12 October 2012 Global equity markets returned 1.6% in local currency terms for the week ending 5 October 2012. Global government bond and high yield markets were marginally down for the week in US dollar terms. Oil prices, were down slightly for the week. The euro strengthened and the yen and Australian dollar weakened, while sterling was broadly flat. It appears that we are in hiatus, helped by an absence of news flow from central banks and politicians alike. Such periods of calm have been rare over the last five turbulent years, but they have also been the prelude to big moves in equities, bonds and currencies. The economic fundamentals are not giving clear signals to investors about whether they should be taking on more risk that will be rewarded with increased returns, or if they should think about reducing risk to preserve capital. Political events to tempt market movements The major events alluded to, and mentioned in previous commentary, were the policy decisions by the US Federal Reserve (Fed) and European Central Bank (ECB), with both turning out to be open to innovation with monetary policy – and purchasing bonds previously thought off limits. These were mortgage-backed securities in the Fed’s case and short dated sovereigns for the ECB. There is now an explicit understanding that both bodies can and will do whatever it takes, with the Fed targeting stronger economic growth and the ECB preserving the eurozone. The next events on the horizon are the US presidential election, which has implications for a potential resolution of the US “fiscal cliff,” while there is also the Chinese leadership transition. Meanwhile, Spanish prime minister Rajoy may sooner or later officially request financial aid for the country. In Europe, Spain continues to move towards a bail-out and appears to be implementing the conditions required by Germany and rest of Europe before requesting help. Spanish auctions went well last week, adding to the German thesis that the bond markets could be calm due to Spain's 2013 budget and economic reform law proposals.
Internal politics keeping Spain at bay On Friday last, Spanish 10-year bond yields fell sharply, to end the week 35 basis points lower at 5.69%. There is speculation that Rajoy’s delay in requesting the bail-out is a result of internal political wrangling ahead of looming local elections. German Chancellor Merkel is expected to show unity and support to Greece’s inclusion in the eurozone despite recent demands for more policy action to achieve bail-out targets. The risk of a re-escalation of the crisis is low as the EU and ECB bond buying moves should keep "contagion" at bay. In the US presidential election, Romney came out fighting last week, beating President Obama in the first of the live television debates, also experiencing a rise in popularity in the polls. However, Obama still commands a significant lead and he is now getting more support from the economy; the unemployment rate is falling and the housing market no longer a drag - even recovering in certain areas. Homebuilding is indeed the best-performing US industry sector, up over 50% year to date. On the economy, the US economy is key to global GDP growth, given euro area expectations are very downbeat outside Germany and China continues to slow. Global manufacturing remains subdued, with purchasing managers surveys weak in many countries, including China. In France, the PMI survey saw one of the sharpest monthly declines since the survey began in 1998. Fiscal cliff resolution In the US, we are seeing a stabilisation of the recent soft data through the second and third quarters of this year. This is being backed up by improving ISM (measure of US manufacturing activity), strong new car sales, company surveys, better housing data, and a drop in the unemployment rate. There is some deferral of capital expenditure and employment by companies sighting lack of clarity around the tax regime next year, which is why there is some concern over how and when the US fiscal cliff is resolved after the US presidential election. Currencies On currency markets, the euro remained close to a two-week high against the dollar after comments from ECB President Mario Draghi last Thursday encouraged European leaders to increase their debt-buying plan. The €/$ rate ended the week at €1.31, a gain of over 1%. Oil & Commodities The West Texas oil price retreated 2.5% lower over the week, finishing at under $90 a barrel. This came amid concern that the global economic outlook in addition to worries that increasing geo-political tensions could lead to a disruption in Middle East oil supplies. Elsewhere, the gold price ended the week, 0.5% higher at $1,781.
Bonds Better-than-expected economic data and a further reduction in eurozone risk aversion boosted appetite for risk assets at times last week. Spain’s ten-year bond yield fell 25 basis points to around 5.72% which is still below 7.5% level reached in July. Overall, the Merrill Lynch over 5 year government bond index ended the week 0.2% higher. Source: Aviva, Blackrock, Bloomberg, Zurich Investment Managers & FT.com