Turnaround in U.S. ISM Contradicts Analysts’ Best Guess

Fixed income trading got off to a blistering start in a week where news events are likely to determine the fortunes for bond prices for the remainder of 2010. The first in a series of critical surveys showed the Chinese manufacturing expansion continued and is likely to be followed by more of the same around the world extending also to the service sector. And while the diffusion indices are a positive influence on risk sentiment they will not be enough to stop more quantitative easing from either the Fed or the Bank of England. Markets continue to rally ahead of the FOMC statement precisely because the central bank’s action is a growth-positive event. On Friday the October jobs report may yet show a deeper thaw in the labor market if the latest initial claims reports are anything to judge by.

Eurodollar futures – The December 10-year note futures contract has erased an initial 10-tick gain, currently sitting at 126-10 to yield 2.61%. The manufacturing sector picked up steam throughout October with the ISM survey rising further into expansion territory rather than falling. The FOMC’s two-day meeting starts on Tuesday and markets may be slow until then. For now the bias is towards lower yields in anticipation of a large amount of quantitative easing. Ever since the Fed said it would survey market participants over their sense of direction in light of the magnitude of the actions of the central bank, dealers have geared up for more rather than les. Eurodollar futures have also pared earlier gains once again with implied yields now higher lower by a couple of pips across the curve.

European bond markets – More fallout for peripheral government debt spurred investors back into German government debt causing yield spreads to widen. There was no fundamental data to drive direction while the follow-through buying of European stocks withered as government paper prices fell. The German December bund future added 56 pips to 129.79 spurred on by a friendly session in North America. Yields in the Eurozone suffered last week on the view that several ECB governing council members are keen to leave easy monetary policy behind. Euribor futures rose by two pips on Monday.

British gilts – The surge back into fixed income favored the December Gilt futures contract despite a strong PMI for the British manufacturing sector. The PMI for October rose to 54.9 and moved contrary to expectations for a steady decline. Nevertheless the December contract added 50 ticks to 123.85 after a leading real estate agent said that home prices fell by 0.9% during October for the biggest monthly decline in average home prices since January 2009. Short sterling prices hardly budged on the news.

Australian bills – Interest rate futures ceded some ground ahead of Tuesday’s decision on monetary policy from the Reserve Bank of Australia. The finely-balanced decision was complicated by two pieces of data on Monday. A measure of Chinese manufacturing activity indicated ongoing rebound and a healthy pace of expansion, which can only be good news for Australian exporters. Second was a report indicating that hiring amongst Australia’s manufacturers picked up during August as overall activity across the sector contracted but at a marginal pace. 90-day bill futures shed four basis points as dealers positioned ahead of the meeting. Aussie 10-year yields jumped three pips to 5.19%.

Canadian bills – Canadian bond futures followed the treasury market south following the release of ISM manufacturing data. The December contract is now trading around a session low at 126.23 despite a positive start that lifted the contract to 126.64. The 10-year yield added a pip to stand at 2.81%.

Japanese bonds – The mood in Japanese fixed income markets remains bullish in anticipation of further measures from the central bank likely to be announced on Thursday in response to whatever the FOMC decides the day before. However, following the Chinese manufacturing report, JGB futures fell to send the yield higher by three basi points to 0.945%.

About Andrew Wilkinson 1023 Articles

Affiliation: Interactive Brokers

Andrew Wilkinson is the senior market analyst at Interactive Brokers Group, where he provides daily commentary and analysis on U.S. equity options trading throughout the trading day. Andrew provides webinars designed to explain option-related trading scenarios covering futures, fixed income, forex and equities.

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