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Government bonds under pressure

January 29, 2007 | Financial Times

Government bond markets in the US and Europe were under pressure this week amid concerns over future interest rate policy.

In the US, benchmark bond yields were at five-month highs and within a hair’s breadth of the psychologically important 5 per cent level.

While the high yields did attract some buyers on Friday, sentiment was still bearish as investors scaled back expectations of interest rate cuts this year. The US Federal Reserve meets next week to make its interest rate decision. Next week there is also macro-economic data due from the US and Europe.

William O’Donnell, strategist at UBS, said that over the past two weeks the market had taken the view that the US Federal Reserve would keep rates on hold in the coming months. “The market is now pricing in no Fed moves until past the June 28 meeting,” he said.

Stronger-than-expected durable goods data and new home sales initially weighed on the US market on Friday, but traders said selling on the data was balanced by bargain hunters, preventing yields from breaching 5 per cent. Buying is often triggered when yields approach a milestone.

The yield on the 10-year bond was up 0.2 basis points at 4.88 per cent, after starting the week at 4.78 per cent. The two-year note yield was unchanged on the day at 4.98 per cent, up from 4.94 per cent on Monday.

In the eurozone, data showed that money supply growth surged to a 16-year high in December. This reinforced expectations that the European Central Bank would continue to raise interest rates.

“The ECB’s twin-pillars policy is continuing to come apart at the seams,” said David Brown, chief European economist at Bear Stearns. “Eurozone inflation looks set to break above the ECB’s 2 per cent target this month, while money supply growth is surging.

“This should all be anathema to the ECB. It raises the risk that the next ECB rate hike could come as soon as February.”

In late trading on Friday, the yield on the 10-year Bund was up 2.4bp to 4.09 per cent, after starting the week at 4.02 per cent.

UK gilts were weaker and the benchmark 10-year gilt yield neared the 5 per cent level. The yield on the 10-year gilt was up 2.3bp to 4.987 per cent, from 4.886 per cent on Monday.


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