Wednesday, February 2, 2011

Gross Domestic Pessimism

Last week was dominated by the surprising drop in the GDP figure at
the end of last year. Growth in the UK slid by 0.5% according to the
ONS's preliminary reading, this was made even of poorer quality
coming after the positive data from the 3rd quarter. The news
naturally led to fists being shaken at the government, but the
simplicity measures can only just have caused the slowdown in growth
as they only really kick in this year, it is more likely that the cuts
unnatural confidence. The coalition are sticking to their guns when it
comes to the fiscal squeeze, as delaying the plans would likely scare
bond markets and in turn could chuck us back into the depths of a
crisis. The jury is out on if the economy will bounce back this
quarter, obviously everyone is in suspense that it will, indeed even
if growth continues very modestly, it would still be a positive sign
– especially for the government. MPC member Martin Weale has spoken
to The Guardian about the compelling case for a rate increase at the
January meeting, and how alarming the GDP figure was. He said, 'If
growth resumes shortly, my concerns about inflationary expectations
would remain. But were recent weakness to mark the start of a
sustained new downturn, inflationary pressures would be likely to fade
without a bank rate increase.'

April's tax changes hit the headlines this morning, as it emerged
that the richest tenth of the population will lose about 3% of their
net income compared to an average of 1% of the population as a whole.
According to the IFS, the average household will lose about £200 from
the tax increases, as well as the income already lost thanks to the
VAT rise and higher energy prices. The main changes coming in April
are the national insurance and income tax allowances. The introduction
of these alterations will remove 500,000 people from tax completely,
but will mean more have to join the high-rate bracket.

This morning we have seen UK house prices according to the Land
Registry fall -0.2% from November, but rise 1.5% since December 2009.
Tomorrow is the start of February which inscription an vital month for
sterling, this week alone you should be keeping an eye out for the M4
Money supply meeting as well as household borrowing and PMI.

!! Jeremy's Trade of the Week !!

This week's trade of the week is a new one in that it increases your
level of protection even as the rate goes against you. The Double
Leveraged Convertible Bonus obviously still gives you 100% protection
if the rate goes against you and allows you to gain from beneficial
movements. In this example the client needs to buy US dollars and
wanted to hedge for 6 months from the end of February.

The structure gave the client a worst case rate (WCR) of 1.59 and an
upper barrier of 1.67 with a bonus down to 1.54. This means that on
expiry should the rate be below 1.59 and above 1.54 having never hit
1.54 then your WCR is boosted by the difference between 1.59 and the
spot rate i.e. if spot is trading at 1.55 your worst case rate
increases to 1.63. If the rate it is above 1.67 but they are obligated
to buy twice the amount of dollars hedged at a level of 1.59.

This strategy is free to the client and guarantees a hedge level no of
poorer quality than the current forward. It is also significant 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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