Apart from giving the euro a slap in the face (see our earlier FX commentary) Jean Claude Trichet's remarks about wrapping up the cheap loans awarded to the European banking system a year ago tempered the recent rally in European interest rate futures this morning. One has to be careful where to go with the hawkish comments, which we acknowledge are not new and simply underscore what we already knew about what the ECB would do when loans are coming due in December. Previously the ECB has pulled a line from the Loony Toons cartoons and basically said, That's all folks!

The firmly hawkish stance from Mr. Trichet lays the possibility of inflation as reason for withdrawing the exceptional stimulus measures. Still he also probably correctly points out that such lending practices to the private sector should be withdrawn promptly lest it becomes over reliant on the powers of the lender of the last resort. And we all know what moral hazards that can bring.

Mr. Trichet's message couldn't have come at a worse time for investors who suspect that the global economic recovery is starting to wane. However, from the perspective of manufacturers in the Eurozone the impact of his comments in terms of hurting the euro couldn't have been timed better. The euro slipped back to $1.48 within minutes of the comments. From the perspective of investors, however, the words represent the worst of both worlds. It appears to be a credit restriction at a harsh time, while the ECB once again appears to be frightened of its own shadows at a time when inflation isn't a problem.

As a result European interest rate futures are flowing in the opposite direction to everywhere else on Friday. The June 2010 contract for example, having put in a yield low at 1.05% on Monday is almost six basis points higher at 1.12% and is set to close down on the week compared to last Friday. We noted in Thursday's commentary that the yield spread between December 2011 expiration euribor and Eurodollars was at odds with the expected path of rates from the OECD's report on Thursday - not that they have an established track record of successfully guiding central bank policy. But it is of interest to us that this spread continues to narrow as the two contracts converge.

Eurodollar futures continue to forge higher. The December 2010 contract has added 20 basis points this week to 98.85 inferring a yield of 1.15% at the end of next year. The market continues to diminish its expectations for interest rate rises out of the Fed as the curve pushes lower at the front end. The 10-year note currently yields 3.33%, which means that the 2s10s spread is all the time being stretched higher in response to the prospect of interest rates remaining lower for longer. There has been a flood of cash looking for a parking spot at the two-year maturity pushing yields down to 0.67% leaving that spread through to 10 years at 266 basis points.

British rate futures continue to mirror U.S. markets as investors keep pushing back the ultimate day of likely monetary tightening. A survey of analysts reveals that British home prices are now expected to resume its fall during 2010. The recent respite and actual rebound in home prices was inspired by a double-prong from increased mortgage availability after the lending freeze and a lack of homes on the market. But rising unemployment into next year and the fact that so many homes are now on the market amid limited buying activity hardly bodes well for the economy at large.

U.K. real estate agent, Rightmove lists around 50% more properties for sale compared to early 2007, while national sales data is running at a 61% lower pace than at the same time. One analyst points out that prices must decline by as much as 25% more just to revert to trend. Earlier this week a report showed the first decline in asking prices in three months.

Australian rate futures did the opposite of the domestic dollar. Increasing risk aversion stepped in to thwart the notion that further interest rate rises are on the agenda from the RBA and bill futures were bid up across the curve. The reduced prospects of a move from the U.S. Federal Reserve has helped drive sentiment this week as homebuilding starts and confidence caused worries to resurface over life without stimulus. Despite stronger regional growth evident from Japan's GDP report this week, investors are beginning to sense that rising asset prices in emerging markets are better linked to hot-money flows encouraged as an offshoot of ultra-low interest rates in the United States and other leading nations.

Discussion of Asian governments perhaps adopting measures to stem such flows that they worry are distorting local markets is reaching crescendo point. So we have an input-mix here suggestive of natural and policy-made slowdown, which is taking the heat off the Australian bill curve today. 10-year government bond prices rose and the yield eased two basis points to 5.38%.

Once again it remains the back-end of the Canadian yield curve that is seeing gains as investors continue to temper expectations of any interest rate rise well into the sunset. 90-day bills of acceptance (BA's) are up six basis point at the March 2011 area, while gains taper off at nearer maturities.

Andrew Wilkinson