Sterling is relatively unchanged on the week, however this masks the intra-week volatility observed in foreign exchange trading. The Bank of England indicated that the market had misinterpreted its comments last week and the Bank had no pre-conceived level or target for sterling in mind. However, the near 25% fall in the tradeweighted index, from the 2007 high, was extremely welcome given the UK economy's need to rebalance. This clarification provided a short-lived boost for sterling. The second consecutive dip in the manufacturing PMI report now begins to raise questions regarding the recovery in the economy. The construction PMI report also pulled back, leaving sterling under pressure in the second half of the week - GBP/EUR closed at €1.0877.
The Norwegian central bank has reiterated the need to move the deposit rate away from the current emergency level as the recovery takes hold. Interest rate spreads have continued to move in Norway's favour, resulting in the krone being the second strongest G-10 currency (behind the Canadian dollar) this week. The Australian dollar traded to a 13-month high ($0.8859), supported by strong retail sales and a further increase in the manufacturing PMI. The rally was relatively brief as US economic data underperformed, weighing on commodities as global growth expectations were pared back, and providing coincidental support for the USD.
The Swiss National Bank (SNB) has once again intervened in the currency market to weaken the franc. The intervention appears to have been designed to coincide with the European Central Bank's auction, where €75.2bn was lent for a period of 1-year at a rate of 1%. The Swedish krona has been the weakest G-10 currency this week, closing at SKr7.0250 - a fall of 1.1%.
US activity data have generally disappointed this week. The manufacturing ISM report dipped slightly to 52.6, raising concerns that the pace of recovery may be slowing. Equity markets came under considerable pressure, with the S&P500 falling over 2.5% in a single trading session - the largest single daily fall for 12 weeks. Other economic data - Chicago fed national activity index, Dallas Fed manufacturing activity, consumer confidence, ADP employment and non-farm payrolls reports were all weaker than expected. A fall in global equity markets continues to result in net capital inflows into the USD (safe-haven).
Across emerging markets, the USD has rallied against most currencies. During periods of global equity market falls, capital outflows from emerging market nations induce a rally in the USD. The South African rand has been the worst performing currency, falling 3.1% against the USD. The rand has weakened due to three major events this week. Most important is the intervention by the South African central bank to depreciate its currency in the current fragile environment. Second, softer economic data in the US (most importantly the manufacturing ISM report) weighs on commodities, thereby feeding into rand weakness. Finally, the collapse in the proposed Bharti Airtel and MTN Group merger has weighed on the rand. USD/ ZAR has closed the week 3.2% higher, at R7.65.
Interest rate market review - bonds, cash and swaps
Government bond prices rallied and yields fell for a second week running after disappointing economic data from the US tempered confidence about sustainable recovery. Profit taking in equities triggered flows into safe haven government bonds, and dragged gilt yields lower across the curve. UK 5y swaps hit an intra-week low of 3.06% and 10y yields dropped below 3.50% to a 5 1/2 month low.
A generally positive week for UK economic data was brushed aside by market participants after a series of weaker US economic data stoked concerns about the economic outlook beyond Q3. Mortgage approvals, house prices and the CBI distributive trades' survey all surprised to the upside, underlining the stronger level of housing market and retail activity in September. UK Q2 GDP was revised up marginally to -0.6% q/q from - 0.7% q/q and consumer confidence rose in September to the highest level since January 2008. However, an unexpected decline in the manufacturing PMI to 49.5 in September and a lower construction PMI generated discomfort about prospects for activity in Q4. As inventories are replenished, observers doubt whether private sector demand and investment can take over the growth baton in 2010. With public spending cuts lined up for next year and unemployment still rising, we remain cautious with regard to the near and medium- term outlook for the UK economy. We expect the BoE to keep base rate and its QE target on hold next week at 0.50% and £175bn, respectively. UK 5y swaps fell below key support levels this week, touching a 3.06% low. 2y gilts hit a high of 0.94% as speculation waned of a BoE cut in bank deposit rates, but yields swiftly reversed back to hit a 0.72% low on Friday on safe-haven flows from equities into short-date fixed income paper.
Two gilt auctions this week attracted respectable demand. The 4%, 2022 auction, was covered 1.72 times and the 4.75%, 2030 auction, was covered 1.86 times. A relatively quiet week for corporate sterling issuance saw the EIB come to market for £2.4bn in 2015 paper at 25.5bps over gilts. TUI issued £350mn in 2014 paper. 5y swaps ended the week down 18bps at 3.11%. The 2y/10y swaps curve flattened 8bps to 201bps.
Weak US economic data powered the rally in Treasury prices and fed fund futures. A series of weaker than expected data was capped by a worse than expected employment report on Friday. It emerged that 263,000 jobs were lost in September and the unemployment rate rose to 9.8%. Weekly earnings dropped 0.1% m/m and slowed to 0.7% y/y, underlining the subdued inflation outlook. US 10y yields fell to a low of 3.10%, but profit taking nudged yields higher into the close at 3.21%. Fed fund futures rallied on the run of weak data reports and pared back expectations of a Q1 Fed rate hike despite hawkish remarks by a number of FOMC members. 5y swaps finished the week down 13bps at 2.53%. The 2y/10y spread flattened to below 230bps, before profit taking set in as participants looked ahead to the Treasury auctions next week for a total $71bn. US 3-month libor ended the week flat at 0.28%. Major dollar corporate issuers this week included Enel ($4.5bn of which $1.5bn in 30y bonds $1.75bn in 10y notes and $1.25bn in 5y notes), GE ($3.5bn, reopening of FDIC backed 2012 notes), Republic of Brazil ($1.25bn, 2041 paper at 175bps over).
In the euro zone, the ECB's second one-year tender registered demand for only €75.2bn of funds at 1%, markedly weaker than projected. Euro zone annual CPI came in weaker than expected for September at - 0.3% and helped to squeeze 10y yields below 3.20%. Yields were dragged to an intra-week low of 3.09% on Friday post the US payrolls data. 5y swaps closed the week down 7bps at 2.65%. The 2y/10y spread flattened to 190bps. 3-month libor ended the week flat at 0.70%. Germany, France an Spain were among the main sovereign issuers of government paper. BNP Paribas launched a €4.3bn capital increase to repay state funds received in March. DNB and Unicredit are also said to be planning rights issues.
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