Short-dated German paper slumped in response to hawkish talk from ECB President Trichet and colleague Axel Weber. The acceleration in the growth of the German economy to a 2.6% pace in 2010 brings with it a rise in inflationary pressures, which exceeded the central bank’s 2% tolerance level by the time the year had ended. Trichet and Weber predict that the situation will worsen in the short-term and say there is no particular reason to expect price pressures won’t migrate to the medium-term. If they do, well, don’t blame us for taking remedial action. After all, we never said we wouldn’t.
European bond markets – The yield on Germany’s schatz or two-year government paper has risen from bottom to top by an incredible 31 basis points this week after the central bank duo warned that they never promised not to move interest rates. Inflation in Germany accelerated to above 2% in Germany at the end of December in time-honored fashion as a reminder that with growth comes a strain on capacity followed by rising prices. The strongest performance by Europe’s major economy contrasts sharply with the shrinking experience in Portugal, Ireland and Greece last year. The yield on the schatz rose to 1.16% at its worst on Friday, while euribor futures also continued a Thursday tumble from the top bunk. The implied yield on the December 2011 three-month contract has risen from 1.28% at the end of 2010 to 1.71% today as the Weber and Trichet send shivers down investors’ spines. Analysts are rapidly bringing forward their estimates of when the ECB might now increase monetary policy with the most damage occurring at the more sensitive short end of the yield curve.
Eurodollar futures – Economists will soon be wheeling out the deflation carts following a weaker reading for retail sales while the inflation report was higher than was forecast. Such is the tussle between the two data points that the market is unchanged with the 10-year yield barely budging to yield 3.29%. The December CPI report rose by 0.5% and was marginally higher although stripping out all of the volatile goods behind the increase in the index leaves prices just 0.1% above the prior month and 0.8% ahead of one year ago. Retail sales less autos and gas rose at a 0.4% pace and down from a downwardly revised gain of 0.6% in November. Eurodollar futures reversed earlier losses to gain a couple of ticks as implied yields edged marginally lower.
Japanese bonds – Prime Minister Naoto Kan reshuffled his cabinet and drafted in a new minister for economy and policy, Kaoru Yosana, who three years ago encouraged an increase in the sales tax to offset the rising welfare burden. It’s expected that Mr. Yosana will not await economic recovery and push ahead with tackling the debt burden that overshadows national output. The bond market failed to respond to the announcement partly because dealers are preparing for forthcoming debt auctions next week. The March JGB future slipped only eight ticks to close the week at 139.95 to yield 1.20%.
British gilts – Gilt prices responded negatively to a surge in producer prices in December with monthly input costs coming in at twice the predicted rate. Prices paid by producers rose at a 3.4% pace, which translates into a 12.5% yearly rate of increase. Output costs were a little smoother but accelerated through the year to December by 4.2%. The March contract swooned from a positive opening after the data and reached a session low at 117.30. It later recovered to trade back in the black at 117.66. Short sterling futures also wriggled from earlier depths with the December contract at one point suffering a nine-tick rise in its implied yield. It later rallied to just three ticks down on the session to yield 1.58%.
Australian bills – Government bond yields eased by two basis points as investors remain heavily distracted by the ongoing flooding of Queensland. The short end of the curve was mixed even after negative news coming out of the China where monetary policy was tightened marginally and according to one media source the authorities are thinking about further measures to control prices.
Canadian bills – The premium demanded by investors to hold U.S. over Canadian debt narrowed even further following today’s U.S. data to just six basis points. Signs of weaker consumer activity in December allay fears that the American recovery is overheating, especially in light of a disappointing initial claims reading in Thursday’s session. March government bond futures added 11 ticks to 121.48 to yield 3.23% while 90-day bills remained lower in price implying marginally higher yields in early morning trade.