Bonds Fizzle As European Crisis Stalls

U.S. data released Thursday failed to develop the argument that the Fed will ease further, while a successful auction of Italian government debt found buyers albeit at the costliest price in three years. Some of investors’ earlier fears have evaporated as quickly as they built leaving fixed income buyers perhaps a little overweight having spent a week feasting on safe haven bonds.

Eurodollar futures – Initial claims dropped to 405,000 through last weekend while the reading from the prior week was revised higher by about the size of today’s drop. Retail sales data pointed to the slimmest of gains during June but the report beat estimates of a dip in sales. September treasury futures lost some steam following the latest round-up of economic data because none of it supported a further wave of monetary easing at this point leaving yields to drift marginally higher to 2.92%. Eurodollar futures trading was mixed with contracts expiring through March 2013 making slim price gains while deferred contracts lost ground as the yield curve steepened.

European bond markets – Fitch ratings agency slashed its view of Greece by three notches to CCC saying that the chance of a default was now quite realistic. Italy auctioned bonds maturing between five and 15 years although the yield on its shortest maturity rose to its highest since 2008 in order to attract willing buyers. Yields on Spanish and Italian bonds rose early on as investors sold before loss ameliorated. Irish bonds staged a reversal with yields recovering from an early spike. Eurozone CPI for June came in pretty much as expected at an unchanged monthly reading leaving the year-on-year pace of increase standing at 2.7% Core prices edged higher to 1.6%. German yields fell earlier as fears that over contagion but currently rest at an unchanged 2.74% at the 10-year.  

British gilts – Short sterling futures edged several pips higher as the British pound rose, supported for demand for gilts. With no economic data to report on Thursday investors leaned on the yield curve pushing implied yields lower favoring domestic assets rather than any of the troublesome European peripherals. By mid-afternoon trading the market had lost its luster with short-dated futures back to unchanged while September gilts maintained a mild daily gain to 122.92. The benchmark yield eased to 3.10%.

Canadian bills –Canadian bill futures are mixed with larger declines in implied yields appearing along the curve as investors flatten the curve. Today’s U.S. raft of data failed to spark any imagination among traders and offered precious few clues as to where the Bank of Canada would move next. The September government bond futures continued to underperform U.S. treasuries as investors forced 10-year yields in Canada above those in the U.S. Canada’s debt now trades at a two basis point premium to U.S. treasuries.

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Japanese bonds – Despite slightly alleviated fears in the Eurozone surrounding the sovereign debt crisis, there was no let-up domestically for Japanese bonds. Investors continued to seek the safety of government debt as equity prices stumbled and the yen headed higher crimping recent signs of economic recovery. A five-year auction of paper by the government met with the strongest demand in three months with a bid-to-cover ratio of 3.5-times. The five-year yield fell to 0.375 to its lowest this year. September JGB futures closed almost at the session high at 141.75 as the 10-year yield dipped to 1.068%.    

Australian bills – The Aussie yield curve continues to retain an easing bias on global growth fears. Implied yields rose by three basis points but not before earlier contract gains moved yields to multi-year lows. Futures continue to build a head of steam after reaching contract highs earlier in the week. Compared to the RBA’s 4.75% benchmark short rate, the implied yield on the March 2012 expiration at one point on Thursday reached as low as 1.58%. Meanwhile demand for Aussie government bonds grew sending yields lower to 4.96%.

Andrew Wilkinson

Senior Market Analyst

ibanalyst@interactivebrokers.com