Volatility in major currency markets declined for a second consecutive week, falling to the lowest level since last September. An easing in credit market tensions to levels prior to Lehman Brothers' default and positive Q1 earnings results from US banks helped to shore up market confidence. The euro was one of the worst performing G7 currencies following comments by ECB president Trichet that the ECB will do ‘everything' to restore confidence, and that the euro was ‘not weak' at the current level. The Swedish krona posted the biggest drop among G10 currencies on speculation that the Riksbank may cut interest rates below 1% next week and will announce measures to restore the flow of corporate and household credit. Sterling strengthened against the euro, the dollar, and the Swiss franc. £/$ rose 1.4% to 1.4802, €/£ fell 2.4% to 0.8803, and £/chf firmed above 1.7250 for the first time since February after the SNB reiterated that it would intervene decisively to counter a rising Swiss franc. In emerging markets, eastern European currencies lagged Asian and Latin American counterparts.
A very quiet week for UK economic data put the onus on corporate demand and technical flows for the direction of sterling. The RICS reported a slight improvement in March for its balance of estate agents reporting falling vs rising prices. A fifth successive rise in buyer enquiries added to the view that mortgage activity is bottoming out. Upbeat comments by future MPC member Miles also helped to buoy demand for the pound, pushing £/$ above 1.50 for the first time since January 12th. A respectable gilt auction and bid cover underpinned confidence. Gains in sterling were also replicated vs the euro. €/£ fell below 0.88 for the first time since 24 February, dragged down by comments made by ECB president Trichet and weak euro zone economic data. Evidence of a growing divide on the ECB governing council could make it harder for the central bank to agree on May 7 with regard to interest rates and nonstandard policy measures to ease credit. A sharp fall in euro zone February industrial output added to the euro's woes and turned the single currency into the worst performer in the G7. The euro lost over 2% against the dollar, the yen and the pound.
The dollar posted selective gains against Scandinavian currencies and the NZ$. The good performance against the NZ$ is uncharacteristic considering the bounce in equities. $/sek rose 2.3% above 8.48, marking a 4-week high. Weak US inflation data for producer and consumer prices and a new cycle low for industry capacity utilisation fuelled fears of deflation. A rise in continuing claims above 6mn underscored the weak state of the US labour market. Retail sales, housing starts and building permits dropped more than forecast in March, but the Fed Beige Book took stock of a stabilisation in activity in five of the twelve Fed districts.
The story that Poland applied for a $20bn loan at the IMF and weaker than expected Q1 gdp growth in China made the headlines in emerging markets. The Indian rupee strengthened to a 2-month high vs the dollar as general elections got underway. $/rupee fell below 50.0 to a 49.3250 low in Thursday. £/rupee ended the week virtually flat at 73.90.
Interest rate market review - bonds, cash and swaps
Central bank purchases of government paper weighed on bond yields, but this was offset by some positive earnings reports and stronger equities more generally. In the euro zone, bond yields fell on expectations that the ECB will reduce interest rates at the next meeting in May. The economic data flow from the US was mixed, but some of the more forward-looking indicators supported Fed Chairman Bernanke's contention that there are tentative signs the economic downturn is moderating. In the UK, the RICS house price survey improved, providing a further signal that house prices could show signs of stabilisation towards the end of the year, while the British Retail Consortium's retail sales monitor was less negative than might have been expected, given the timing of Easter this year.
US treasuries in the past week were supported by Fed purchases of government paper and a lack of supply. Benchmark 10yr treasury yields fell to a low of 2.75%, but ended the week at 2.91%, as equities rallied. Similarly, 5yr swaps fell to a low of 2.28%, but closed at 2.45%. Dollar 3m libor fell to 1.10%, the fifth consecutive weekly decline, as money market tensions eased further. Indicators of recent economic activity disappointed on the downside. Retail sales fell 1.1% in March against expectations of a 0.3% rise, while industrial production fell more than expected by 1.5%, the fourteenth fall in the last fifteen months. Further, annual CPI fell to -0.4%, the first negative outturn since 1955, while housing permits fell to a record low. However, some of the more forwardlooking data suggested the pace of decline may be slowing. The Empire manufacturing survey rose to - 14.65 in April from -38.23 and the Philly Fed survey increased to -24.4 from -35.0, while the Beige Book noted that the pace of decline eased in some districts. Moreover, the University of Michigan consumer sentiment index rose to 61.9 in April, while confidence among housebuilders rose to a 6-month high, according to the NAHB survey. The weekly initial jobless claims figure also fell sharply to 610k from 663k, but this may have been affected by unusual seasonal factors. TIC (capital flows) data showed longterm net inflows of $22bn in February, driven by net treasury purchases of $21.5bn.
UK gilts remained under pressure, ahead of next week's Budget, which is expected to show a significant rise in government borrowing projections, though the 5yr auction this week was well received. Economic data continued to provide further tentative signs that the worst of the recession may be over. The RICS house price balance rose to -73.1 from -78.1, while the BRC reported a smaller -1.2% y/y fall in like-forlike retail sales in March, despite Easter falling in April this year rather than in March last year. Nevertheless, these figures are still weak and data next week should remind us that unemployment is still rising rapidly and the economy is still contracting at a fast pace. Benchmark 10yr gilt yields fell to a low of 3.16% midweek, but rallied to 3.36%, while 5yr swaps also rose from a low of 3.10% to 3.27%. Sterling 3m libor fell 5bps to 1.52%. The Bank of England's gilt purchases centred mainly on 2014, 2019 and 2021 maturities, but little activity at the ultra-long end may have helped pushed 30yr yields up 19bps to 4.50%.
In the euro zone, the ECB is widely expected to cut interest rates from the current 1.25% level at the next meeting in May, but there is open disagreement on how large the reduction should be. The influential Bundesbank President Weber on Wednesday said that interest rates should not fall below 1%, arguing that it would paralyse the money market, whereas more dovish Council members have argued in favour of rates falling below 1%. There is also uncertainty about which non-conventional policy measures will be announced. Data confirmed euro zone CPI fell to 0.6% in March, while industrial production was down 18.4% in the year to February. Benchmark 10yr bund yields rose marginally to 3.27%, 5yr swaps fell 5bps to 2.84% and 3m libor fell 2bps to 1.41%.
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