Tuesday, December 14, 2010

Weekly Market Update: The Coalition Predicts A Riot

More dire news was released this morning for the UK housing market, as the Rightmove House Price Index showed a rise from -3.2% to -3.0%, which hardly warrants the term rise! That was also paired with the news that there could be further falls of about 5% next year, this knock to the housing market also caused some damage to sterling this morning as it fell from the 1.19 levels. We are not surprised that nothing but negative housing data has come to light recently, on Friday it was made clear that the number of UK mortgages fell in October to its lowest level in five months and the level of first-time buyers are nearly a fifth lower than this time last year – hardly conducive to a rise in house prices. There is a light at the end of the tunnel however, in that lending criteria has apparently softened in October in anticipation of possible regulatory changes so the lending market looks set to remain small but stable.
Last week was dominated by the students as we saw the coalition government win a dubious victory even with the backbench rebellion which saw the working majority narrow to 21. The bill to extend university fees created the worst unrest in central London for more than a decade, with some protestors vandalising the area and lighting bonfires. Embarrassment surrounded Clegg, as he voted for, his party president voted against, and the deputy leader of the Lib Dems abstained, not a united show on that front. The National Union of Students won’t take this lying down as more protests are planned for today and in the future, which will at least give the police another chance at handling the rioters more effectively.
The Bank of England held interest rates last week and did not announce any further quantitative easing, this was as expected and will likely remain this way until the end of 2011, this depends on what happens in the eurozone and how the story unfolds. If things go from bad to worse then we could have to increase QE in order to reduce the impact on the UK. Things to keep an eye on this week are Inflation and retail sales announcements on Tuesday and Thursday, traders are hoping for a strong inflation figure as that would be good news for the pound but it looks unlikely. Many retailers are expecting the important Christmas period to be no worse than last year and what with discounts and optimism increasing we could see a rise in retail sales.
Have a lovely week!
Jeremy’s Trade of the Week
This week’s trade of the week is a brand new structure combining the ability for you to hedge close to the current market giving you the facility to add to your worst case rate when the rate falls. This new structure is called the ‘Convertible Bonus’ and allowed our client to hedge himself though 2011.
With a GBPEUR forward rate for a year at 1.18 we were able to give the client a hedge at a level of 1.15. This structure gives you a protection rate to buy EUR at 1.1500 on the settlement date but for every percent spot is below 1.1500 but above 1.0970, having never traded below 1.0970 during the window period, your protection rate of 1.1500 increases by the same percentage difference. If the spot rate is higher than 1.1500 on the expiry date of the contract, you can choose not to exercise the protection option and instead buy EUR in the spot market. However, if spot is above 1.3100 during the window period, you will have an obligation to buy the notional amount of EUR at 1.1500.
This strategy is premium free to the client and is also relevant for sellers of sterling and buyers of other currencies. As there is a potential further weakening for sterling against the US dollar given the run it has had of late, it provides a balanced upside for this potential, while guaranteeing a tight worst case rate.

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