09.11.09 1 Market Snapshot: Summary of rate movements and important - - PowerPoint PPT Presentation

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09.11.09

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Economics Watch:

Market Snapshot: Summary of rate movements and important announcements

Monday: BoE 2020 – 2032 reverse gilt auction Tuesday: UK RICS housing market survey, price balance UK BRC retail sales monitor, total sales, % y/y UK trade balance (£ billion) 2019 Gilt Auction Wednesday: UK BoE publishes quarterly Inflation Report UK Claimant Count Unemployment, change ‘000 UK Average earnings growth, % 3m y/y BoE 2013 ‐ 2019 reverse gilt auction Thursday: UK Linker 2032 auction US initial jobless claims Friday: Euro zone “flash” GDP, % q/q US Trade Balance, $ billion

Source: Barclays Capital

Contents:

Last week Economics Watch 3 Equities 4 Credit 5 Nominal Yields 6 Inflation 7 Real Yields 8 Other News: Property market upturn 9 Spotlight on Central Banks Appendix 10 11

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Last week Economics Watch

02‐Nov‐09 UK Manufacturing PMI Index 53.7 03‐Nov‐09 UK Construction PMI Index 46.2 04‐Nov‐09 US FOMC rate decision Maintain the target range for fed funds rate at 0 to 0.25% UK Nationwide consumer confidence index 72 points UK Services PMI Index 56.9 05‐Nov‐09 UK BoE MPC Bank Rate decision Maintain official bank rate at 0.5% and extend Quantitative Easing programme by £25 billion Euro zone ECB rate announcement Maintain the key rate at 1% UK Industrial Production, % m/m (y/y) 1.6% m/m (Sep) UK Manufacturing Production, & m/m (y/y) 1.7% m/m (Sep) Euro zone Retail Sales, % m/m ‐ 0.7% US initial jobless claims 512,000 06‐Nov‐09 US Change in non‐farm payrolls ‐190,000

Key data released last week

• Equity markets in the UK and US ended the week on a high with the FTSE 100

increasing by 1.9% and S&P 500 rising by 3.2% over the last week . The VIX index (CBOE volatility index) decreased over the week and ended at 24.19% .

• The key focus for this week was the Central Bank meetings (see slide 10)
• Fed Committee maintained the target funds rate at 0 – 0.25% and hinted

at rate being low for an extended period of time

• Bank of England maintained official rate at 0.5% and extended its

Quantitative easing programme by £25 billion. The FTSE 100 reacted to the news by recovering its early morning losses and ending the day up 0.35%.

• ECB maintained its key rate at 1.00%. The committee acknowledged the

high uncertainty in the market but expects the euro area to recover at a gradual pace in 2010

• Mixed economic data continued to be released during the week with equity

markets moving up and down.

• UK manufacturing PMI index rose to 53.7 in October from 49.9 in

September indicating that the sector is expanding;

• British construction activity fell at a slightly faster pace in October than it

had in September (PMI index dropped to 46.2 in October from 46.7 in September);

• UK services PMI index rose to 56.9 in October from 55.3 in September;
• US Non‐farm payrolls decreased by 190,000 and unemployment jumped

to a 26‐year high of 10.2% in October, more than the expected decline.

Source: Bloomberg, Redington

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Equities : “FTSE 100 ends week up...”

Figure 1: Total Return on major Equity Indices Figure 2: VIX Index

Source: Bloomberg, Redington

• Credit was resilient this week despite mixed news flow and rising volatility,

possibly on the back of strong technicals. Over the last week, corporate spreads as measured by the Barclays Sterling Non‐Gilt corporate index widened by 2 bps for AA but narrowed by 5 and 3 bps for A and BBB respectively.

• On a sector basis, sub‐financials and cyclicals tightened by 14 bps and 3 bps

respectively while spreads widened on senior‐financials, non‐cyclicals and telecoms by 2, 4 and 2 bps respectively.

