Global yields plunged again on Tuesday in response to evidence of lackluster global growth as traders used the excuse of spending cuts agreed within the move to extend the debt ceiling for the U.S. as reason to expect further economic contraction. The coincident signs of economic headwinds were served up on Monday in the shape of manufacturing surveys showing the challenge to factory owners. We'll learn more about the service sector throughout the remainder of the trading week and ahead of critical employment reports in the both the U.S. and Canada. It's also central bank week although few have room for further policy easing, with some observers considering whether some might have been too swift to act by tightening policy already.

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Australian bills - Money traders were shocked by the RBA's sensitivity to growth prospects outside of the nation following its decision to leave its policy settings unchanged for an eighth-straight meeting. Implied yields slid by around 33 basis points at all expirations beyond March next year while that on the nearby December futures contract slid by 28 basis points. The Bank has to an extent wrong-footed the cash market by continually sounding tough over the threat of inflation and has repeatedly threatened to tighten policy. Its caveat has for long enough, however, been the threat to external growth from a slowing global economy. The reaction in the bill market was sizeable but was accompanied for the first time in more than two years by a slump in the 10-year benchmark government bond yield beneath its 4.75% short-term policy setting. Traders can no longer envisage a policy tightening over the remainder of the year with cash markets responding further by predicting the potential for a policy easing should global conditions continue to weaken.

British gilts - U.K. government gilts have so far this year delivered better gains than either U.S. treasuries or German bunds. British yields have tumbled as investors recognized just how slow the economy was inching in light of a radical approach to a fiscal shortfall. Earlier in the week the CBI pared its forecast for 2011 growth to 1.3% while raising the question over where it expects next year's 2.2% projection to stem from. The pattern of trading across the short sterling futures strip was similar to that in the Eurodollar market where nearby expirations saw implied yields rise at the margin while those on deferred maturities eased as tensions grew across peripheral areas of the continent. The 10-year government yield eased to a record low at 2.76% as gilt prices peaked during the day.

Eurodollar futures -Yields across the government debt curve slid to the lowest in nine-months as fears over a slowdown in the world's leading economy were accelerated as investors mulled the recent agreement over raising the debt-ceiling. The height of fear was exemplified by the flattest reading of the yield curve since November with the gradient at the two-to-10-year curve falling to 234 basis points. But signs of growing tensions in European debt markets weighed on the Eurodollar futures curve where contracts fell sending implied yields higher at maturities as far forward as 16-months. Adding fuel to the fire on Tuesday was a Commerce Department report showing a decline in consumption by shoppers in June where spending unexpectedly fell by 0.2%. Income rose at just half the expected pace at a 0.1% clip with consumers adding to existing savings rather than choosing to spend. The September treasury note futures contract pared an earlier 20-tick gain to a session high at 126-13 after the data but remains higher on the session at 126-12 where the cash yields reads 2.70%.

European bond markets - Fresh tensions returned to haunt European bond markets. The lackluster growth outlook was served up no favors by the news of $2.4 trillion in spending cuts over a decade as fears circulated that recent signs of slowing growth would ripple further around the world. Euribor futures rose as the yield curve flattened with few investors indicating that the ECB would be in any mood to further restrict monetary policy when it meets on Thursday. Looking at euribor contracts makes you think that a bull market is already well underway with implied yields continuing to slide. September German bund futures remain half a point firmer at 131.67 having earlier made gains of 82 ticks on the day. The 10-year German benchmark was pressured lower to 2.42% after an EU report from the Luxembourg statistical office showed a slowdown in producer price inflation to an annual pace of 5.9% in June. Italian and Spanish yields surged again adding 12 basis points to the level of benchmark yields. Both nations issue shorter-dated bonds later this week. Italian yields rose to the highest since 1997 as investors bet that the European debt crisis remains unresolved.

Japanese bonds - A Nikkei newspaper report implies further monetary easing at this week's Bank of Japan meeting and predicts expansion of the Bank's asset purchase plan. With the bull market for interest rates fostering further support from a global slowdown bond yields in Japan also slumped to the lowest in nine-months. September JGB futures added a solid 42-ticks on the day to send the 10-year yield lower the least since November at 1.038%.

Canadian bills - Bill prices are much firmer as Canadian investors return from a holiday weekend. Deferred maturities rose sending implied yields at expirations more than one-year forward lower at a double-digit clip. Preying on sentiment today is the growing fear that the debt resolution in Washington containing $2.4 trillion in spending cuts over the next decade adds to an existing slowdown. Government bond futures surged by a full point sending the 10-year yield lower to %

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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