Bonds stay resilient despite uncertainty on interest rates

Bonds stay resilient despite uncertainty on interest rates
By Joanna Chung
Published: February 18 2006 02:00 | Last updated: February 18 2006 02:00Copyright by the Financial Times

Government bonds around the globe showed resilience this week in spite of uncertainty about the future direction of interest rates, heavy supply pressures and a flood of economic data from both sides of the Atlantic.

"It's probably fair to say that we have had a pretty bumper week in terms of news," said David Brown, chief European economist at Bear Stearns. But he noted that, in spite of this, the bond markets were relatively stable: "It is as if uncertainty breeds low volatility."

One of the most anticipated events of the week was the first Congressional testimony by Ben Bernanke, the new US Federal Reserve chairman. Mr Bernanke noted that longer-term inflation expectations remained contained, hinted at further monetary tightening but would not be drawn on how far interest rates would rise.

Interest rate sentiment in the UK "see-sawed sharply", said Don Smith, bond economist at ICAP, the broker. "The market is teetering on the brink of pricing in a rate cut as its central view, but there remains a lot of uncertainty."

Weak consumer price inflation numbers earlier in the week raised hopes of a near-term cut. But after the Bank of England's quarterly inflation report forecast that inflation would stay near the target of 2 per cent for the next two years, sentiment changed. By the end of the week, poor retail sales data bolstered interest rate cut hopes again.

Meanwhile, a long-awaited sale of 50-year conventional gilts - the last tranche of this fiscal year - was met with modest demand. Demand at the auction amounted to 1.49 times the £2.5bn on offer, compared with the 1.95 bid-to-cover ratio at the last sale of the same paper in December.

Still, the bond was sold at a yield of just 3.82 per cent, compared with 4.03 per cent last time. The auction brought the total outstanding amount of 50-year gilts to £9.6bn. Yesterday, the 50-year gilt yield lost 2.8 basis points, to 3.733 per cent, in late trade.

Analysts said that part of the lower demand was due to the sharp fall in yields in recent months - due to a surge in demand from pension funds - combined with expectations of an increase in supply of very long-dated paper. Gilt market participants have been calling for more supply.

But Marc Ostwald, analyst at Monument Securities, said the sluggish demand at this week's auction might have heightened speculation that the financing remit for 2006-2007 could be "less bold" in skewing supply towards long-dated and index-linked issues - thus putting further downward pressure on the long end.

The eurozone provided more than €20bn of supply this week, much of it in long-dated paper. Still, bonds in the eurozone, the UK and the US ended the week higher.

Gains in prices pushed the yield on the 10-year US Treasury in afternoon trade yesterday to 4.541 per cent, compared with 4.584 per cent at the beginning of the week. The 10-year gilt was yielding 4.127 per cent, compared with 4.193 per cent.