Friday December 11, 2009

Global interest rates are stuck in a rut it would seem. At the end of a week that saw investors lunge into fixed income investments on account of rising fears of sovereign defaults coming soon to a government near you, a further reading of the health of the tenacious American consumer is helping to peel another layer of support off the 'eternally low' interest rate argument.

Yields at the U.S. 10-year have risen to 3.54% following a 1.3% improvement for retail sales during November. Rates have now entered territory unseen in at least a month. Indeed, despite the trials and tribulations of growth fears, a potential Dubai-bust and fears for sovereign downgrades across the Eurozone, bond yields have turned tail and reversed from a low at 3.16% just two weeks ago.

Interest rate futures began to see losses as a result of very positive economic data emerge from China (see our Daily FX View for more color).

Eurodollar futures responded poorly to the November retail sales report and have sold off increasingly at further durations. The December 2010 contract slipped four basis points to yield 1.24%. The two-year note, which slipped to yield close to 0.6% as Dubai's finances were exposed, rose a further three basis points on Friday to yield 0.8%. The gradient of the 2s/10s yield curve is pressing closer towards its May high of 276 basis points. Today it stands at 271 basis points. March t-notes are down around a half-point at 117-24. Reuters/University of Michigan consumer confidence is due at 10amET.

European short futures - At 122.74 the March German bund contract remains 20 ticks higher on the week, but is in danger of seeing an acceleration of selling pressures ahead of Friday's close in the event that U.S. markets deteriorate during the morning. While the weekly picture remains positive for now, the intraweek high for bunds seems a long way away now at 123.72. In the mean time yields have jumped to 3.2% today. An earlier EU report concluded that Eurozone monetary and fiscal policy should remain stimulus until signs of a recovery emerge. The report failed to stimulate euribor buyers and indeed the tone remains negative as future slip two basis points on the session.

British interest rate futures - face similar losses. While there are few fears that British rates will need to be adjusted anytime soon, the overriding theme is the negative tone set off by bullish Chinese prospects released overnight. Also the gilt market continues to find little reason to rally after a larger than forecast public sector deficit accompanied the government forecast this week. Short sterling contracts lost three basis points and the December 2010 expiration yields 1.79%.

Australian rate futures - The Aussie rate complex was hit especially hard by the surge in Chinese output and news that steel production during November was a record for Australia's largest trading partner. It sucks in much of what Australian mining companies churn out and the news that retail sales continue to increase thanks to a surge in new loans and a record pace of money supply expansion. Overall the data concludes that there is no near-term respite due for Australian growth. While this is good news, investors in the money market can see the writing on the wall and fear more action from the Reserve Bank if it feels the need to artificially cool the economy through more interest rate increases. The December 2010 contract shed a further 12 basis points to yield 5.46%. On Tuesday, as sovereign debt woes resurfaced the yield on this contract slipped to 5.19% just to show you the magnitude of recent selling pressures.

Canada's 90-day BA's continue to edge lower. The rise in new home prices of 0.3% for October is hardly a market-mover and the Canadian complex continues to drift lower in sympathy with Eurodollars, impacted by strengthening consumer spending. The March 10-year government bond future is lower by 35 ticks to 119.92 and yields 3.38%.

Andrew Wilkinson

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