As the shroud of the Dubai saga is lifted from investors' mindsets, equity markets continue to rally as trading for the final month of the year gets underway. Bond markets are marginally lower price wise and shorter durations are a tad higher this morning. Rather than sending fears over imminent monetary tightening, today's slew of positive purchasing managers data from around the world helps underpin the global recovery. And while it could serve up fears of accelerating activity, the reality is that the recovery is on track and has not been derailed.

Even in Australia, where the RBA dished up the first ever hat-trick of interest rate rises, short-dated rate futures rallied as governor Stevens appeared to suggest that the monetary policy committee could relax. Inflation is now expected to be within the target range of between 2-3% following what he described as material adjustments to monetary policy.

Equity prices were fuelled overnight by comments from the gulf state of Dubai, where officials reported that half of its loans were stable. Elsewhere further Japanese intervention aimed at stabilizing the currency, falling prices and consumption highlighted the ongoing need to maintain low global interest rates.

Eurodollar futures are inching higher even though the equity market has already added more than 1% in early trading. The softer tone to  implied Eurodollar yields comes ahead of the key ISM manufacturing gauge, which is due to evidence continued manufacturing expansion for the fourth month. March t-notes are lower by 6/32 ahead of the 10am data and carry a yield of 3.23%. 

Both European and British interest rate futures curve are higher in price despite modestly positive data. For Britain it was another positive reading on house prices from the Nationwide housing lender that boosted the fortunes of the pound, while helping to lift the yield on the 10-year government gilt. March gilts are lower by 21 ticks at 118.27 carrying a yield of 3.55%. German bunds fell in price sending yields up by two basis points to 3.17% after German unemployment declined unexpectedly in November while retail sales data pointed to the first rise in trade in three months. Euribor prices are rebounding from losses over the past couple of weeks following comments from ECB officials addressing how it can possibly start the process of weaning the money market off emergency liquidity measures.

Australian rate futures rose and the yield curve flattened out quite noticeably following the RBA's move to 3.75%. The December/March 2010 spread narrowed by 10 basis points as cash prices rose while expectations for further rate increases were lessened across the curve. The yield at the December contract rose to 4.09% while that on the March contract slipped to 4.39% leaving the spread between the two at just 30 basis points. The distance between the two has narrowed from 54 basis points at the time of the last RBA meeting in November as the market factors out more tightening.

90-day bill futures advanced further along the curve with the September expiration declining by 10 basis points to 4.91%. The market is currently expecting the RBA to finish its rate-rising mission by late next summer and currently projects a further 1% on top of the 0.75% put in place. Local mining companies including mining behemoth BHP Billiton have openly stated their surprise at the pace of growth emanating from China, which represents Australia's largest export market. Key to the path of future rate expectations is how inflation pans out in the coming quarters. With the RBA stating that the status quo is currently enough to achieve inflation within its target range, it makes me wonder what magnitude of deterioration is necessary to deliver a further 1% monetary tightening.

If the Australian dollar continues to benefit from carry plays as investors seek out heartier amounts of risk-taking, the impact of a stronger currency could downplay inflationary pressures causing the RBA to balk at further rate rises.

10-year Canadian bond prices fell 18 ticks to yield 3.22% while 90-day bills of acceptance (BA's) stood still. The money market currently implies a 3-month cash rate of 0.5% by mid-June 2010.

Andrew Wilkinson