Tuesday, July 17, 2007

The Short View By John Authers - World bond markets

The Short View By John Authers - World bond markets
Copyright The Financial Times Limited 2007
Published: July 17 2007 03:00 | Last updated: July 17 2007 03:00


World bond markets have now been through a month, and a month's cycle of data, since their big sell-off in early June. They seem to have found a level, with 10-year US Treasury yields oscillating around 5.1 per cent and 10-year German bunds at around 4.6 per cent.

Traders seem comfortable with the sudden reassessment of risk that was made a month ago. They have also resisted more bearish predictions that 10-year Treasury yields could shoot all the way to 5.6 or 6 per cent. Volatility remains much higher than it was in May.

All of this comes in for a stiff test this week. Ben Bernanke, the Federal Reserve chairman, addresses Congress today and tomorrow. A year ago, he used this address to prepare the market for the "pause" in the Fed's campaign of interest rate rises that has been in place ever since. Few expect him to deviate much from the Fed's current position, that inflation remains the greatest risk. Anything else could spark a market over-reaction.

Fed Funds futures suggest the market has not wavered in its expectations of the Fed in the past month. It is still pricing no change in rates until next year, with a slight chance of a cut.

This week also sees a welter of US inflation data, starting today with producer prices, and continuing tomorrow with the key consumer price data. The bond market has not yet priced in greater inflation risks but concern from economists is growing. An "upside" surprise could send yields higher.

Finally, today sees the start of a wave of earnings reports for the second quarter from US banks. If the subprime lending debacle has truly had knock-on financial effects on banks and their balance sheets, this may be the time to reveal it.

Perversely, subprime losses could be good for bonds. They would increase the chance of a Fed rate cut, as a "bail-out" for the market, and they would also raise demand for bonds as a safe haven - both factors that would drive yields lower.

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