IB Interest Rate Monitor

Tuesday January 19, 2010

Eurozone bond buyers suddenly lost their appetite for fixed income Tuesday, balking further faced with the prospect of €25 billion in supply this week. The driver today was the release of British consumer price data, which breached the government's 2% ceiling for the first time since May. And while investors spent the tail end of 2009 fretting over the prospects for higher interest rates around the world, they did so because they foresaw strengthening evidence of growth that would permit central bankers to revert to a normal monetary stance throughout 2010. A largest jump in a one-month inflation series since records began in 1997 has sent shivers across the world of fixed income today as investors turn their backs on a string of yield declines in the past week or so.

British interest rate futures - 10-year British government gilt prices are off their earlier lows after the December reading of CPI rose by a surprisingly strong 0.6% lifting the annualized pace of consumer inflation to 2.9% and well above the Bank of England's 2% ceiling. However, much of the jump can be blamed on surging crude oil prices between last December and a year earlier, while a tax-cut on retail spending also expired in recent data, creating the impression that prices have jumped. Investors will be looking to the Houdinis at the Bank of England to pull an escape stunt from today's data. In the meantime panic quickly spilled over into losses for short sterling, where futures contracts slumped as much as 14 basis points as investors were left with no choice but to join the selling in the fear that the Bank would soon be raising interest rates. December expiration sterling contracts last traded at 98.20 implying a yield of 1.80%, while current short term rates remain anchored at 0.5%. The yield on the 10-year gilt rose to 4.01%.

European short futures - When analyst and investor confidence expectations typically fall, one would expect German bund prices to rally. However, even in the face of a larger than expected decline form the ZEW institute's reading for January today, which fell from 50.4 to 47.2, investors chose to focus on the message from British inflation data. March bunds lost 31 ticks after rising earlier and currently yield 3.28%. A weaker euro is also weighing on fixed income demand as investors try to avoid the mess created by what's happening with Greek government reforms as it tackles its budget deficit. Spreads between peripheral nation's debt and those of core German continued to widen today after European finance ministers voiced concerns that plans by the Greek government to cut spending look ambitious.  

Eurodollar futures - Earnings season for corporate America continues this week with reports from 65 of the S&P 500 index components due. Investors will be looking for signs of growth to vilify another bout of risk appetite the inflation backdrop took a step backwards with British data earlier. The yield at the 10-year area of the curve consequently backed up to read 3.70%. Weighing on the short end was the rout for global short ends followed by a sharp lift to early trading for the S&P index. Eurodollars dropped by between two and three basis points.  

Australian rate futures -Australian rate futures missed out on the developments later in the day, which might resurface Wednesday. The subtle ongoing messages from the People's Bank of China continued today as it allowed yields to creep higher on one-year bills at today's regular auction. Even though investors are coming around to the view that a tightening of the purse strings is the positive side-effect of a growing economy, the overall edge towards risk appetite is missing its shine. Aussie bonds remained steady today although the market will be tested in light of the British inflation data tomorrow. 

Canada's 90-day BA's - The Bank of Canada left its benchmark rate stable at 0.25% today as dealers expected. As a result bill futures remained unchanged despite the largest rise in Canadian leading indicators in 27 years. The jump in the measure is brought on by stronger household spending and a jump in stock prices as confidence returns. The index while welcome is not likely to change expectations over a Bank of Canada change to rates ahead of mid-year. The 10-year government bond yield rose two basis points to 3.49%.  

Japan - JGB prices were largely unchanged after the big news of the day that Japan Airlines, whose share price had recently plunged, finally filed for bankruptcy. The yen rose earlier but the dollar later flexed its muscles. Yields eased to 1.31% at the 10-year.