Sunday, January 24, 2010

Financial Markets Review : Fall in Equities Boosts Government Bonds

Financial market review - foreign exchange

After a strong start to the week, sterling gave up much of last week's gains versus the dollar. Against the other G-10 currencies, however, sterling outperformed, registering gains of 2.5% versus the New Zealand dollar and 1.66% versus the Canadian dollar. EUR/GBP continued its descent, hitting a fivemonth low of 0.8651 following continued concerns over public finances in Greece and strong UK CPI data early in the week. The USD took another leg higher as equities moved lower during the course of the week on concern over the impact of Chinese tightening measures on global growth, banking sector reform proposals by the US government and weaker Q4 US corporate earnings. The Brazilian real dropped a further 2.4% versus the dollar and 1.7% versus sterling.

GBP/USD started the week positively, continuing on from last week's rally and spiking to a five-week high of 1.6458 following the shock UK CPI numbers which posted the largest rise in the annual rate on record, just as last year saw the largest drop. Downside surprises, however, to economic data during the rest of the week combined with the broad based US dollar rally led to GBP/USD selling off over the course of the week to a low of 1.6078 on Friday, before closing at 1.6144. Weaker than expected money supply data and retail sales weighed on the currency as markets began to entertain more seriously the notion that the Bank of England may well opt for an extension of quantitative easing at the next MPC meeting.

GBP/EUR rallied at the start of the week until its seven day winning streak came to an end on Thursday after breaking above 1.15. Concerns over the state of Greek public finances continued to weigh on the euro which fell through key technical levels versus sterling and the US dollar, accelerating the fall. Profit-taking on Friday, however, saw the euro recover some ground with GBP/EUR falling back to 1.1407. After a test of 1.44, EUR/ USD sold off to key support at 1.4293 (the 200 day MA). Once this level gave way, a flood of sell orders pushed the currency pair down to an intra-week low of 1.4029 before profit-taking on Friday to close at 1.4153.

Commodity currencies were hit hardest this week following concerns over the durability of the global recovery. Despite China posting a robust set of economic data this week, namely GDP up 10.7% in Q4 2009, measures to restrict bank lending combined with an increase in the three-month bill rate has fuelled speculation that full monetary policy tightening will occur in the near-term in an attempt to rein in speculative excesses, leading to concerns that the global recovery may be stifled. USD/CNY 12-month forwards rose further during the week to 6.68. AUD/USD fell 1.07% on the week while the New Zealand dollar underperformed, falling 2.49% versus the US dollar. In the emerging market space, the Brazilian real continued to underperform on foreign portfolio outflows

Interest rate market review - bonds, cash and swaps

Government bonds extended their excellent performance since the start of the year, buoyed by a retreat in equity markets and weaker than expected economic data from the G3 economies. UK 5y swaps hit a 3.33% high but closed the week below 3.20% near a 4-week low. Roughly £4bn in sterling issuance was raised in the capital markets, with mostly foreign financial names raising finance. The 2y/10y swaps curve steepened back up to 221bps. 10y yields for Greece and Portugal spiralled higher as budget concerns intensified.

The report on Tuesday of a steep rise in UK inflation in December unsettled UK debt markets on Tuesday, causing a surge in gilt yields. 10y yields rose 12bps to a 4.05% and 2y yields rose 15bps to 1.36%, causing the yield curve to flatten. 5y swaps hit a high of 3.33%. Annual CPI soared to 2.9% in December vs 1.9% in November. RPI jumped to 2.4% from 0.3%. Stronger than expected labour market data. The question for the BoE is whether the data will influence inflation projections over a 2y horizon, and whether it believes there is a risk that inflation expectations could rise. This would put pressure on the BoE to decide to halt asset purchases at the MPC meeting next month.

Gilt yields reversed and fell sharply later in the week, however, as equities posted heavy falls and UK M4 money supply showed a surprise 1.1% m/m drop in December. Markets looked though the stronger UK labour market figures on Wednesday - the claimant count total fell for a 2nd successive month in December - causing 10y yields to fall back below 3.90% and 5y swaps to fall through 3.20% to the lowest level since December 21. Retail sales disappointed in December, showing only a 0.3% m/m gain vs median expectations of a 1.1% rise.

In a speech to business leaders in Exeter, BoE governor King steered clear of commenting on whether he favours extending QE, and instead sounded confident that inflation would fall back to target by year-end provided that monetary growth stays under control. Markets have been at pains to try and infer clues from recent MPC commentary with regard to the BoE's plan on QE. With no one quite prepared to rule out more QE if UK Q4 GDP disappoints next week, gilts and swaps may target a return to the November lows, supported by fading equity market optimism. The FTSE-100 experienced a bad week, falling below 5,300 to a one-month low as markets reacted to US plans to reform the US financial industry. A retreat in commodity prices also weighed on the FTSE after the Australian press reports of government plans to levy a 40% tax on mining companies. The concentration of commodity listed companies in London gives the FTSE greater exposure to profit taking in commodity stocks if prices fall. Corporate sterling issuance was heavy and dominated by overseas financial institutions including the EIB (£1.3bn) and Intesa SanPaolo (£350mn). London and Quadrant Housing raised £300mn.

US Treasuries outperformed gilts and bunds as the S&P and Dow registered heavy falls on President Obama's statement and failed to convert solid Q4 results from a number of US blue chips. Weaker than expected Philly Fed survey and a stronger USD also bolstered demand for US paper. 10y yields sank to a 1-month low of 3.58%. 2y yields dropped to a 0.81% low and 5y swaps closed below 2.70%. The UK/US 10y swap spread widened to 25bps. KfW raised $4bn in USD funds, and was followed in size by Italy ($2.5bn) and Bank of Nova Scotia ($2.5bn).

Euro zone bunds equally drew support from lower stocks (Dax closed the week below 5,700), but more importantly for economy watchers was the surprise drop in the January composite PMI survey to 53.6 vs 54.2 in December. This marked the first decline since last February. 5y swaps finished 2bps lower at 2.62%, having touched an intra-week low of 2.58%. Greek 2y yields surged 80bps intra-day on Wednesday to 4.66%.

Full Report in PDF
Lloyds TSB Bank
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.

No comments: