Bonds are once again in the firing line as the need for safe haven is melting in response to the heat felt from glowing equity markets where investors have returned benchmark indices to two-year highs. Continued expansion across global manufacturing also argues against maintaining ultra-low or as some would say excessively loose monetary policy. Bond futures in some cases have fallen to the weakest in two weeks as the combination of healthier activity and growing inflation concerns weighs on fixed income prices. 


Eurodollar futures - Treasury futures were lower ahead of an ISM manufacturing report expected to confirm growth within the sector and highlight rising cost pressures. The March contract slid by a half point to 120-09 sending yields seven pips higher to 3.43%. Deferred Eurodollar contracts joined in the bearish mood surrounding global interest rates as implied yields added a further none basis points as the curve continued its steepening process. The one-year September 2011/September 2012 eurodollar calendar spread for example widened by five basis points as investors concentrate rate rising expectations for next year rather than this.  

Canadian bills - Investors sold short-dated bill prices in sympathy with losses to other short-ends on Tuesday. With a quiet economic report card until the employment report on Friday, the Canadian credit market remains slave to the fortunes of eth Eurodollar market. The spread between Canadian and U.S. yields widened a little as the 10-year Canadian government bond slipped a little less than its Washington-issued counterpart. The March future dipped by 46 ticks to 120.80 to yield 3.32%.    

British gilts - An advisor to the Bank of England sent shivers through the short sterling interest rate futures complex today when they warned in a report that the policy mix was topsy-turvy and that as a result interest rates will end the year at 1.25%. The message sent implied yields surging by around 12 basis points given the fact that the National Institute for Economic and Social Research warned that the central bank will now need to take remedial steps to prevent inflation from becoming entrenched. And of course it's an easy sell. Already the European credit markets are fretting over the potential for rising inflation and the Bank itself admits that temporary food and energy pressures will perhaps lift the near-term pace of inflation to 5% this year before easing. In a sense it's an easy sell for the NIESR to spook the markets but it does appear that Governor King's mind is made up. The only catalyst for change would be if companies conceded to inflation-busting wage demands in which case the Bank would exercise its right to change its mind. March gilts slid by 62 ticks to 116.71 lifting yields to 3.72%.

European bond markets - Three month Euribor rose to its highest since July 2009 as bank-to-bank lending costs increased. A firm set of economic reports provided a downbeat tone to credit markets with three-month contracts falling by three basis points on a deepening of inflation concerned. The March German bund shed 78 ticks to 122.96 for a two-week low sending its yield up seven basis points to 3.22% after unemployment in the core Eurozone nation fell to an 18-year low at 7.4%. Inflation concerned were fanned by an acceleration in the pace of manufacturing expansion across several nations coinciding with a lower-perceived need for the safety of government bonds on reports that EU leaders were making progress in overhauling rules surrounding the use of the European stability fund. 

Japanese bonds - A rebound for regional stocks including a 0.5% increase in the MSCI Asia Pacific index inspired sellers of government bonds. The March JGB future shed 32 ticks to close at 139.70 yielding 1.33%.

Australian bills - An upbeat RBA said it would look through aberrations to trend growth and inflation caused by recent flooding events. It maintained a bullish outlook on economic affairs outside Australia leaving investors marginally more concerned that it had not yet finished with pulling its monetary levers. Bill prices slipped to reflect firmer yields across time with losses of around six basis points. Bond futures fell sending yields seven pips higher following the meeting to 5.56%.

Andrew Wilkinson                                                                    

Senior Market Analyst