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World Week Ahead: Have bond yields reached their lows?

Monday 26th September 2011

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US 10-year Treasuries fell on Friday in New York, pushing their yield up from a record low, amid signs the global economy has spat out all its bad news for now.

Europe’s sovereign debt crisis risks spreading unless leaders in the region step up efforts to reach accord on support for Greece, which still appears to be slow to take its medicine.

Financial aid it needs to avoid default hangs on its ability to prove it is taking its crisis seriously enough and is appropriately tightening its belt. The next few weeks are crucial.

Meantime, debate rages about whether the U.S. will sink back into recession. Two legs of the global economy are seriously wobbly.

The yield on 10-year Treasuries sank to 1.67% last week, the lowest level since 1953. It closed at 1.83% on Friday.

Westpac is forecasting that the 10-year notes will be back up at 2.10% by December and 2.40% by June 2012.

German and Austrian 10-year yields also touched all-time lows. New Zealand's benchmark bond yield reached the lowest since February 2009.

The Federal Reserve last week announced it would sell shorter-dated debt to buy longer-dated bonds to drive down borrowing costs in a plan known as "Operation Twist' and said there are "significant downside risks" to the economic outlook

With the Fed's target interest rate already near zero, the central bank has sought new and novel ways to continue to support the world's biggest economy.

The scope of that challenge will become clearer this week, with Commerce Department figures expected to show U.S. consumer spending slowed to a 0.2% pace of growth in August, according to a Bloomberg survey, from 0.8% in July.

Other figures may show the Conference Board’s consumer confidence index held near a 2 1/2-year low this month.

"In addition to very easy U.S. monetary policy, focus continues to be split between the struggling domestic recovery and the sovereign credit crisis and slowing economies in Europe," Ian Lyngen, a bond strategist at CRT Capital Group, told Reuters.

The U.S. Congress is set for a repeat of its stand-off on the debt ceiling, with lawmakers delaying until Monday in Washington the vote on a trillion-dollar bill that would top up government coffers including nearly depleted funds that the Federal Emergency Management Agency uses for disaster relief.

Equity markets rose into the end of last week. The Standard& Poor's 500 Index gained 0.6% on Friday and appears to have found a base, having tumbled in late July.

Yet the CBOE Market Volatility Index, or VIX, is at an elevated level - with a reading of 41 on Friday, having rarely risen above 24 in the previous 12 months. To put that in perspective, the VIX, known as Wall Street's fear gauge, reached about 90 in the wake of the Lehman Brothers failure in late 2008.

Gold, one of the key beneficiaries of increased volatility and economic uncertainty, has come off its highs above US$1,900 an ounce this month. Spot gold closed at US$1,754.71 an ounce on Friday.

The Dollar Index, which measures the greenback against a basket of trading partner currencies, rose 1.9% last week, with the euro rounding out a 1.6% weekly slide against the U.S. dollar. The yen remains near a record low (meaning it is stronger) as Japan's currency maintains some safe-haven appeal.

"For the coming weeks, we still see risk aversion dominating until there are some more decisive steps to address the European debt crisis, a key driver of market volatility," Wells Fargo currency strategist Vassili Serebriakov told Reuters.

Talk of a Greek default linger, with the region's banks seen taking heavy losses against their holdings of Greek debt. Moody's Investors Service cut the credit ratings on eight Greek banks because of their holdings of the nation’s debt.

Economic confidence for September is due out in Europe this week, with the measure expected to have sunk to the lowest level since early 2010.

The European Union is awaiting approval from the region's governments for new powers for the 440 billion euro European Financial Stability Facility in what is seen as a step in preventing contagion engulfing the global economy.

U.S. Treasury Secretary Timothy Geithner has urged European leaders to increase the GSFS spending power, with suggestions it needs to swell to at least 1 trillion euros.

But can the multi-headed euro-region get anywhere close to agreeing to a course of action?


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