Overview
European interest rates led the way up, many reaching their highest point in several years. German Schatz at 4.345% is back to June 2002 levels and Swiss ten-year Conf over 3.00% likewise. These dragged UK ten-year Gilts up to 5.25% (highest since June 2004), UK 3-year Swaps to over 6.00%, and benchmark US TNotes far less dramatically to 4.90%. Emerging market bonds were largely unaffected by these moves. Equity indices, which started the week on a positive note rallying to new recent highs, eventually woke up to the threat of higher rates and closed a little lower on the week. The move may have also been helped by Mr. Alan Greenspan who described Chinese shares as, ‘clearly unsustainable…there is going to be a dramatic contraction at some point’. China B shares retreated from 381 to 278 closing at 323 today, but there was zero effect on Shanghai’s Composite Index. Exceptions as always: South Korea with a strong close at a new record high, Germany within a whisker of its all-time high of March 2000 (8136), and a strong performance from Finland. Currencies generally were quiet with corrective US dollar strength for most. The Canadian dollar gained to C$1.0800 to its US counterpart, its strongest since the mid-1970’s. Sterling improved against the US dollar and the Euro (to £0.6758) on M&A flow and hawkish Minutes from the Bank of England (unanimous vote for a rate rise). Base and Precious Metals retreated a little for the third week in a row, and CBOT Soybeans, Soybean Oil and Oats are at multi-year extremely expensive levels, while Wheat is probing key resistance at 500 cents per bushel. Spot Brent Crude is trading at over $72.00 per barrel and gasoline pumps across America are charging a record average price of $3.22 per gallon.
Political and Economic Developments
More pain for US house builders: April New Home Sales rose 16% from March’s extreme low, but at the expense of profits. In order to get supply down to 6.5 months’ worth, prices had to be slashed by 11% Y/Y, the biggest discount since 1970. Note that stocks remain well above the 4 months’ norm of 2001-2005. Existing Home Sales dropped to 5.99M, lowest since June 2003. The United Nations atomic agency watchdog said Iran had accelerated its nuclear programme. The Pentagon sent dozens of warships and thousands of soldiers to the Persian Gulf. Iran’s nuclear negotiator meets the EU’s Javier Solana for talks on the 31st May. If these break down further economic sanctions will probably be called for.
Underlying Themes
A stroke of genius and impeccable timing from China this week. Three billion dollars from its ballooning FX reserves of US$1.2 trillion will be invested in Blackstone Group LP, a large US private equity firm. The move allowed the founders to nearly double the planned $4B IPO to $7.8B, gives them a one-year lead into the country, and valuable expertise for the investors. In the week that a top Chinese delegation headed by Vice Premier Ms Wu Yi came to Washington for talks, and US Treasury Secretary Paulson is being pressured by Congress, this is one sure fire sweetener. Now the press and other funds are salivating at the thought that not just China, but other Asian central banks will diversify their holdings. With a total pool of US$3,300 billion it looks as though the asset ‘bubble’ will roll on. By the way, the three day talks ended with little progress made.
What to watch for next week
Monday 28th May, Whit Monday, there are holidays in many European countries (including the UK) and in the USA (Memorial Day marking the start of the ‘driving season’). Nevertheless it is a busy week for economic releases. Tuesday Japan’s April Jobless, Overall Household Spending, Retail Trade and May Small Business Confidence. UK May Nationwide House Prices, US Consumer Confidence, Eurozone March Current Account and the Bank of Canada decides on rates (unanimously expected unchanged at 4.25%). Wednesday Japan April Industrial Production, German Retail Sales, Eurozone M3 Money Supply, US May ADP Employment Change, Minutes of the FOMC’s May 9th meeting and the Norges Bank decides on rates (expected +25 basis points to 4.25%). Thursday Japan April Labour Cash Earnings, Housing Starts and Construction Orders, UK May GfK Consumer Confidence, CBI Survey and April Net Consumer Credit. Then German May Unemployment and Eurozone Confidence Surveys, US preliminary Q1 GDP, April Construction Spending, Help Wanted Index and May Chicago Purchasing Managers. Friday 1st June May Manufacturing PMI’s for several European countries, Eurozone Q1 GDP, US April Personal Income and Spending, PCE Deflator, Pending Home Sales, May Non-Farm Payrolls and Unemployment, plus Manufacturing ISM.
Positioning and Technical Analysis
The ‘carry trade’ did not work this week and is unlikely to work the next one. Although there are few clear signs of topping, we continue to urge extreme caution as a corrective move lower is what we still favour. This may snowball into something quite dramatic, especially in the thin summer holiday months. Major currencies should again try to form interim bases against the US dollar which will eventually see them strengthen later this quarter. Moves in Eurozone interest rates look and feel like some sort of ‘extension’ and we shall be watching for a dramatic reversal any day now.
