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Weekly Market Commentary

Extremely tight money markets have dragged Treasury yields to their highest levels this year

Mon, Jun 2 2008, 06:04 GMT
by Nicole Elliott

Mizuho Corporate Bank

Overview

Extremely tight money markets have dragged Treasury yields to their highest levels this year. Especially hard-hit were ten-year Singapore where the MAS’s disastrous auction had a cut-off rate at 3.50%, up from 2.40% at the beginning of the month. South African benchmark ten-year hit 10.00%, and Czech five-year almost 5.00%, higher than it has been in six years. In the process many yield curves flattened and the UK’s inverted. The foreign exchange market has been mixed as the process of US dollar correction and consolidation continues. The Euro dropped to $1.5460, Cable stuck stubbornly at $1.9700, and the Brazilian real at 1.6340 is at its strongest since 1999’s devaluation. Against the Euro Slovakia revalued the koruna to 30.126 (while keeping the 15% fluctuation band) and the Hungarian forint at 239.50 is almost at its best ever. Commodities all traded lower, partly because of the dollar but also unwinding excesses. The biggest loser was spot Platinum, down to $1946 per ounce, LME Nickel and Zinc dropped by 8%, CBT Soy 4%, and Nymex Crude $124.67 per barrel as the US CFTC comes to an arrangement with Britain’s FSA for increased surveillance of energy futures markets. Despite continued pressure on the financial sector, most equity indices were a little higher, Australia, India and Thailand lower.

Political and Economic Developments

Catastrophic housing figures. Spanish house sales in March dropped 38.6% to 46,074 units, after shrinking by 24% and 27% the previous two, while mortgage lending dropped 41.9% to €9.98B. No wonder April Consumer Confidence and Retail Sales are the lowest in ten years. Similarly in the UK where in May Nationwide House Prices dropped a record 2.5%, and –4.4% in twelve months the biggest fall since 1992. Ergo GfK Consumer Confidence at –29 most negative since November 1990 and the Gordon Brown’s 23% approval rating is the lowest for the Labour party since 1943. Things in the US are bad too, the Case-Shiller House Price Index –14.1% Y/Y, New Home Sales bumping along just over 500K annualised (lowest since 1991), Existing Home Sales a record low 4.89M, and Consumer Confidence its lowest since 1992. Note that these three countries are technically not in recession as they were in 1990, nor are interest rates at sky high starting points.
Unemployment in Germany inched higher, +4K and the first increase in two years, and in Japan rising to 4.00% from 3.8% in March. The Job-to-Applicant ratio dropped to 0.93, its lowest since March 2005 (despite still being difficult to recruit new graduates), and Household Spending dropped 2.7% over the year.

Underlying Themes

There are quite a few top jobs still waiting to be filled at central banks. For months, and at a very sensitive point, the FSA has advertised for a new head, yesterday announcing that Adair Turner will be its new chairman; he has worked closely with the Labour government in previous roles at the CBI and the Climate Change Committee. The Bank of England’s secretive appointment procedure rumbles on as a replacement for Rachel Lomax, who chose to stand down when her five-year term ends next month, is added to the search for a deputy governor to replace Sir John Gieve (Mervyn King starts a second term in July). Fed governor Mishkin tendered his resignation in order to return to academia, effective 31st August. Nominated governors Duke and Klane await Senate confirmation and Kroszner needs his reappointment agreed. The Bank of Japan is having trouble filling two of its nine senior posts, the main opposition party blocking nominations. This sort of thing is unhelpful in febrile financial conditions and some might associate it with rats leaving sinking ships.

What to watch for next week

Sunday 1st June, the start of the US hurricane season, is the tenth anniversary of the founding of the ECB and the single currencyand EU finance ministers meet in Frankfurt Monday. Japan publishes April Labour Cash Earnings, the UK its Consumer Credit, May Manufacturing PMI, US Manufacturing ISM and April Construction Spending. Tuesday UK May Construction PMI, EZ15 April PPI and Q1 GDP, US April Factory Orders, May Car Sales while the Reserve Bank of Australia decides on rates (expect unchanged at 7.25%). Wednesday GB May Consumer Confidence, BRC Shop Price Index, Services PMI, Eurozone April Retail Sales, US May Challenger Job Cuts, ADP Employment Change, Q1 final Productivity and Unit Labour Costs. Later the Reserve Bank of New Zealand decides on rates (unanimously expected unchanged at 8.25%). Thursday German April Factory Orders and the Bank of England and ECB decide on rates (both expected unchanged). Friday German April Industrial Production, US Wholesale Inventories, May Non-Farm Payroll and Unemployment.

Positioning and Technical Analysis

Treasury yields should retreat, possibly very sharply, after this week’s squeeze. The only reason we can imagine they are up where they are is because possibly banks are selling anything of value to raise cash. While inflation is a very real threat, and ‘stagflation’ a possibility, the tottering financial system is a closer and more tangible danger. Money markets will remain tight and may well seize up even further. Commodities and the US dollar will continue to correct and consolidate; currency crosses will be a lot more interesting.

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Published on  Mon, Jun 2 2008, 06:15 GMT

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Mizuho Corporate Bank  | 1-3-3, Marunouchi, Chiyoda-ku, Tokyo 100-8210
http://www.mizuho-cb.co.uk | Nicole.Elliot@mhcb.co.uk