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Global Markets Weekly - 21 September 2009

• Financial markets continued recent upward trends this week in response to positive US economic newsflow. Equity markets rallied to new year-to-date highs on the back of better than expected US activity data. Both retail sales and industrial production, came in ahead of market expectations. Government bond yields, however, were little changed with the exception of UK short rates. These fell to new lows as investors pushed the timing of eventual rate rises out further following comments by the Bank of England Governor, Mervyn King, highlighting the large amount of spare capacity that the recession has opened up and, hence, the lack of inflationary pressure in the economy. Oil and industrial commodity prices also rose, but unlike equities, failed to break out to new highs for the year.
• While sterling and the dollar continued to decline, gold touched new year-to date highs. Driven by a combination of improving appetite for risk and declining faith in the major fiat currencies, sterling and the dollar continued to decline on a trade-weighted basis and have fallen by around 4% since early August. The dollar, in particular, appears to be heading back towards the low it hit in March this year. Fear about the outlook for the dollar enabled gold to reach a new high for the year.
• One year on from the financial Tsunami unleashed by Lehman's bankruptcy, trust in the solvency of the banking system has been restored. Last week saw the first anniversary of the bankruptcy of the US investment bank Lehman Brothers. In the quarter after the US authorities failed to rescue Lehman, the global economy joined financial markets in freefall. Globally co-ordinated action by central banks and governments eventually rescued both the banking system and the wider economy. One year on from the collapse of Lehman, liquidity has returned to financial markets. Both the Ted Spread, the spread between the rate at which banks can borrow in the money market and the rate paid by the US government, and investment grade credit spreads, started to widen during 2007, then increased significantly post the Lehman bankruptcy, before declining dramatically. Despite falling, spreads remain at levels consistent with pricing a recession. Likewise, while lending standards are not tightening anywhere near as quickly as they were post Lehman, they are still tightening.
• Equity markets remain below their pre-Lehman level but market volatility has stabilised. Although equity markets have risen around 60% from their March 2009 lows, they remain around 15% below their pre-Lehman level. By the time Lehman failed, equity market volatility had already risen to the levels seen during the bear market of the early 2000s and when Long-Term Capital Management, the large US hedge Fund, failed in the late 1990s. After Lehman’s collapse, however, market volatility nearly doubled. Volatility has now returned to more normal levels and in recent months, investor sentiment has moved from risk aversion to risk seeking.
• Interest rates will have to stay low to allow the economy to recover. Trust in banks and market volatility have recovered from the failure of Lehman. Both the equity market and to a lesser extent, the economy are still on the road to recovery. To facilitate that healing process, monetary policy is likely to remain loose for a considerable period and tax payers will be left with a lasting legacy of fiscal deficits.

Indices, Interest rates and Inflation

	Close - 18 Sep 09	1 Week%	1 Month%	3 Months%	YTD %
FTSE ALL Share	2,658	3.0	10.6	21.9	20.3
FTSE 100	5,173	3.2	10.4	20.8	16.7
S&P 500	1,068	2.5	7.9	16.3	18.3
Nasdaq Composite	2,133	2.5	9.1	18.0	35.3
DJ Stoxx (Europe)	270	2.2	10.4	21.5	21.4
Nikkei 225	10,371	-0.7	0.8	6.9	17.1
Hang Seng	21,623	2.2	6.5	21.6	50.3

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Dec-09 Forecast	Mar-10 Forecast	Current	Next Date
US (Fed Funds)	0.25	0.25	0.25	-1.5	23-Sep
UK (Base rate)	0.50	0.50	0.50	1.6	08-Oct
Euro-zone (Repo Rate)	1.00	1.00	1.00	-0.2	08-Oct
Japan (Call rate)	0.10	0.10	0.10	-2.2	17-Sep

View the full Global Markets Weekly report (pdf).

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