcome of the Bank of Japan meeting due Wednesday in which it is widely expected to make additional funds available to the banking system in an effort to help counter deflationary economic conditions.

Andrew Wilkinson

Senior Market Analyst