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Wednesday July 7, 2004 - 07:31:48 GMT
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Fixed Income Trading Strategies - July 7th 2004

Sept Bund may indeed bottom out at 113,50; Sept Bobl should hold 110.62 - 112.60 support area

Fed fund futures were unchanged Tuesday after retrenchment of ISM non-manufacturing index. Topline index was below market expectations; new orders, exports and employment sub-indices were all upbeat.


- Australia's central bank kept interest rates unchanged for a seventh month amid signs the housing market has slowed and as the inflation rate is at a four-year low. Reserve Bank of Australia Governor Ian Macfarlane and his board left the overnight cash rate target at 5.25 percent, as forecast by all 23 economists surveyed. The bank has kept rates unchanged this year as reports showed house prices fell and fewer homes are being sold after borrowing costs increased a half percentage point last year. Still, signs the economy is rebounding from its slowest growth in a year have prompted some economists to forecast a rate increase by December.

- Australian employment probably rebounded in June, keeping the jobless rate at a 23-year low and adding to signs the economy is recovering after growing at its slowest pace in a year. The economy probably added 25,000 jobs last month following the loss of 41,100 positions in May, according to the median forecast of 23 economists surveyed. The jobless rate probably stayed at 5.5 percent as more people sought work. The report will be released tomorrow at 11:30 a.m. in Sydney. Figures the past two weeks have shown exports rose to a 16- month high in May, retail sales rebounded and credit is growing at its fastest annual pace in more than 14 years. A pickup in growth may support some economists' expectations the Reserve Bank of Australia will raise interest rates this year.

May ISM Services:

The May ISM services index dropped 5.3 points to 59.9 in June, the first reading below 60 in six months. But the components did not change much from Mayís level. Indeed, the new orders and new export orders indices were up during the month, even as the backlog index retreated. The employment index rose to 57.4 from Mayís 56.3; this is the highest level in the seven-year history of this series and signals a very upbeat hiring outlook. And inventory sentiment was also essentially unchanged from May.

All this suggests that the decline in the headline services index may be sending a misleading signal regarding the magnitude of the deceleration -- the decline in both the manufacturing and services index does suggest some deceleration. The recent surge in energy prices is likely acting as a restraint with the usual lags. Higher interest rates and the winding down of the tax stimulus are also having an impact.

At any rate, a slowdown from the torrid pace of the prior few months was inevitable as both the manufacturing and services expansion transitioned to a sustainable pace. This is not a development one should lose sleep on.

Bond Market Summary

Japanese bonds rose today, pushing 10-year yields to the lowest in almost a month, after stocks declined on concern demand for exports from the U.S. will slow as a gauge of service industries in the world's biggest economy fell. The benchmark 1.8 percent bond due in June 2014, which was auctioned yesterday, rose, pushing its yield down 2 basis points to 1.755 percent, as of 12:31 p.m.. The yield earlier fell to 1.735 percent, the lowest for a benchmark bond since June 10. Ten-year bond futures for September delivery rose 0.09 to 135.54.

U.S. Treasury notes may fall for the second day in Asia after indexes measuring prices and employment in service industries rose to record highs in June. The Treasury will sell $15 billion of five-year notes today. Indirect bidders, a category that includes foreign central banks, bought more than half of the securities at last month's auction. The 4 3/4 percent note maturing in May 2014 was little changed at 102 4/32 at 9:15 a.m. in Singapore. Its yield was 4.47 percent. The 4 percent note maturing in June 2009 was little changed at 100 20/32 to yield 3.63 percent.

Fed fund futures contract prices were virtually unchanged Tuesday following the sharp retrenchment of the ISM non-manufacturing index. While the topline index was below market expectations, the new orders, exports and employment sub-indices were all upbeat, quelling any fears of a sharp downward correction in the services industry.

Current Fed fund prices continue to indicate that traders anticipate the Fed will raise its target rate by 25 basis points following the August 10 FOMC meeting. A larger, 50 basis point move remains unlikely given current contract prices. The December Fed fund contract now fully prices in only 75 additional basis points of tightening this year, down from 100 basis points which had been the market consensus until the weak June employment report. Current prices hold for August, September and November as the likely months for movement, bringing the target rate to 2.00% by year end. Looking over the contract horizon, traders expect the Fedís target rate to reach 2.50% by April 2005.

Bond Technicals:

Sept 04 T-Bond - the contract corrects back further -- support may firm up at 107-16 area. We still expect the rally to resume soon. We reaffirm the scenario -- the contract should accelerate higher and have a shot at 110-00. Further break of 110-00 suggests further moves to 115-00.

Sept 04 10-yr Note - the contract eventually may end the corrective decline at 110-04; it should push further to 112-16 thereafter.

Dec 04 3-mo. Eurodollars -- the contract may terminate the correction at 97.55, and should push towards 97.85 further out.

Sept 04 German Bunds - the contract may end the corrective decline at 113.55/50 today. The contract should advance to at least 114.25 thereafter.

Sept 04 German Bobl - the contract may correct back to 110.62/60, which should hold support. The contract should rally thereafter further towards 111.25.


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