Equities slip and French bonds rally after Fed minutes

Equity benchmarks are generally softer and the dollar is strengthening as investors digest the minutes of the Federal Reserve’s January policy meeting.

French bond yields are dipping and the rally in Bund prices has stalled as eurozone political stress wanes somewhat.

What to watch
The Bundesbank is due to deliver its 2016 annual report on Thursday. Will it address the trend of burgeoning inflation amid continued quantitative easing by the European Central Bank?

The ECB’s bond buying is an important reason why the yields of highly-rated government debt have shrugged off improving economic conditions of late.

But another big factor suppressing yields is political stress, with investors moving into German, and other “core” eurozone paper in an attempt to protect themselves against the possibility of victory by the anti-euro candidate Marine Le Pen in France’s presidential election.

And so, despite faster activity in the continent’s manufacturing and services sectors, the German 2-year bond yield on Wednesday hit a record low of minus 0.92 per cent. German 10-year Bund yields fell to just 0.25 per cent.

French 10-year yields, in contrast, hit 1.15 per cent earlier this month, the highest since September 2015, as investors demanded more compensation from Paris to hold its debt.

However, on Thursday, French 10-year’s are 1.02 per cent, off 3 basis points, after presidential candidate Francois Bayrou threw his weight behind fellow centrist Emmanuel Macron, possibly increasing the latter’s chances of defeating Ms Le Pen.

As tension eases, so demand for German paper wanes a bit: the 2-year is adding 1bp to minus 0.89 per cent and the 10-year is up a fraction of a basis point to 0.27 per cent.

Hot topic
The suppression of core eurozone yields has been widening the yield difference, or spread, with US paper as the Federal Reserve prepares to tighten monetary policy further.

The Fed’s minutes released on Wednesday showed that “many” policymakers thought it would be appropriate to raise short-term US interest rates again “fairly soon”, even given potential uncertainty around the new Trump administration’s economic policies and possible tax cuts.

Analysts’ view on rates had already taken a hawkish turn following a recent speech by Fed chair Janet Yellen that prompted speculation borrowing costs could be raised as early as March — though futures markets are still only pricing in a 34 per cent chance of that happening.

The US 2-year bond yield, which is particularly sensitive to monetary policy, is steady on the day at 1.22 per cent, leaving its spread with equivalent maturity German paper at an historically wide 211 basis points.

The 10-year Treasury yield is easing 1bp to 2.41 per cent for a benchmark US/Germany spread of 214bp.

Forex
The rate differential in favour of the US has been supporting the buck. The dollar index, which hit a 14-year high of 103.82 at the start of 2017, is up 0.1 per cent to 101.33 as the euro dips 0.1 per cent to $1.0548.

Sterling is up 0.1 per cent to $1.2456 and the yen is flat at ¥113.26 per greenback.

South Korea’s won is 0.1 per cent stronger at Won1,135.93 after the central bank held interest rates steady as expected.

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