A View from the Bridge - August 2013

The threat of a western air strike on Syria spooked the global markets with most stock markets drifting lower and oil and gold prices heading upwards. However, in emerging markets it was the battle against rapidly falling currencies that took centre stage, resulting in the central banks of India and Brazil in particular fighting to prop up their currencies by direct intervention of nearly $60bn each and by raising interest rates, with Brazil raising rates for the 4th time since April to 9%. In the year to date the Brazilian Real has dropped 20% and the Indian Rupee and Turkish Lira 15% vs the US$, bringing back memories of the Asian crisis of 1997/98.

In both Europe and the UK the central banks left interest rates unchanged but it was the latest incarnation of QE and the concept of “forward guidance” by the new BoE governor Mark Carney that dominated the economic headlines. The intention now is to link interest rates to an unemployment level of 7% (which is seen as a proxy for the rate of economic output) and which, according to BoE growth forecasts would keep interest rates low for another 3 years; longer than the current market expectation of rates rising in the latter half of 2015.

There are also a couple of “knockouts” included such that the:

i) current tolerance for above target inflation could be put aside if the inflation rate threatens to rise above 2.5% in the medium term and

ii) the MPC is ready to undertake further asset purchases through the QE programme while the unemployment rate remains above 7% and further stimulus is warranted.

Against this background we have seen that the UK recovery may be taking hold with Q2 GDP revised upwards to 0.7% and the UK service sector at its strongest since 2007.

Forward guidance had no impact on near term rates which remained pretty much unchanged (3mth closed at 0.515%, 6mth closed at 0.59%). The same could not be said for Fixed Term rates (longer than 1 year) which all moved higher , 5 Years closed at 1.71% (+32bp), 10 years closed at 2.687% (+23bp), 20 years closed at 3.24% (+8bp) and 30 years closed at 3.31% (unchanged)).

UK Government Bond were slightly lower. The 10 year UK Gilt Benchmark closed at a yield of 2.79% and the 30 year UK Gilt Benchmark closed at a yield of 3.59%.

GBP future inflation expectations expressed through 20 year Inflation Swaps traded within a range with a low of 3.62% ,a high of 3.72% and closing again at 3.70%.

In the Foreign Exchange Market GBP was higher against the USD$ at 1.5473(1. 5180) and higher against the EURO at 1.1728 (1.1431)

In the credit markets UK Banks 5 years CDS spreads ended mixed with RBS ended at 172bp (-9bp), Lloyds 143bp (+6bp) , Barclays 134bp(+11bp), Nationwide 115bp (-1bp), HSBC 106bp (+14bp) and Santander UK 154bp (-2bp).