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Fixed Income Trading Strategies - July 12th 2004
U.S. Treasuries keep bullish underpinnings -- consolidation likely to end very soon. Sept Bonds may reach 110-00
Fed fund futures contracts were largely unchanged last week. Current prices continue to indicate that traders anticipate the Fed will raise its target rate by 25 bps following August 10 FOMC meeting.
DEVELOPMENTS TO WATCH TODAY: July 12 - Europe
- Japan's ruling coalition held onto its majority in the upper house, allowing Prime Minister Junichiro Koizumi to pursue his policies of curbing government debt and spurring the economy. Koizumi's Liberal Democratic Party won 49 seats -- more than some polls had suggested before Sunday's vote. The opposition Democratic Party of Japan won 50 seats according to preliminary results reported by NHK Television. The LDP's coalition partner, New Komeito, gained 11 seats. Koizumi will probably remain prime minister until 2006, when his term as LDP leader ends, because he needn't face a general election before that and the party has no credible alternative
- The surplus in Japan's current account rose 23.8% in May from a year earlier. The surplus now stands at •1.71 trillion (US$15.88 billion); the eleventh consecutive monthly rise trails the 23.1% growth in Aprilís current account surplus. The increase in the Mayís surplus was substantially larger than the rise of 11.9% expected. Japanís unadjusted trade surplus, part of the current account, rose 37.7%, year-on-year for May. Japanís export-led recovery continues with exports increasing 10% to 4.5 trillion yen in May, while imports rose 3% to •3.4 trillion. Trade with Europe and China remained particularly strong.
Bond Market Summary
Japanese 10-year bonds fell for a third day in four as stocks rose after the ruling party won more seats than some polls last week had indicated. Yesterday's upper-house election result makes it more likely Prime Minister Junichiro Koizumi will be able to maintain pressure on banks to pare bad loans and to spur economic growth. Japan's recovery may also benefit from expectations the central bank will leave monetary policy unchanged during a two-day board meeting that ends tomorrow. The benchmark 1.8 percent bond due in June 2014 fell 0.210 to 99.748 as of 1:40 p.m. in Tokyo, according to Japan Bond Trading Co., the nation's largest debt broker. Its yield rose 2.5 basis points to 1.830 percent. The benchmark 1.8 percent bond due in June 2014 fell 0.210 to 99.748 as of 1:40 p.m. in Tokyo. Its yield rose 2.5 basis points to 1.830 percent.
U.S. 10-year Treasuries may fall today on concern reports this week will show inflation is accelerating, curbing demand for debt as rising prices diminish the value of fixed-income payments. Investors may look at the reports for indications on the Federal Reserve's pace of interest-rate increases. The Fed raised its benchmark target for overnight bank lending at the end of June from the lowest in 46 years and said it is prepared to lift rates at a faster pace to maintain ``price stability.'' The 4 3/4 percent note maturing in May 2014 was little changed at 102 10/32 at 11 a.m. in Singapore. Its yield held at 4.46 percent.
U.S.Treasuries traded in a narrow range on light volume Friday as players took the market back into positive territory on short covering and defensive weekend positioning. The early activity saw a few attempts to break through on the downside, with the 10-years failing a couple times at the 4.49% barrier. The yield curve was also restrained, with the 2-10-year hanging near the 195 area. Options trade saw the occasional flurry of activity with some outright call and strangle (call and put strikes higher and lower than the at-the-money's) selling, as the early part of next week will likely see continued low volatility.
Fed fund futures contracts were largely unchanged Friday. Current 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 prices. The December Fed fund contract fully prices in 75 additional basis points of tightening by the end of the year. Current prices show that the market consensus is for August, September and November as the likely months for movement, bringing the target rate to 2.00% by the end of 2004. Looking over the horizon, traders expect the Fedís target rate to reach 2.50% by April 2005.
Sept 04 T-Bond - the contract effectively traded sideways -- and kept its bullish underpinnings. The corrective phase may have ended at 107-18 -- the rally should resume shortly. 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 - no change in view -- the contract may have indeed completed the corrective decline at 110-06; it should push further to 112-16 from here.
Dec 04 3-mo. Eurodollars -- no change in view -- the contract terminated the correction at 97.61, and should push towards 97.85 further out.
Sept 04 German Bunds - the contract has been on a tear going as high as 114.10. The contract should advance to at least 114.25 from here and may even focus at 114.50.
Sept 04 German Bobl - the contract has been to 110.98, and should continue to pile on gains. But the contract should rally further towards 111.25 at least, possibly even 114.40.
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