Sunday, January 10, 2010

Financial Markets Review : Strong Start to the Year for Equities and High-Yield Currencies

Financial market review - foreign exchange Sterling got the New Year off to a poor start, underperforming the other G-10 currencies over concerns of the fiscal situation. On the political side, a potential leadership challenge to Prime Minister Brown added to the downward pressure. The boost to sterling into the close of the week from a weak US non farm payrolls report was also short-lived as gbp/ usd ended the week below 1.60 at 1.5974, down 0.9%. Commodity currencies outperformed (Australian dollar, Canadian dollar, New Zealand dollar) as equities rallied and yield differentials widened.

Sterling experienced a fairly volatile week but the trend was clearly one way. Hitting the weekly high against the US dollar at the Monday open at 1.6241 following better than expected PMI manufacturing data, the currency pair was pushed below the 1.60 handle by Tuesday. Rallies above 1.60 were short-lived during the rest of the week as dealers reacted to reports that PIMCO warned of an 80% chance of a downgrade to the UK's credit rating. There was firm support at 1.59. Economic data, on the whole however, has been on the positive side in the UK this week with improvement in both December PMI surveys and a larger than expected rise in the December Halifax house price index. The MPC meeting was a non-event with no change to either the Bank Rate (0.50%) or the size of the Asset Purchase Facility (£200bn). Sterling lost further ground against the euro as eur/gbp ended the week at 0.8983, 1.3% higher.

Commodity currencies started the week positively with large gains for the Australian dollar and the New Zealand dollar on Monday. Trading was lacklustre midweek as the market awaited the US non-farm payrolls report on Friday. Despite increased optimism that payrolls in December would print a positive number for the first time since December 2007, the report disappointed to the downside with a fall of 85k. That said, the November data was revised up to +4k. The US dollar predictably sold off following the release with eur/usd moving from 1.4264 up to 1.4415 while gbp/usd rallied from 1.5973 to 1.6110. The move was short-lived however as the dollar clawed back its losses in the afternoon. The dollar DXY index ended the week a touch lower at 77.68. Over the week, the Australian dollar was the star performer (up 3.65% versus the US dollar) with the Canadian dollar (+2.8%) and the New Zealand dollar (+2.52%) not far behind. In EMEA currencies, the Turkish Lira outperformed (up 3.69%) after Fitch upgraded its rating on the country, following on from a similar move by S&P in December.

The euro was little changed against the dollar over the week, trading in a range of 1.4258-1.4484. After a positive start to the week driven by its correlation with equities, there was pressure mid-week following comments from ECB's Stark who noted that “markets are deluding themselves” in thinking that other member states would bail out Greece in the event of a default. There was decent demand below 1.43 from reserve managers, however, which meant that eur/ usd managed to eke out a small (0.22%) gain on the week.

Interest rate market review - bonds, cash and swaps

Global government bonds experienced a mixed performance this week. Upward pressure on yields from higher equities and oil prices was counterbalanced by disappointing US employment data. Yield curves extended their steepening trend, with UK 2y/10y swaps widening to 220bps and US 2y/10y treasuries widening to 285bps. UK 10y yields cleared 4% and 5y swaps were steady in a range around a 3.35% mid-point. Heavy corporate issuance saw several sterling deals brought to market, but this was dwarfed by an extremely busy week for capital raising in US dollars.

Strong UK PMI data for manufacturing and services sectors along with a sharp increase in output prices, and a rally in the FTSE-100 over 5,500, boosted gilt yields and pushed 10y yields above 4.05% to a high of 4.11%. The manufacturing PMI rose to 54.1 in December vs 51.8 in November. The services PMI edged up to 56.8 from 56.6. The surveys underpinned confidence that the economy will return to positive GDP growth in Q4 2009. Core output prices jumped 0.7% in December, registering the biggest monthly increase since May 2008. The annual rate accelerated to 2.6% from 2%, the highest since April 2009 and confounded the more benign view based on the squeeze in company profit margins. The increase in pipeline inflation is likely to add upward pressure to CPI and RPI over the coming months. The BoE left Bank Rate and gilt purchase targets unchanged at 0.50% and £200bn, respectively.

A strong 2.75%, 2015 gilt auction by the DMO was covered 2.68 times. The BoE conducted two reverse gilt auctions. The 2020-2034 auction was covered a paltry 1.27 times. The 2013-2019 auction in contrast drew the strongest participation since November 25 and was covered 3.92 times, above the five-auction average of 3.37. Three corporates issued sterling paper this week. National Express Group launched 350mn of 2017 paper at 280bps over gilts. Dexia issued 1.25bn in three year FRNs at 30bps over Libor. The EIB tapped the market for 1.525bn of 2013 paper at 81.2bps over gilt and 1.2bn of 2014 paper at 95.9bps over. 5y swaps ended the week 6bps lower at 3.33%. 3-month libor was unchanged at 0.61%. The 2y/10y swap spread widened 10bps to 220bps, the highest since February 1993.

US yields were under upward pressure for most of the week on fairly upbeat economic data, higher stocks, and confidence of a first gain in the monthly employment report. However, yields fell back on news that the US economy lost 85,000 jobs in December, though added 4,000 jobs in November. The unemployment rate was unchanged at 10%. The 2y/ 10y spread widened to 285bps as 2y yields dropped below 0.95% and 10y yields rebounded as dealers positioned for long dated Treasury supply next week. Corporate issuance in US dollar surged to at least $44bn this week, led by a $4bn issue by GE, as fixed rate borrowers take advantage of low market rates and investors hunt for extra yield. 5y swaps ended the week down 11bps at 2.87%.

Eurozone swaps moved lower in step with the UK, though 10y yields outperformed gilts and ended the week unchanged at 3.39%. The ECB meeting next week will take centre stage though no major announcements are expected on monetary policy. Data this week showed stronger German exports in November, a rise in euro zone unemployment to 10% from 9.9%, and a further increase in economic confidence. Bond auctions in Germany and France were well supported. Financials were among the main issuers this week and included Rabobank, Sanpaolo, Svenska Handelsbanken and Banesto. Canada tapped the euro market for the first time since 1999.

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