The pledge by the G20 leaders to boost the lending facility of the IMF up to $1 trillion gave emerging markets and equities a shot in the arm this week. The unwinding of safe haven flows and the decision by the ECB to cut interest rates by a smaller than expected 0.25% weighed on the dollar. Sterling was buoyed by better than expected data for the two March PMI surveys, and rose to a high of 1.4845 vs the dollar and 1.1061 vs the euro. The Polish zloty and the Turkish lira were among the best performers in emerging markets thanks to the funding increase for the IMF and the explicit pledge by the G20 to support emerging market economies in difficulty. Elsewhere, the rally in equities and weak Japanese economic data put downward pressure on the yen and helped $/Y to break 100 and strengthen to a 5-month high. Asian and Latin American currencies also fared well and propelled the Korean won and Mexican peso higher by 17.7% and 9.7%, respectively.
Hopes that the worst for the UK economy may be behind gathered support when manufacturing and services sector PMI's showed stronger than expected results in March. However, we stress that the indices are still running well below the 50-watershed and this suggests that activity in both sectors is still contracting. The manufacturing PMI rose 5 points to 39.1 and the services PMI edged up 2 points to 45.5. A rise in new orders suggests that the rate of contraction may gradually be slow in Q2 in both sectors. This was credited for most of sterling's gains against its major counterparts. Better than feared gilt auctions on Wednesday and Thursday showed respectable bidder participation and this also helped to put a floor under the pound.
The dollar experienced mixed fortunes as participants unwound safe haven flows and bid up emerging market currencies. Against the G10 majors, the dollar fell against the euro, the Swiss franc and the antipodean currencies, but rose against the yen. The break above 100 in $/Y is a powerful move that could in our view turn out to be the start of a broader slide in the yen. The yen also posted heavy losses against the euro and sterling, reaching 134.98 and 148.35, respectively. IMF data showed that the share of US dollars in global foreign exchange reserves fell in 2008 to 64%. The account of euros rose to 26.5% and the allocation of sterling fell to 4.1%. The shift was particularly marked in emerging markets where dollar holdings fell below 60% and the share of euros rose above 30%. The dollar also lost ground on the back of more comments, this time from Russia, that there could be merit in an alternative to the dollar as a international reserve currency. The report on Friday that US unemployment rate rose to 8.5% in March had only a miniminal impact.
Emerging markets experienced strong demand on the back of a rally in equities and the G20 commitment, and this particularly buoyed the currencies of export orientated economies like South Korea, Mexico and Brazil. The statement by Turkey that it will soon agree to a new IMF loan accord lifted the lira vs the dollar to a 2 1/2 month high below 1.60. The South African rand was also bid after prices of platinum, an important exports resource, rallied to a 6-month high. The rand rose below 9.0 vs the dollar for the first time since last October. £/rand fell to a 3-month low of 13.2939.
Interest rate market review - bonds, cash and swaps
The broadly positive financial market response to the G-20 summit in London, in which measures worth over $1 trillion were announced, boosted equity prices and bond yields. The FTSE-100 index rose above 4,000 for the first time in six weeks, while Brent crude oil prices rose above $54 per barrel. Some upside surprises in UK economic data and the smaller than expected ECB interest rate reduction also supported gilt and bund yields. However, weak US employment and survey data at the end of the week led to some retracement in yields. For the week as a whole though, bond yields and swap rates generally rose, while interbank rates continued to fall.
UK bond yields were boosted by stronger than expected purchasing managers' surveys. The manufacturing PMI rose to 39.1 in March from 34.7, while the services survey rose to 45.5 from 43.2. These surveys are still consistent with a deep recession, but they suggest that the pace of contraction may begin to ease in Q2, helped by an improvement in the availability of credit, as indicated in the Bank of England's latest credit conditions survey. Further, mortgage approvals rose to 38,000 in February, the highest level since May 2008 and GfK consumer confidence rose unexpectedly, albeit from a very weak level.
There was some relief that the 30yr gilt auction, which was outside the 5-25yr range of purchases by the Bank of England, was successfully covered. UK benchmark 10yr gilt yields rose 14bps to 3.42% this week in the aftermath of the G-10 summit and following the services PMI survey, while 5yr swaps moved further above 3%, rising 13bps to 3.23%. The recent rise in bond yields is likely to reflect hope that policy measures will succeed in restoring growth, but we still expect the economy to contract nearly 4% this year. Thus, in our view, a more sustained rise in yields may not occur until later this year at the earliest.
The ECB surprised the financial markets this week by cutting benchmark interest rates by 25bps to 1.25%, rather than 50bps. The deposit rate was also reduced by a quarter point to 0.25%. Moreover, ECB President Trichet deferred the adoption of non-standard policy measures until the next meeting in May. The details of such measures will be announced then, along with another likely reduction in benchmark rates to 1%, though the deposit rate is likely to have already reached a bottom. The pressure on the ECB to move to quantitative easing has continued to increase, given ongoing poor data and a significant fall in inflation. Euro zone unemployment rose to 8.5% in February, while industrial confidence fell to new cyclical lows. However, there were some slight upward revisions to the PMI surveys, though they were still consistent with a significant pace of economic contraction. Euro zone inflation fell to only 0.6%, according to the preliminary flash estimate. The ECB policy decision and the global equity rebound helped benchmark German 10yr bond yields rise 13bps to 3.22%, while 5yr swaps rose 13bps to 2.88%.
In the US, equities were further boosted by the decision to ease mark-to-market rules, which weighed on treasury prices. The key employment report showed another large rise in non-farm payrolls of 663,000 in March, but revisions to past months amounting to an additional 86,000 lost jobs. In only the past three months, employment has fallen by more than 2 million. The jobless rate soared to a 25-year high of 8.5%. The ISM surveys were mixed and remained consistent with negative economic growth, though factory orders rose 1.8% in February. Overall, 10yr bond yields rose 10bps to 2.84% and 3m libor fell for the third consecutive week to 1.16%.
Lloyds TSB Bank http://www.lloydstsbfinancialmarkets.com
Disclaimer: Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.
