Wednesday Interest Rate Brief

The FOMC rock-solidly defended its position in the minutes of its December meeting, absolutely standing behind its decision to see through a second wave of quantitative easing. Bond-buying hopefuls spotting the resumption of an engineered drop in the yield curve were eager to snap-up bonds on Tuesday. By midweek an ADP employment report and a loosely-linked forerunner to the big non-farm payroll data due out on Friday stunned investors suggesting a wave of hiring last month and reversed the direction of yields mercilessly. That, as they say on Wall Street, makes a market.

Eurodollar futures –

Expectations

for a decent ADP reading of 100,000 additional payrolls during December were well short of base on Wednesday when the private payroll processor reported that 297,000 jobs were created. This is indeed a huge number and has set the cat amongst the pigeons in Chicago’s bond pits where the 10-year note yield reversed an earlier decline to 3.29% to its current 3.41%. The March note future slumped from 120-23 to 119-15 as investors rushed to lock in borrowing costs. Ahead of today’s report bond buyers responded to the encouraging set of FOMC minutes from the Federal Reserve in which the committee acknowledged the recent spurt to growth and recognized a “near-term” impetus to growth as a result of the $858 billion tax-cut extension signed by the President in December. Losses for Eurodollar futures were accentuated across a steeper yield curve resulting in wider calendar spreads. For example the September 2011/2012 one-year calendar spread moved back above 100 basis points or 1%. The spread was last as wide in June (apart from a visit there last week in thin markets) before sovereign debt woes forced a compression of spreads to 30 basis points. The widening spread is hardly consistent with the Fed’s policy of buying bonds to lower the yield curve, but it is consistent with an objective of improving the economy.

European bond markets – Very little went untouched as a result of the outright strength in the ADP report. March bunds broke a nearby uptrend and shed 30 ticks to trade at 125.81 on heavy volume lifting its yield in the process by three pips to 2.91%. Euribor futures retreated in similar fashion as the cost of short-term money increased marginally. Peripheral bond prices fell in-line with core German bonds as yield spreads managed to remain in-line. Earlier in the day data showed a decent expansion for both services and manufacturing in a PMI survey report showing an increase from 55.0 to 55.2.

British gilts – March gilts tumbled from earlier heights inspired by an interruption to the ongoing recovery for construction. It appears that weather-related weakness may have caused the first decline into contraction territory during December. Once again it took a reversal in expectations in the North American market to crater the gilt market with the March future sliding from a session peak at 119.36 to an intraday low at 118.30. Yields on the 10-year government bond have surged six basis points to 3.52%. Short sterling futures followed suit sending implied yields seven basis points higher along the curve.

Japanese bonds – March JGB futures of course missed the hoopla, closing before the release of the ADP report. The contract rose 16 ticks to 140.44 yielding 1.155%. A private Chinese services report from HSBC revealed an unchanged reading of 53.1 in December providing support to regional bond prices.

Australian bills – Aussie bond prices haven’t moved to price in either an increase in issuance should it be required to pay for infrastructure funding as a direct result of the devastating floods in Queensland. The floods cover an area equal to the size of France and Germany and have the capacity to cause a distinct upset to the overall economy given that the state accounts for one-fifth of national output. The 10-year yield edged higher by three pips to 5.57% while short-term bill prices rose helping to send implied yields lower by four basis points. It can’t be out of the realms of all possibility that the Reserve Bank considers lowering its benchmark given the scale of the flooding and it’s certainly within investors’ capacity to drive the market to such a conclusion even if it is premature. Already the Aussie dollar is sliding in response to the estimated drop in Australian commodity output after its biggest regional operators enacted force majeures because they cannot deliver coal to buyers as previously contracted. Quite how long flooded mines will be out of production at this stage is anybody’s guess.

Canadian bills – Government bonds fell hard following the glowing labor report from its biggest customer. The March CGB future shed 69 ticks to 121.29 sending the cost of government borrowing higher by seven basis points to a yield of 3.25% and 16 basis points beneath comparable treasuries. Bill prices reacted to the ADP data by falling six basis points and ahead of Canada’s own employment report on Friday.