Friday, November 16, 2007

Renewed Stress Apparent in Money Markets

Persistent credit market concerns, worries about liquidity and a mixed bag of economic data ensured the mood in financial markets remained nervous on Thursday.

Barclays, the UK bank, unveiled a £1.3bn writedown on securities linked to US subprime mortgages. While this was much less than had been rumoured last week, the news failed to soothe lingering fears about the impact of the credit squeeze.

Renewed stress was apparent in money markets on both sides of the Atlantic, suggesting banks remain very reluctant to lend to each other. The two-month sterling Libor rate rose to a two-month high, while three-month sterling Libor moved to 48 basis points above the expected level of UK base rates in three months' time. Overnight dollar Libor rose 18bp to 4.955 per cent from 4.774 per cent on Wednesday.

Investors also had to get to grips with a barrage of US economic reports. "Today's mix of data was positive for the economy on net, with a particularly strong Empire State index that continued to defy credit turmoil effects," said Rick MacDonald at Action Economics.

The New York Fed's index of manufacturing activity slipped only moderately to 27.4 in November from 28.8 last month, which was the highest reading since July 2004. Data on the labour market were not quite so encouraging, however. Initial jobless claims rose by a bigger-than-forecast 20,000 to 339,000, while the four-week moving average held steady at 330,000, the highest since April. "If this soft trend extends into next week's report, it will point to a weak outcome for November payrolls," said Ted Wieseman, economist at Morgan Stanley.

US inflation figures were more benign. Headline US consumer prices rose 0.3 per cent last month while the core rate - which excludes food and energy prices - advanced 0.2 per cent. Both increases were in-line with expectations.

"Overall, core inflation remains at a level the Fed will likely be comfortable with," said Drew Matus, economist at Lehman Brothers. "While a weakening dollar and elevated commodity prices have increased inflation concerns, soft growth, weak rents and well-anchored inflation expectations suggest a turn higher in the inflation trend remains unlikely."

Headline inflation in the eurozone was confirmed at an annual rate of 2.6 per cent in October, up from 2.1 per cent in September. Core inflation edged up to 2.1 per cent. "The European Central Bank will obviously be far from happy with the October data; and it will note that even though core inflation is currently only edging up, it is nevertheless now atits highest level since mid-2004," said Howard Archer, economist at Global Insight. "Even so, we still expect the ECB to hold off from raising interest rates further."

Equity markets were broadly weaker. The Dow Jones Industrial Average took a plunge during afternoon session and closed down 0.9 per cent, while the S&P 500 was down 1.3 per cent and the Nasdaq Composite was down 1 per cent.

There were bigger losses for European and Asian stocks. The FTSE Eurofirst 300 index fell 1.1 per cent, while in Tokyo, the Nikkei 225 Average slipped 0.7 per cent and most other markets in the region shed between 1 and 2 per cent. In Shanghai, the composite index ended 0.9 per cent lower amid concerns that Chinese interest rates might be raised as early as Friday.

The uncertain mood surrounding equity markets underpinned gains forgovernment bonds. The yield on the rate-sensitive two-year US Treasury fell 6bp to 3.44 per cent; the 10-year yield was 2bp lower at 4.23 per cent.

On the currency markets, the yen staged a broad rally as weaker equities encouraged an unwinding of carry trades in which investors sell the Japanese currency to fund purchases of higher-yielding assets. The pound remained under pressure after weak UK retail sales data increased the likelihood of cuts in UK interest rates.

In commodities, oil prices retreated sharply after weekly US inventories data showed an unexpected increase in stockpiles last week. December West Texas Intermediate was hovering around the $92 a barrel mark after closing on Wednesday at $94.09. Gold fell below the $800 a troy ounce level.

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