Peripheral Yields Lowered as ECB Meeting Looms

on September 05 2012 3:56 AM

Peripheral European yields slipped yesterday amid expectations of ECB's bond purchases. Stocks fluctuated between gains and losses with the DJIA and S&P 500 Indices dropping -0.42% and -0.12% respectively. Disappointing ISM manufacturing index countered optimism of potential easing measures. In the commodity sector, crude slumped with WTI and Brent crude contracts losing -1.21% and -1.38% respectively, erasing the gains made in the previous day amid concerns over economic growth. Gold remained resilient, breaking above 1700 at one point before ending the day at 1696.0, up +0.50%.

Investors were thrilled after ECB President Draghi's comments made before the European Parliament that the central bank would be comfortable to buy bonds of maturity up to 3 years. Spanish and Italian bonds rallied, sending the yields lower, although the steepest declines occurred in the short ends of the curves. Italian 2-year bond yields dropped -26 bps to 2.37% while 10-year bond yields slipped -10 bps to 5.67%. In Spain, 2-year bond yields plunged -44 bps to 3.07% while 10-year yields fell -28 bps to 6.57%. Other European officials also indicated confidence over the outlook. For instance, French President Hollande stated that the EU leaders' summit on October 18/19 would "find solutions" for Greece and Spain.

In the US, the ISM manufacturing index declined to 49.6 for August from July in 49.8. Missing market expectations of 50, the data signaled that manufacturing activities in the US has fallen into the contractionary territory for a third month. Construction spending contracted -0.9% m/m in July after gaining +0.4% in the prior month. Focus of today would be the BOC meeting but nothing new is expected from the central bank. The BOC would likely leave the policy rate unchanged at 1%. In contrast with other major central banks, the BOC would continue to hint that monetary tightening (instead of easing) might follow should economic developments justify.

Although the yellow metal has stayed firm in recent trading sessions, lack of follow through by Fed and/or ECB easing would trigger a reversal. Indeed, the physical demand would hardly sustain the recent uptrend. India may raise an import duty for a 3rd time this year to reduce its current account deficit which is at record high. An increase in tax would expect to curb gold purchases which have already been negatively affected by weak rupee and bad harvest in the country.

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