Global Markets Weekly - 12 October 2009
- Bonds and equities are both supported by low interest rates in major developed economies...
Two-year government bond yields hit a new historic low in the UK last week and remained close to their lows in the US and Europe. Equity markets recouped much of their 4% two-week slide to stand almost 60% above March’s bear market bottom. The current combination of historically low bond yields and strong equity markets is driven by equity investors focusing on the turnaround in the growth rate of economic activity while bond investors focus on the low absolute level of activity. With the level of activity low relative to the economy’s productive capacity, the major developed economies have plenty of slack to use up before their central banks feel the need to raise interest rates. That view was reinforced last week when US Federal Reserve Chairman Ben Bernanke reiterated that ‘accommodative policies will likely be warranted for an extended period’ while both the Bank of England and the European Central Bank kept rates on hold at emergency levels.
- ...but a rise in rates would knock bond markets and perhaps equities too.
So what might shake up the current dynamic of strong bond and equity markets? If rates were driven higher by strong growth using up spare capacity in the economy, that would hurt bonds but not equities. If rates rose because unreliable measures of excess capacity had overstated the amount of slack in the economy – leading to unexpected inflation pressure – that would depress bonds and equities, just as it would if central banks decided to ignore spare capacity and raise rates in order to lean against asset price bubbles.
- By contrast, Australia has raised rates to avert asset bubbles and inflation...
In stark contrast to the continued need for ultra-low rates in the US, the eurozone and the UK, the Reserve Bank of Australia became the first G20 central bank to tighten, raising rates by 0.25 percentage points, to 3.25%. This was a response to: the boost its commodity exports are getting from Asian demand; its buoyant housing market; and signs that its unemployment rate has peaked. Australia, like the rest of Asia, is at risk of asset price bubbles and inflation unless it tightens monetary policy and allows currency appreciation.
- ...and some other countries are set to follow suit shortly.
Other countries likely to raise rates this year or in the first quarter of 2010 include South Korea, Taiwan, Norway, New Zealand and Canada. All of their banking systems have avoided the problems experienced in the US, the UK and much of Europe. In addition, South Korea and Taiwan, like Australia, are benefiting from trade with China.
- US dollar weakness has prompted intervention by Asian central banks...
The US dollar continued its slide towards what we expect will ultimately be a new trade-weighted low in the face of Australia’s rate rise and stories suggesting that China, the Gulf states and other major economies are in negotiations to sign non-dollar-denominated oil contracts. Asian central banks intervened heavily in foreign-exchange markets in order to slow their currencies’ rise against the dollar, because of concerns about declining export competitiveness. Despite their efforts, the Asia Dollar Index, which tracks the ten most active regional currencies (excluding the yen) against the dollar, rose further last week. However, the dollar needs to fall against Asian currencies if global growth is to be better balanced.
- ...and is driving gold to new heights - though not in euro terms.
Gold is also benefiting from the dollar’s weakness and has now broken decisively above its high of March 2008, when stagflation fears were rife. But gold is yet to reach a new peak in euro terms, as the euro is gaining from the dollar's dwindling status as a reserve currency.
Indices, Interest rates and Inflation
|
Close - 9 Oct 09 |
1 Week% |
1 Month% |
3 Months% |
YTD
% |
|
FTSE ALL Share |
2,656 |
3.7 |
3.1 |
25.0 |
20.2 |
|
FTSE 100 |
5,162 |
3.5 |
3.2 |
24.1 |
16.4 |
|
S&P 500 |
1,071 |
4.5 |
3.7 |
21.4 |
18.6 |
|
Nasdaq Composite |
2,139 |
4.5 |
3.8 |
22.1 |
35.7 |
|
DJ Stoxx (Europe) |
271 |
4.6 |
3.2 |
26.0 |
21.7 |
|
Nikkei 225 |
10,016 |
2.9 |
-2.9 |
7.8 |
13.1 |
|
Hang Seng |
21,499 |
5.5 |
3.1 |
20.9 |
45.2 |
| Official Rates (%) |
Inflation (%) |
Rate announcement |
|
Current |
Sep-09 Forecast |
Dec-09
Forecast |
Current |
Next Date |
|
US (Fed Funds) |
0-0.25 |
0-0.25 |
0.25 |
-1.5 |
04-Nov |
|
UK (Base rate) |
0.50 |
0.50 |
0.50 |
1.6 |
05-Nov |
|
Euro-zone (Repo Rate) |
1.00 |
1.00 |
1.00 |
-0.2 |
05-Nov |
|
Japan (Call rate) |
0.10 |
0.10 |
0.10 |
-2.2 |
14-Oct |
View the full Global Markets Weekly report (pdf).
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