Global Markets Weekly - 24th September 2007

Key global market developments

• The Fed steps in – surprise 50 bp cut boosts markets
  Central banks have dominated the headlines over the past week. Before last Tuesday’s meeting of the US Federal Reserve (Fed), the market was expecting a rate cut of 25 basis points. But the Fed took investors by surprise, cutting 50 basis points, from 5.25% to 4.75%. Equities responded positively. US, UK and European markets rose almost 3% on the news, and Hong Kong was up closer to 4%. The Fed’s decisive action shows it’s willing to do all it can to unblock the money markets and limit the impact of the US housing market slowdown on the broader economy.
• Equities and commodities to benefit
  We have examined the performance of asset prices in the months after the start of a Fed easing cycle. Our analysis suggests that, provided the Fed has succeeded in staving off recession, the main beneficiaries have historically been equities – particularly in Asia and emerging markets – and commodities. As well as offering protection against inflation, commodities are a hedge against a weak dollar, which has tended to suffer when the Fed has eased in response to a financial crisis.
• Panic in middle England forces the Bank’s hand...
  By contrast with the Fed’s decisive action, the Bank of England is yet to signal any cutting of the base rate and only belatedly announced last Wednesday that it will try to unfreeze the three-month inter-bank money market. That signal came in response to the Northern Rock crisis, the first run on the UK banking system since 1866.
• …with rates to fall this year in the UK...
  In our view, the downside risks to the UK economy will force the Bank to follow the Fed and cut interest rates. That could come in November or even, if events move fast enough, in October, with another cut to follow in February. We expect strains to appear in the housing market as credit standards tighten and employment falls in financial services and the public sector.
• …and next year in the eurozone
  The RBS/NTC Eurozone Purchasing Managers Index for September was weaker than expected, adding to the signs that the European economy is losing momentum in the face of a strengthening currency and turmoil in markets. We now expect the European Central Bank to cut rates by 50 basis points to 3.5% in the middle of next year, rather than staying on hold.
• US banks dodge the sub-prime bullets…
  When the music stopped, it wasn’t the Wall Street investment banks that were left holding the parcel of bad debts. Over the past few days, the US investment banks have released a broad spread of quarterly results, ranging from Goldman Sachs (excellent), Lehman’s (good) and Morgan Stanley (fair) to Bear Stearns (disappointing). But even Bear Sterns was in profit for the quarter, despite reporting its first reduction in profits for ten years.
  The banks’ hedging gains and diversified businesses produced offsetting profits, while good control of liquidity meant that they were not left with an unmanageable overhang of unsold bonds on their balance sheets.
• …but losses will continue to surface
  Of course, the turmoil in global financial markets is not over. As Credit Agricole’s announcement of a €250 million loss on an unauthorised proprietary trading position demonstrates, more problems are yet to be revealed. But the week of the rescue of Northern Rock appears to have marked the beginning of the end.

Indices, Interest rates and Inflation

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