The words of Fed chairman, Ben Bernanke caused a seismic shift in the yield curve on Monday, driving the yield on the 10-year to its lowest level in five weeks at 3.33%. The reiteration of the 'extended period of monetary easing' was enough to spark contract highs across the Eurodollar complex with the 2010 strip advancing by around 10 basis points. In Tuesday's early action there is some profit-taking ahead of the release of industrial production this morning.
Eurodollar futures along with treasury prices are weaker in prices today after Monday's surge. The 10-year note is down around 6/32 pushing the yield to 3.35%. The reiteration of the extended period continues to capture the attention of money-markets traders who can't see visible signs of price pressures across the medium-term price horizon. The December t-note future at 119-15 is now within half a point of a contract high set at the start of October. At that time the spread between the December 2009 and December 2010 contracts stood at 127 basis points, while today the flattening tendency of the yield curve has forced the same spread to 99 basis points. This underlines the ongoing belief in the duration of low inflation, while it also reflects the lack of anticipated action on behalf of the Fed.
British gilt prices continued to rise even after data showed the first rise in eight months for the year-over-year increase in the consumer price index, which came in at 1.5% rather than 1.4%. Last week the Bank of England predicted that if it followed the path of predicted market rates, inflation would remain beneath the 2% central rate as far out as three years. Today's report does little to change that view and since the report short sterling prices are ultimately little changed at the front end. The March contract for example indicates a yield of 0.76% compared to a closing yield the day before the quarterly report of 0.78%. Today, however, looking at the deferred contracts, which have rallied six basis points, you can clearly see the reduction in inflation expectations filtering out. The March 2011 contract has fallen in yield terms by 20 basis points to stand at 2.5% during the same time frame.
Comments from MPC member, Andrew Sentence today also fuelled speculation that the economy might get more of a boost from future quantitative easing given the need of the Bank to remain open-minded on the matter. However, he also referred to the potential risks to inflation inherent in failing to deal with a timely removal of stimulus measures.
European interest rate futures were marginally lower in price on Tuesday with little data to trade off. The yield on the 10-year German bund future at 3.32% remained near to its lowest since September. Yield traders were likely still trading with an ongoing bias of low inflationary pressures tempered by modest growth. IMF chief, Dominique Strauss Kahn today referred to a sluggish global economic recovery, while comments from Finnish ECB member, Erkki Liikanen on Monday discussed the global economic recovery in the context of the long shadow cast by rising European joblessness. The three-month March euribor contract trading on LIFFE is down a shade at 99.20 indicating a cash rate of 0.8%.
Australian rate futures were jolted to life following the release of the minutes of the latest RBA meeting at which rates were lifted by one-quarter percent. Futures contracts on 90-day bills jumped in price by around 10 basis points across the curve reflecting the dovish tone. The reduction in investors' expectations for more tightening from the RBA is reflected in a fall in the probability of a rate hike at the start of December from 82% to 62%. The minutes reveal the frame of mind within which the RBA decided to raise rates. If economic conditions evolved as expected, further gradual adjustment in the cash rate would most likely be appropriate over time, officials said.
What stoked the rally in 90-day bills is the reference to the pace of future tightening set against the backdrop of rates already at too low a level versus the drawdown of government stimulus measures. Investors were quick to seize the moment and the June 2010 90-day bill dropped seven basis points in yield to 5.04%. However, what traders may be missing here is a valuable piece of the jigsaw puzzle. The meeting was ahead of the October employment report in which employers added 24,500 jobs at a time when companies were expected to reduce workers by a further 10,000. This new evidence maybe enough to swing the pendulum in favor of a rate rise at the December meeting.
Canadian bills of acceptance (BA's) are taking the tone from Eurodollar futures this morning and are marginally higher in yield. The June BA future is trading at a yield of 0.68% (up 2 basis points) and compares to a yield in the September expiration of 1.13%. This will be an interesting spread to watch considering the prevailing stance from the Bank of Canada when they stated earlier this year that monetary policy was likely on hold through the second quarter of 2010.
Senior Market Analyst