• The main focus of this week was the regulatory‐driven changes at Royal Bank
• f Scotland (RBS) and Lloyds Bank.
• RBS: Key terms of the Asset Protection Scheme (“APS”) were

restructured such as increase of first loss on pool to £60 billion from previous£42.2 billion; replacing the initial fee of £6.5 billion with annual fee of £700 million for 2009‐11 and thereafter of £500 million

• Lloyds: Lloyds will pay £2.5 billion to avoid joining APS and will raise

£21 billion including £13 billion via a government‐underwritten rights issue and £7 billion via an exchange offer into contingent‐capital notes.

Figure 3: Corporate Spreads by Rating Figure 4: Barclays Sterling Non‐Gilt by Sector

Source: Barclays Capital, Redington

Credit: “Credit remains resilient amidst mixed news flow...”

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Source: Barclays Capital, Redington

• Nominal swap rates remain above gilts at all maturities up to 25 years (Figure

5). Over the last week, both gilt yields and swap rates increased across the curve by about 18‐26 bps (5y‐50y points)

• Swap spreads at the short end of the curve (2y point) widened by around 12bps

while in the middle of the curve narrowed by about 1‐2 bps. At the very long end, the swap spread increased by about 1‐2 bps as swap rates increased by more than gilt yields (Figure 5)

• This week will be the first week of new Quantitative Easing schedule with Bank
• f England buying back £1.7 billion of 10‐25 years gilts on Monday (09‐Nov‐09)

and another £1.7 billion of 3‐10 years gilts on Wednesday (11‐Nov‐09).

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Nominal Yields: “Nominal Yields rise across the curve...”

Figure 6: Nominal Swap Spreads (Z‐spreads) on Selected Gilts

Source: Barclays Capital, Redington

Figure 5: Nominal Term Structure of Gilts vs. Swaps

Source: Bloomberg, Redington

• Gilt breakeven inflation increased by about 10‐15 bps across the curve with the

highest increase at the 30y point

• Swap inflation moved by less than gilt breakeven, rising by about 6, 11, 8 and 12

bps for the 10y, 20y, 30y and 50y point respectively. The gap between Gilt Breakeven Inflation and Swap Inflation narrowed in the front end while widened in the long end.

• The big event of the week will be Bank of England’s Quarterly Inflation Report
• n Wednesday. The report sets out the detailed economic analysis and inflation

projections on which the Bank’s Monetary Policy Committee bases its interest rate decisions, and presents an assessment of the prospects for UK inflation1.

Figure 8: Swap Inflation‐ Gilt Breakeven Inflation 7

Inflation: “Breakeven Inflation rises...”

Figure 7: Gilt breakeven inflation term structure vs. swaps

Source: Barclays Capital, Redington Source: Bloomberg, Redington

1Source: Bank of England website

• Swap real yields remain roughly the same as gilt real yields up to around 15
• years. From 15‐45 years, gilt real yields remain above swap real yields after

which the difference disappears (Figure 9).

• The difference in real yields may be driven by differences in swap and gilt

breakeven inflation.

• Z‐Spreads are the weighted average constant spread added to the swap zero

curve to get the market price of the gilt. They are used as a relative value measure between cash and the swap market.

• Z‐spreads on linkers remain positive, but over the week have decreased by

around 4 bps for IL2020 and about 8 bps for IL2037 and IL2055 (Figure 10).

• The decreasing z‐spreads on long end linkers, which are close to 0 now ,suggest

a disappearance of relative value between cash and the swap market. The z‐ spreads on long ended gilts on the other hand still are at around 10 bps.

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Real Yields: “Z‐spreads on linkers decrease...”

