Bond yields fell following the resignation of Bundesbanker Juergen Stark as the ECB's chief economist. He will leave at the end of the year and although personal reasons were cited, one familiar source said that he had disagreed with the ECB's bond purchase program. European share prices extended losses as the divisions between lawmakers and central bankers claims its first victim. Global risks are rising as are the tensions. On any other day a U.S. Presidential address delivering a $447 billion stimulus that could shave 1% off the unemployment rate and boost 2012 growth by 2% might have weighed heavily on treasury yields. Yet the government's need to act is borne out of the same crisis that has investors worried over the dangers lurking within the Eurozone once again on Friday. The financial crisis has left the world's major economies crippled by a debt hangover of monolithic proportion. The President's speech ought to motivate pig-headed politicians to join forces although that debate remains a significant risk to the economy. The limited losses facing treasuries have gradually worn away as Wall Street opens sharply lower on contagion fears and omnipresent worries about the state of global growth.

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Eurodollar futures -December treasury note futures shook off an earlier loss to rise to 130-22 driving the yield four basis points lower to 1.94% and within four basis points of last week's all-time low for the 10-year yield. The proposed package laid at the door of Congress could be worth 1% more for 2012 GDP according to Moody's Analytics Inc. with the proposed extension of unemployment benefits and payroll tax cuts. From the supply side the President promised that the cost would come from future spending cuts, which shouldn't trip the treasury market up at all. But with the rate of unemployment stuck at over 9% the impact of the measure would not deliver a rate that would shake the Fed from its promise of maintaining short-term interest rates at practically zero. In order to shift monetary policy from its torpor the Fed has stated that the level of joblessness would have to fall to between 7% - 7.5%. And while the package doesn't guarantee that kind of impetus to growth, as the President said this is the right thing to do right now.

European bond markets - The core-peripheral strains are once again showing within European bond markets as German yields carry Dutch and Finnish bonds higher while exerting upside pressure to Greek, Italian and Spanish yields. Thursday's admission from the ECB that growth potential has diminished allowed the German yield curve between the two-10-year range to slip to a further record low in response. ECB Chief Trichet noted that growth this year would be 1.6% and not 1.9% while output next year was also shaved by four-tenths to 1.3%. Dealers have grown suspicious that the central bank's two earlier rate increases won't last under the stress and have advanced euribor futures to reflect a change of heart. Six weeks ago short-dated markets implied a rate increase of a third quarter-point advance in the central bank's policy rate. Today the implied move is for a reduction of 35 basis points. For now the ECB maintained that the inflation risks were still present, but one suspects that it's purely a matter of time before they stand up to be counted. German 10-year bunds surged by 112 ticks Friday as the benchmark yield slid by seven basis points. Italian and Spanish bond yields jumped by 12 basis points as spreads widened and the dull toothache of the sovereign debt crisis wore on.


British gilts - Gilt prices ignored a producer price gauge that kept factory output costs close to the highest in two years. The market chose to follow its gut instincts recognizing instead the clear rise in risk aversion. Core output prices rose by 0.2% during August lifting the annual pace of growth to 3.6%. The raw measure rose by 0.1% leaving costs 6.1% higher over the course of the year. The shorter-end of the yield curve implies sub-1% three-month yields between now and March 2013 as the curve stays extremely flat. The yield on the 10-year benchmark gilt futures contract expiring in December fell by seven basis points as the contract advanced by more than a full-point to 129.81.


Australian bills - The Aussie short-end has given up hopes of a sizeable monetary easing yet remains optimistic that the Reserve bank will ultimately cut policy at least twice over the next 12 months. A second month of net job losses revealed on Thursday stemmed some of the waning optimism with the short-end of the market now steady at about 4% compared to a current short rate setting at 4.75%. Government bonds advanced leaving yields lower by two basis points at the 10-year maturity at 4.20%.


Canadian bills - Government bonds jumped lowering the 10-year yield to 2.15% following an increase in the number of job losses during August. Gains in health care and social assistance positions were outweighed by losses across contraction and natural resource companies causing the national unemployment rate to rise to 7.3%. Bill futures jumped by eight basis points with yields through March 2013 all pointing to a sub-1% three month rate with the market pricing in an official rate reduction in the fall months.

Andrew Wilkinson

Senior Market Analyst       

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