Tuesday Interest Rate Brief

Bond investors had emotions tugged both ways as a volatile Libyan situation drove safe-haven demand skyrocketing before hawkish commentary from an ECB member later dampened enthusiasm for government paper. Yields continue to remain towards the day’s lowest point, however, as enthusiasm for a stock market recovery becomes a distant memory.

Eurodollar futures – Yields on benchmark U.S. government debt fell to a two-week low, recovering more than 25 basis points from its highest point in 10-months. At one point on Tuesday the 10-year yield slumped to 3.49% as investors’ fears over rising geopolitical tension were fuelled by a 10% jump in the price of crude oil. Libya is Africa’s largest crude oil resource and its President Qaddafi appears to be adopting a scorched-earth policy before giving in to protesters demanding he hands over power. The March treasury note future jumped to a session high at 119-28 before sentiment was dashed by comments from a European central banker. Nevertheless the contract remains a half-point higher at 119-20 for a yield drop of five basis points on the day at 3.53%. Eurodollar futures have also pared an earlier surge but implied yields are still lower by six or so pips along the curve. Consumer confidence across the U.S. jumped to 70 and in excess of today’s expected reading to register a gain from a January reading of 60. The threat from Libyan political meltdown stems not simply from rising Middle East tension, but rather the jump in crude prices has the ability to crimp the global recovery, which is also outweighing the inflationary implications at this point in time.

European bond markets – ECB governing council member Yves Mersch warned that the central bank might be forced to adjust monetary policy as inflationary pressures stare it in the face. He noted that there was an inevitability about the need to rebalance in light of a return to the central bank’s 2% target ceiling. Discussion at the central bank must by now be pretty heated given the recent calm by its President Trichet and others who have moved to quell speculation that recent comments not be taken out of context. Mr. Trichet earlier noted that policy was set appropriately but now faces the rebuke of Mersch who says that his colleagues couldn’t be faulted for reaching his same conclusion. German bunds rose with the March contract reaching 124.36 before gains were pared to 124.10. The yield fell to 3.16% despite an advance to a four-year high in a GfK consumer confidence reading for Germany. Italian consumer confidence also rose. In contrast to falling bond yields those at the short-end of the curve rose on comments from Mr. Mersch.

British gilts – Benchmark yields in Britain fell by four basis points as Middle East tensions mounted and were provided a tailwind of a £5.3 billion net debt repayment in January as the government recorded its largest tax collection of the year. March gilts rose to 117.31 at the session high while short sterling prices gave up earlier gains and dipped slightly into the red following the hawkish European script.

Japanese bonds –Government bond prices rose despite a fresh ratings downgrade on the outlook for the nation’s debt this time by Moody’s Investor Services. Last month it was S&P who provided a similarly poor prediction for the outlook for the nations’ rising debt burden. Fixed income buyers were more prone to head for government paper on account of the slide in the region’s stock prices as the MSCI Asia Pacific index slumped by 1.8%. The March JGB future rose and also ignored the smallest monthly decline for supermarket sales as the shopping index teetered on the brink of returning to positive territory for the first time in four years. The futures contract rose by 61 pips to 139.58 sending the 10-year yield lower by five basis points to 1.26.

Canadian bills – Yields are lower in Canada in response to the impact of geopolitical risk and a dour December retail sales report, which edged to a marginal decline for the month. Investors had hoped that at worst the index would stand still. The March government bond contract moved ahead by 62 ticks to 120.45 as the investors bought Canada’s bonds to match the decline in U.S. yields. The 10-year yield recently traded at 3.40% yielding 13 basis points less than comparable U.S. debt.

Australian bills – Aussie government bond prices rose sending yields lower by six basis points to close at 5.58% as investors responded to slumping global stock markets as Libyan protesters faced the wrath of its military forces. Bill prices rose gently at the front-end and increasingly so along the strip with the March 2012 forward yield declining by five basis points. An index of consumer confidence from NAB for the fourth quarter also showed sentiment tailing off as the index slipped from none to five points.