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More blood on the streets of financial markets yesterday and overnight, with risk assets reversing still further and safe haven currencies and bonds smelling like roses. Interestingly, while the dollar remained very much in favour and money poured into US treasuries, it was actually the Japanese yen that shone even more brightly. Indeed, USD/JPY is now below 79, which no doubt will both alarm and disappoint Tokyo in equal measure. Although bond yields for Europe’s fiscal miscreants soared, the price action in the single currency was more measured, as it drifted gradually down below 1.24, a fresh 2yr low. High-beta currencies such as the Aussie fared worse –it fell below the 0.97 level overnight. In general, May has been a dreadful month for emerging currencies – for instance, the likes of the Russian ruble and the Polish zloty have suffered a 10% decline thus far, while the Indian rupee has dropped to a record low. Likewise, commodities have been hard hit – Brent crude fell to USD 103.34 overnight, down more than 3% over the past 24 hours, while the copper price lost another 2.5%.
Get me out (of Spain, Italy, Greece...)! Spain was again the centre of attention in financial markets yesterday after various news reports claimed that the ECB had told the central government that its proposed bailout of Bankia was a very bad idea. Subsequently, the ECB declared that they have not been consulted on the plan. Either way, confusion reigns supreme in Spain right now with respect to how to fix the broken banking system. Sounding increasingly desperate, we even had the Economy Minister De Guindos suggesting that the FROB bank fund would be used to recapitalise Bankia, which on the surface sounds a stretch given that the FROB has a few billion euros available while Bankia needs almost EUR 20bn. To add to the panic and pessimism, we also had the departing BOS Governor declaring that the country faced a crisis of confidence. Spanish bond investors continued to sprint for the exit, with the 10yr yield climbing another 25bp at one stage to 6.66%, and the 5yr yield trading above 6%. Alarmingly, short-dated yields rose more rapidly than those at the longer end – the 2yr yield jumped 32bp to 4.95%. The financial cancer in Spain spread to their surrounding Mediterranean neighbours, with the 10yr yield in Italy reaching 6%. Like Spain, the short end was crucified, with the 2yr yield up 45bp at 4.53%. Auctions held yesterday in Italy went badly, with very tentative bidding and a weak bid/cover. Meanwhile, G4 bond markets continue to register new record lows in yield. The 10yr Bund yield fell to just 1.25%, the US 10yr yield declined to 1.62%, and the 10yr Gilt yield is now just 1.64%. After two years of largely unsuccessful fire-fighting, European leaders are clearly unable to fashion a cohesive and comprehensive response to their sovereign debt and banking crisis, especially now that it has spread like a brush-fire through both Italy and Spain. The way things are headed, it will not just be Greece that is soon forced to reintroduce their own currency.
The UK credit contraction. Some interesting numbers out of the UK yesterday, although you have to dig around a bit to find the real story. On the lending side, the numbers up to April offer further confirmation that the contraction in bank balance sheets is feeding through into the wider economy. The fall in credit card lending in April (GBP 118m) was the largest since Aug-06; credit card lending has fallen in 4 of the past 6 months. There is also the impact we’re seeing on rates, mortgage rates in particular. The Bank’s data shows that 2 year fixed rates (75% LTV) rose for the six months up to April of this year, with 3.66% being the highest rate for a year. Whilst gross mortgage lending is not falling in response, it remains pretty moribund, April’s GBP 12.5bln only just above the average of the previous 6 months. On the lending side at least, the data continue to illustrate the fact that even though the Bank rate is at a record low and the Bank of England has pumped more money into the economy over the past 8 months, it still feels very much like a credit crunch for households. The other angle to the data is gilt purchases by the overseas sector. Yesterday’s data shows that they were again net sellers of gilts in April, but the pace slowed, from GBP 1.73bln of sales in March to GBP 1.28bln in April. It’s likely that this figure could well have turned positive this month on the back of the further turmoil in the eurozone and the performance of the sterling. Still, despite record lows on yields and better trends on overseas buyers, it’s not something the UK are going to be celebrating given the contagion risks from events in the eurozone.
No escape for the Aussie. The Aussie fell back below 0.97 overnight in response to the latest swing towards risk avoidance, in part triggered by a report in the Asian press claiming that Chinese policy officials were not contemplating a sizeable fiscal stimulus in response to the recent deterioration in the economy. Risk appetite was also tempered by various reports suggesting that the ECB has ruled out controversial plans mooted by the Spanish government for the rescue of Bankia. Domestically, the economy continues to struggle as well, with retail sales declining by 0.2% last month. Indeed, excluding food, retail sales actually declined in real terms in the year to April. Aussie consumers have been hibernating for some time now, beset by falling real income growth, a moribund labour market, declining house prices and falling wealth. It remains a close call as to whether the RBA will lower the cash rate again when they meet next week, having already reduced it by 50bp just four weeks ago. Perpetuating the Aussie’s demise this month has been a dramatic capitulation on the part of traders. From a significant net long position in the Aussie in the first week of this month, traders and short-term speculators have switched to their largest net short position for almost four years. Unfortunately, this is likely to be the new normal for the AUD over coming months. For the first time in a very long while, the Australian currency may now be a sell-on-strength, rather than a buy-on-weakness.