What EZ Bond Yields Imply About S&P Downgrades

Since Standard & Poor’s cut the ratings of 9 Eurozone countries, the euro has done nothing but rally. One of the main reasons why the EUR/USD has been so resilient is because the downgrades had very little impact on European bond yields. French and Spanish bond yields have increased but by less than a tenth of a percent while Italian bond yields decreased since the S&P announcement. The following table compares the 10 year bond yield and 5 year CDS spreads of key EZ nations today vs. before S&P’s announcement. Five year credit default spreads rose, representing an increase in risk premium but the uptick was nominal. The biggest consequence of sovereign downgrades are higher yields and borrowing costs but based upon 10 year bond yield spreads, troubled European nations have been spared from Armageddon for the time being.

FOMC, ECB, RBA Meetings: What is Priced in?

The Federal Reserve, European Central Bank and the Reserve Bank of Australia have monetary policy meetings scheduled this week and some investors expect these central banks to change monetary policy. Here’s what the market is pricing in according to interest rate futures. You can compare them with the Central Bank expectations back in September. What is interesting is that the market does not expect the ECB to cut interest rates this year even though many economists predict a 50bp cut in December.

FED – Nada for 2011 and 2012

ECB – 25bp rate cut by July (sharp upgrade from Sept when rate cut expected in Dec)

BOE – Nada for 2011 and 2012 but slight shift to dovish bias

BOC – Rate Cuts now expected in 2012, down from rate hike by April

RBA – 25bp Rate cut by Dec – upgrade from 100bp by year end

RBNZ – No Major Changes, Rate Hike Expected July 2012

And here are the details:

ECB to Leave Rates Unchanged for Rest of the Yr? RBA to Cut?

Even though ECB President Trichet was quite clear last week in signaling that rate hikes are not over, based upon interest rate futures, investors are actually pricing in NO RATE HIKES for the rest of the year and into the first half of 2012.

Since the beginning of the year, the ECB insisted that the sovereign debt crisis would not affect their monetary policy decisions which are made based exclusively on the levels of inflation but investors believe that the crisis cannot be ignored.

The other major changes are the following:

RBA – Market now expects a Rate Cut in October
FED – No rate hikes expected before the second half of 2012
BOE – No rate hikes expected before the second half of 2012
RBNZ – First rate hike pushed out from Jan to March
BoC – First rate hike pushed out from Feb to April

Here are the details: