Tuesday February 9, 2010

You can almost hear an audible sigh of relief echoing around risk managers' desks and that tone is reflected by a positive market sentiment on hopes for a solution to the fiscal problems facing the government of Greece. Given the far more favorable tone to both equity and commodity prices on Tuesday, it seems that something is out of whack since bond prices have failed to decline. Yields have remained relatively unmoved, adding just a couple of basis points. That begs the question as to whether investors are expecting little more than a relief rally. Why sell bonds for more than a couple of sessions at most? Short term interest rate futures around the globe are just about flat to higher arguing in the face of the rally in risk appetite.


Eurodollar futures -With a 1.1% opening gain for the stock market reversing Monday's unexpected losses, one might be forgiven for expecting a big down day for notes and Eurodollar futures. However, that's far from the truth and the December expiration implied yield remains below 1% indicating the likelihood of tighter monetary policy this year remains extremely limited. As such markets are coming round to accepting slower growth and a departure from easier quantitative policies, not necessarily because fixed income investors have crunched the permutations, but because they are accepting that economic growth will remain slow on the other side of recession.

Treasury notes reached a knee-jerk low on higher pre-market equities at 118-10, but have since come back to an astounding two tick intraday loss where the 10-year yield stands at 3.60%. In addition the market today faces the auction of $40 billion in three-year notes, also offering the potential to see yields back up. Yet it simply isn't happening.

European short futures - There is an easier tone to the cash market as some of the recent stresses and strains are relived today by better prospects for peripheral Eurozone nations. Short end euribor contracts are higher by a couple of basis points. I noted last week some flattening of the curve as cash market pressures forced selling of nearby contracts lower. That pressure has unwound somewhat today on the story that ECB President Trichet quit a central bankers' coven in Sydney in order to arrive at a hastily convened EU meeting in Brussels to discuss Eurozone's most busted economies. As it turns out the market's detective work is a little flawed and the meeting has been on the agenda for a month already. Still, the market continues to live by the caveat that where there's smoke, there's fire. Hopes for some kind of package, aid or resolution for Greek public finances has lifted confidence in plundered debt prices across the belt of Europe's endangered periphery.

The recent escalation of selling that drove the price of Greek two-year notes into the ground has abated. Record costs to buy insurance against the default of Portuguese and Spanish government debt have stopped rising. The yield on the 10-year Greek bond eased eight basis points today to 6.68% while the spread over comparable bund yields narrowed to 354 basis points, having exceeded 400 last week.

British interest rate futures - British debt prices continued to underperform peer benchmarks. The March gilt futures contract is lower by 16 ticks at 115.30 where the yield has risen to 3.97%. Trade data revealed concerns over growth as the deficit grew again in December and showed that a weaker currency was not leading to a flood of orders for British goods and services. Short sterling is virtually flat while the FTSE100 has risen by 0.4%.

Australian rate futures -A warning by the RBA governor Glenn Stevens that falsely depressing interest rates ran the risk of creating asset bubbles had interest rate markets on the back foot on Tuesday. Interest rate bulls had recently feasted on 90-day bill contracts after the RBA kept rates unchanged earlier in the month. Now, a reversal in stock market losses in China and words of wisdom from Mr. Stevens leaves traders with a little indigestion. Bill prices slipped about four basis points on Tuesday while a further flattening in the yield was apparent with the 10 year bond losing three basis points in yield at 5.37%.

Canada's 90-day BA's - Yields of the 10-year Canadian government bond added a single basis point in light of a rally for gold, crude oil and other national treasures that helped also lift the value of the local dollar. Bills are slightly higher in price with yields one or two basis points lower.

Japan - The Nikkei fell to a two-month closing low although an optimistic Finance Minister Kan deflected blame saying that it was not a weakening Japanese economy driving down stocks. Rather the problems were those of foreigners especially those faced by European governments.

Bond markets responded to weakness in stocks and tales of woe from abroad by rallying after a highly successful auction of ¥600 billion in 30-year government bonds. Almost four buyers turned up to purchase each bond at auction, which is the best turnout since June last year. Bond traders seem to be warming to a message that bonds represent an appealing alternative to other available asset classes given the fact that equity markets keep running repeatedly into the same old brick wall.

Andrew Wilkinson