There was a muted response to the third-straight reading of contraction amongst manufacturers across the Empire State. While the dollar's slide was notable, there was little left for the treasury market to do other than unwind a slim loss. Bond dealers are likely going to have to accept smaller daily ranges and perhaps lower volatility after the Federal Reserve outlawed discussion of tighter monetary policy at last week's meeting. And that means that with permanently low yields a fixation of the bond markets, price-moving data is likely to be harder to come by.


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Eurodollar futures - The September treasury note future was trading down by just one tick at 129-27 on Monday as investors mulled over the impact of the New York Fed's latest reading of factory activity across Southern Connecticut, New Jersey and the New York areas. The reading was expected to return from two monthly readings depicting economic slowdown to back above the zero line separating expansion from a contraction. The report barely managed to erase an earlier loss, but who can blame dealers following a week in which the yield on the 10-year benchmark slumped by 30 basis points? Drumming up an appetite to buy is likely to prove hard work unless materially weaker data transpires, and of course a soothing jump in benchmark equity indices doesn't argue for lower yields at this point. Eurodollar futures are higher at the front end of the curve as liquidity concerns wear thin, while longer-dated contracts are a pip lower. The 10-year note currently yields 2.265%.

European bond markets - Hopes for containment of the debt crisis are unusually high ahead of Tuesday's Merkel-Sarkozy summit. EU monetary affairs commissioner Olli Rehn told reporters over the weekend that he doesn't expect that some of the Eurozone's larger nations will need additional borrowings because they have taken the necessary steps to rein in wayward budget deficits and spur growth. Recent market dislocation would appear to disagree with part two of his outlook and you can ask the British audience how they feel about the impact of fiscal austerity on growth. German yields marked time ahead of the meeting remaining at 2.328% while the more settled tone saw sellers hit the euribor strip for a good eight basis points.

British gilts - Short sterling futures dipped by three basis points along the curve in a sign of how tired the market is following a strong advance for the most part of last week. Chancellor Osborne told politicians last week at an emergency sitting of parliament that "the recovery will take longer and be harder than had been hoped." It seems that the austerity measures have taken a deeper hold on business and consumer sentiment than was hoped with growth forecasts for 2011 now lagging those of leading nations. House prices fell across the nation according to the latest reading from Rightmove Plc. The drop in asking prices of 3.4% across London homes was greater than in other cities and is a sign that recession is once again nipping at the heels of the economy. Gilt yields are unchanged at 2.53% having reached record lows last week.

Japanese bonds - All eyes remain on the value of the yen, especially those of Finance Minister Noda, who told a talk-show host over the weekend that he was prepared to make bold moves against the still-strong yen. Despite a sustained period of yen strength the Japanese economy shrank far less than economists had predicted in the three months ending June. GDP shrank 0.3% between quarters and by 1.3% on an annualized basis. Still, yields remained stuck at 1% to start the week with most economists forecasting an improvement in the current quarter, but insufficient to send yields climbing just yet.

Australian bills - Aussie government bonds fell sharply on Monday sending the yield on the benchmark 10-year yield nine basis points higher to 4.53%. The steadier start to Asian trading during the week helped confront arguments over an imminent rate reduction at the Reserve Bank. While many economists have recently jumped ship in the expectation that the central bank will act, not all are expecting lower interest rates. The soothing sight of rising equity prices helped weaken the argument for lower rates. So too did a July report showing an 8.6% improvement in new motor vehicle sales. For the year, sales improved by 0.9%. Aussie short-dated bill futures fell by 15 basis points tempering dealers' expectations over the magnitude of any monetary easing.

Canadian bills - Bill prices fell by six pips on Monday while the yield on 10-year government bonds was unchanged at 2.46%. Money market prices in Canada shadowed the fortunes of those in the U.S. with shorter-dated yields backing up a little despite a poor showing from the New York Fed's Empire State manufacturing report.

Andrew Wilkinson

Senior Market Analyst       

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