Figure 10: Z‐spread on selected linkers

Source: Barclays Capital, Redington

Figure 9: Real Gilt yield term Structure vs. Swaps

Source: Bloomberg, Redington

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“Direct and synthetic property market upturn in Q3”

UK Property market seems to have revived in the recent months after the crash following Lehman collapse in September last year. According to the press release of the quarterly briefing breakfast meeting on 3 November 2009, jointly hosted by IPD and IPF, all three property sectors (retail, office, industrial) had delivered positive capital growth for the first time since the second quarter of 2007 over the three months to September. According to the IPD UK Quarterly Property Index, the 1.5% positive capital growth recorded over the third quarter was the largest quarterly figure since Q4 2006. A modest upturn was also confirmed in the synthetic market with IPD’s Head of Indices Angela Sheahan mentioning that Q3 global property derivatives trading volumes were the strongest this year – with £762m worth of contracts executed in 78 trades and UK still dominating, accounting for £670m in 69 trades. UBS Portfolio Manager Sam Sananes explained the enduring popularity of central London and West End offices despite their volatility. He told delegates: “The weak sterling has driven

• verseas investors in – UK central London offices seem good value and there has always been an

appetite for offices among that investor base. Domestic investors will more gradually start to show more interest as the rental story improves, which I expect it will.” Nick Scarles, Chairman of the IPF PDIG and Grosvenor’s Group Finance Director, said: "This quarter’s derivative volumes show a continuation of the gradual market recovery, both in absolute terms and relative to the level of direct property transactions. While the substantial reduction in the number of transactions has been balanced with an increase in average deal size, what stands out is a significantly increased market participation by end users” Deutsche Bank’s Senior Trader Charles Harris told delegates: “End user activity has leapt up across the board. There are different rationales for trading now: from asset managers looking to rebalance portfolios, to investors seeking protection against further falls, while some will simply be looking for a quick property market exposure. According to Alpha Beta Fund Management’s Founding Partner Robert Page, who also spoke at the briefing, there was an estimated £150 million worth of notional UK residential derivative contracts traded against the Halifax House Price Index over Q3. Page said: “To be able to buy PUT and call options on house prices will become increasingly useful for both debt markets as well as the wider real estate sector.”

Source: IPD IPF Forum Press Release 04 Nov 09

Other News:

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“Spotlight on Central Banks”

The Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage‐backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace

• f its purchases of both agency debt and agency mortgage‐backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.

Excerpt from press release by Federal Reserve Excerpt from press release by Bank of England

The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to continue with its programme of asset purchases financed by the issuance of central bank reserves and to increase its size by £25 billion to £200 billion. On balance, the Committee believes that the prospect is for a slow recovery in the level of economic activity, so that a substantial margin of under‐utilised resources persists. That will continue to bear down on inflation for some time to come, offset in the short run by the impact of the past depreciation of sterling. In the light of the Committee’s latest Inflation Report projections and in order to keep inflation on track to meet the 2% inflation target over the medium term, the Committee judged that maintaining Bank Rate at 0.5% was appropriate. The Committee also agreed that it should extend its programme of purchases of government and corporate debt by £25 billion to a total of £200 billion, financed by the issuance of central bank reserves. The Committee expects the announced programme to take three months to complete. The scale of the programme will be kept under review. On the basis of its regular economic and monetary analyses, the Governing Council decided to leave the key ECB interest rates unchanged. The current rates remain appropriate. The incoming information and analyses that have become available since our meeting in early October have confirmed our expectations. While annual HICP inflation was ‐0.1% in October, according to Eurostat’s flash estimate, it is expected to turn positive again in the coming months and to remain at moderately positive rates over the policy‐relevant

• horizon. At the same time, the latest information continues to signal an improvement in economic activity in the second half of this year. The Governing Council expects the

euro area economy in 2010 to recover at a gradual pace, recognising that the outlook remains subject to high uncertainty. Medium to longer‐term inflation expectations remain firmly anchored in line with the Governing Council’s aim of keeping inflation rates below, but close to, 2% over the medium term. The outcome of the monetary analysis confirms the assessment of low inflationary pressure over the medium term, as money and credit growth continues to slow down. Against this background, we expect price stability to be maintained over the medium term, thereby supporting the purchasing power of euro area households.

Excerpt from press release by European Central Bank

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Appendix: Summary Tables

Figure 11: Growth Assets Figure 12:Traditional Liability Matching Assets:

* In normal market conditions, z‐spreads on linkers are negative (a negative spread must be added to the swap zero curve to get the market price of the gilt). Last year this trend had reversed although the effects of QE are helping to reduce z‐spreads.

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** * * *IPD Property Index is as of September

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