Some of the recent enthusiasm for global short-end futures was undone midweek as equity markets underwent a strong rebound. Yet the fall in government bond prices was only a mild one where yield remained depressed with a gloomier bigger picture in which investors are itching to hear the shape of government and central bank response.

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Eurodollar futures - The benchmark 10-year government bond yield added six basis points as equity indices staged a 3% response to Tuesday's near-5% slide. Economic data was mixed with first-time initial claims through last weekend rising by 395,000 suggesting the labor market hasn't yet weakened in response to the latest crisis of investor confidence. On the other hand a widening of the trade deficit in June suggested that overseas buyers were uninspired by a softer dollar that month with U.S. exports facing a malaise. Imports fell, on account of a declining energy bill but by less than the drop-off in exports, forcing the deficit to widen unexpectedly to $53.1 billion. The dramatic recent slump in the U.S. yield curve changed little except for a minor parallel price shift lower across the Eurodollar complex by around five basis points. The September treasury note future had the opportunity earlier to test overhead resistance as equity index futures slumped. However, the slide ran out of steam and bonds reversed course leaving the contract close to session lows where it recently traded at 122-18. A half-point loss on the day lifted its yield to 2.20%.

European bond markets - French stock prices swung from a gain to a loss on renewed banking sector fears before the Elysees palace announced that President Sarkozy would meet with German Chancellor Merkel to discuss recent financial market follies. That seemed to change the tone, perhaps because the meeting is not imminent but rather will take place after the weekend and presumably when markets may have calmed. While most economic releases might have been overlooked in this headline-driven environment, German bund fell by 80 ticks with the September contract trading at 133.32 as its yield jumped by 12 pips to 2.31%. The calmer tone to equity prices also alleviated pressure on peripheral nations' debt prices. Italian and Spanish bond rose causing a narrowing relative to safer German debt.

British gilts - The narrow distance of just seven basis points stands between the soon-to-expire September short sterling future and that expiring in 19 months in March 2013. Such a narrowing has indeed been seen before when Lehman Brothers collapsed and markets accurately predicted recession. At the time the Bank of England was actively lowering its short-rate - a luxury it doesn't have today. Out of interest the spread traded at 179 basis points as recently as six months ago. Today's gradient of one-sixteenth a percentage point represents an extremely flat curve that has been dragged down under the dawning realization that the Fed will maintain zero interest rates for that long. Meanwhile the fiscally austere budget measures in Britain are already delivering sledgehammer blows to forward forecasts for Britain's GDP. Coming off a huge upwards move on Tuesday, short sterling futures have given back around 10-basis points along the strip. Gilt futures also pared recent gains with the September future losing 28-ticks to 128.67 adding just four basis points to the yield of 2.51%.

Japanese bonds - A relatively buoyant performance across the Nikkei 225 stock index meant that bond dealers responded little to its fall as they kept a watchful eye on the value of the yen. The rising yen harms exporters' earnings and its continued strengthening is likely to usher a further wave of Bank of Japan intervention. There is a reluctance to dampen yields further below a level of 1% where they closed midweek.

Australian bills -A dour employment report accelerated buyers' appetite for 10-year government paper shaving four basis points off its yield to 4.42% and sinking it to 33 pips below the central bank's official short rate. Investment banker Goldman Sachs reversed course after the report and now predicts two official quarter-point reductions from the Reserve Bank before year-end. Employers shed around 22,000 full-time positions while part-time positions of about the same order were created leaving the net number unchanged and less than the expected creation of 10,000 jobs in July. The rise in the rate of unemployment to 5.2% was the first since October 2010. Bill prices in Sydney jumped to imply around 1% off rates within 12-months.

Canadian bills - Bill prices slipped taking a negative tone from the performance of Eurodollars and fared a rise in implied yields of about four basis points. Housing price data for June was roughly in line with forecasts, rising by 0.3% on the month and standing 2.1% higher than a year ago. Government bond futures fell by a half point to 131.40 to yield 2.36% and maintaining a premium to U.S. treasuries of 16 basis points.

Andrew Wilkinson

Senior Market Analyst       

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