Wednesday June 3, 2010

A sharp rebound for Asian stock markets supported optimism over the health of the global economy allowing risks to prospects for European growth to take a back seat. Fixed income assets accordingly returned to sell mode as investors demanded higher yields in exchange for holding bonds. The focus shifted to employment prospects as the first pieces of job market data started to come on tap. Elsewhere, strength in various readings of service sector PMI data failed to support the view that economic downturn was dead ahead as some had predicted on the basis of earlier readings for manufacturing PMI data.

Eurodollar futures - If tomorrow's employment report lives up to expectations of a net gain of 515,000 positions it will apparently be the strongest reading since 1983. On Thursday signs were reasonably supportive after a decline in weekly initial claims to 453,000 through last weekend accompanied an ADP report showing the addition of 55,000 private sector roles during May. In addition the April reading was revised to show an increase in jobs added to 65,000.

Ten-year U.S. notes have added about 15 basis points in yield since the start of the holiday shortened week and today the yields reads 3.38% with the September future losing a further seven-ticks today to 119-09. In a speech today, Atlanta Fed President Dennis Lockhart threw out the notion to an audience that despite the still high rate of unemployment the Fed may yet need to consider lifting its official policy stance from a near-zero reading. The market has not yet reacted to this prospect and Eurodollar futures remain around three ticks higher in price with implied yields falling gently.

Canadian bills - Canadian bond prices are two basis points firmer at 3.40% on a data-free day. The government also reports May employment data on Friday and is expected to follow a monster jobs report from April showing 108,700 additional jobs with a further increase of 15,000 new jobs. Bill prices marked time and are unchanged. A healthy report will only guarantee further monetary tightening from the Bank of Canada assuming the fallout from Europe is contained.

Australian bills - The better tone to risk helped buoy the Aussie and helped focus investors' minds on real growth prospects. The healthier feel caused government bonds to crash sending yields 10-basis points higher to 5.41%. Bill prices also fell sending implied yields around seven basis points higher. Trade data for April revealed surging iron ore and coal exports from the nation, which improved the balance of trade to a A$134 million surplus.

European bond markets - Two factors drove European government bond yields higher in trading on Thursday. The better tone to risk and a focus on improved data helped dull investors' appetite for fixed income. The September German bund futures came under pressure following the release of a better than hoped for reading of Eurozone PMI data. The yield rose three basis points to 2.68%. Having announced in May that it would act to directly purchase government bonds in the open market, peripheral bond yields are once again inching higher despite the improved appetite for risk. One wonders whether this raises the question of whether another blow-up in debt prices is lurking around the corner.

The September bund contracted has rebounded from its intraday low at 127.67 as German debt is holding relatively firm in a market that has seen peripheral spreads widen out sharply again today. Investors are in a sense pushing the envelope in seeing how far those bonds might fall without intervention form the ECB.

British gilt -A 9.8% annualized pace of increase in British home prices in conjunction with ongoing service sector expansion prodded investors to buy stocks and sell bonds on Thursday. Investors sold the September gilt down by 32 ticks to 118.52 where the implied yield is 3.58%. Short sterling futures faced a minimal decline of a tick across the curve.

Japanese bonds - Bond prices fell at the long end in sympathy with a rally for Asian stock markets while shorter maturities gained in the hope that should Naoto Kan become the next Prime Minister he might be more fiscally aggressive in dealing with a growing deficit. June JGBs fell 17 ticks while the yield at the 10-year added one basis point to 1.265%.

Andrew Wilkinson Senior Market Analyst