Financial market review - foreign exchange
The US dollar remained under selling pressure this week, as data raised hopes of a global economic recovery. Equities and commodities rallied higher, with crude oil pushing above $65 for the first time in six months and gold breaking through $975. This saw commodity currencies head higher, with the New Zealand, Canadian and Australian dollars posting the biggest gains against the US$ in the G10 this week. NZD/$, AUD/$ and CAD/$ all set fresh 2009 highs, with momentum still appearing strong behind them. The UK pound was buoyed by data showing the second rise in house prices in the last 3 months according to the Nationwide, helping £/$ climb to 1.6183 on Friday, the highest since November. £/$ closed the week up 1.6% at 1.6156. The news that euro zone inflation had fallen to zero for the first time in May failed to prevent €/$ from pushing above 1.41 on Friday for the first time in 2009. It ended the week 0.9% higher at 1.4135. However, €/£ closed lower for the third successive week at 0.875. The yen and Swedish krona were the only G10 currencies to close lower against the $ this week.In emerging markets, the high-yielding South African rand and Icelandic krona posted the biggest gains against the US$ this week. $/rand eased below 8 for the first time since September, in spite of the central bank cutting interest rates to a three year low of 7.5%. Concerns about regional instability, following the testing of nuclear missiles by North Korea, led Asian currencies to post the largest falls against the US$ this week.
Although it was a relatively quiet week for major data and events in the UK, the pound appeared to benefit from their overall positive tone. First, the BBA reported that mortgage approvals had picked up in April, then later the Nationwide reported house prices jumped by 1.2% in May, easing the annual decline to 11.3% from 15% in April. The Gfk consumer confidence index was steady at -27 in May, however that still matched the highest reading for 11 months. After a surprisingly strong bounce last month, probably boosted by Easter sales, the CBI distributive trades survey headline index fell back to -17 in May, from +3 in April. However this was still well above the -44 outcome in March, while the quarterly index of retailers' optimism improved to the highest since November 2007.
Although starting the week on a firmer footing, after fears about nuclear missile tests in North Korea, the dollar came under renewed selling pressure towards its close. However, US economic data this week were largely supportive of a possible return to GDP growth in the third quarter. The Conference Board's consumer confidence index posted another strong rise in May, hitting an 8-month high of 54.9, up from just 26.9 in March. Durable goods orders rose by a solid 1.9% in April, while both existing and new home sales posted modest rises. The second estimate of US Q1 GDP showed the economy contracted by an annualised 5.7%, up from a fall of 6.1% in the preliminary estimate. There was also grounds for optimism in the euro zone this week, after the German IFO survey posted its second consecutive rise in May and the euro zone economic confidence index rose to a 6-month high
Interest rate market review - bonds, cash and swaps
US 10-year treasury yields hit a 6-month high of 3.75%, despite decent demand in the auctions and talk of further asset purchases by the Fed. Five-year swaps surpassed 3% for the first time since November. Instead, increasing concerns about the rising fiscal deficit weighed on treasuries, despite Moody's affirmation that the country's AAA rating is stable. Reports of MBS-related selling also exacerbated the rise in yields. Further out on the curve, 30-year treasury yields hit a 9-month high of 4.65%, raising concerns about the impact of higher mortgage rates on any potential recovery in the housing market, while 30-year swap spreads were the least negative for four months. Case-Shiller figures showed US house prices continued to fall sharply by 18.7% on the year, while new home sales in April were weaker than expected and Q1 mortgage delinquencies rose to 9.12%, including a rise in subprime delinquencies to nearly 25%.At the short end of the US curve, 2-year treasury yields rose and touched 1% for the first time in three weeks, but the 2s/10s spread nevertheless continued to rise. Other US data showed an upward revision to Q1 GDP to a quarterly annualised contraction of 5.7%, compared with the 6.1% fall in the advance estimate. The surprisingly strong rise in the Conference Board consumer confidence index to 54.9 in May earlier in the week helped pull treasury yields off their lows and set the stage for the sell-off later in the week. Strongerthan- expected durable goods orders data also weighed on treasuries. Ahead of next week's release of labour market data, initial jobless claims remained above 600k, though the 4-week average has edged down slightly, which may signal that the pace of decline in non-farm payrolls eased in May. However, further Fed asset purchases and a lack of supply next week may support treasuries. Dollar 3m libor fell again this week, but only marginally to 0.656% from 0.660%.
In the euro zone, German 10-year bond yields rose to a 6-month high of 3.69%, pulled higher by US treasury yields. Yields at the short end also increased, despite a smaller-than-expected rise in the German IFO business survey, a fall in euro zone annual May CPI to 0% and decent bid/cover for the inaugural 2-year schatz. Moreover, M3 money supply and private sector credit growth continued to moderate. That said, the German unemployment rate fell unexpectedly to 8.2% in May. Over the week, 5-year swaps rose above 2.90% and ended the week up 9bps at 2.84%, while euro 3m libor edged up for the second consecutive week to 1.27%.
Gilt markets were driven largely by developments overseas, as 10-year yields rose to 3.84%, the highest level since February, while 30-year yields stayed around recent highs. Sterling 3m libor fell further to 1.28%, while 5-year swaps recovered from a low of 3.08% to end the week at 3.28%. Departing MPC member Blanchflower said that the economic recovery is likely to be slow and that there may be many 'false dawns', as unemployment is set to still rise significantly. Nationwide reported an unexpected rise in house prices in May, which was the second monthly rise in three months, while figures from the BBA showed a small rise in the number of mortgage approvals. Although housing market conditions have improved recently, it is could be too early to see this translating into a sustained period of rising house prices. The Halifax measure, due next week, has been notably weaker in recent months. Other figures showed the GfK consumer confidence index stayed at a weak level of - 27, while the CBI distributive trades survey indicated that retail activity deteriorated in May, though the recent monthly trend had improved.
The Bank of England and ECB are expected to keep respective benchmark interest rates on hold at 0.5% and 1% next week. The BoE is not expected to make any new announcements on the asset purchase facility, which was recently expanded to £125bn, but the ECB is expected to provide details of its plan to purchase €60bn of covered bonds. Elsewhere, the RBA and BoC are also expected to leave interest rates unchanged at 3% and 0.25%, respectively.
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