Europe
A continuation of the sell-off in government bonds and a sharp drop in the US dollar sent equity markets into risk-off mode on Tuesday.
Bond yields had been rising all last week before a huge one day reversal on Thursday, May 7 and left many wondering if the move was over. The reversal didn’t last long- the US 10 year treasury yield broke its May 7 high on Tuesday while German bunds and UK gilts were close to breaking theirs.
German bunds yields are rising faster than US treasuries yields and closing the interest-rate advantage of US debt over European debt. US dollar-denominated assets are now becoming relatively less appealing than the equivalent European assets.
This unwinding of the yield differential between treasuries and bunds is driving EUR/USD higher which in turn is causing a drop in the German DAX stock index. German stocks, mirroring the wider economy tend to be export-orientated and are sensitive to moves in the euro, which up until recently had been falling because of quantitative easing by the ECB.
The sell-off in bonds might lead to asset re-allocation to stocks and boost stock markets, particularly those with a strong dividend payout in the medium term. In the short term, the lost bond market liquidity thanks to central bank intervention coupled with higher leverage chasing capital returns instead of income means a mass liquidation of risky assets as everyone fights for the exit door.
It was confusion and scepticism rather than relief that met Greece’s early loan repayment of 750m euros to the IMFon Tuesday. It appears Greece made its payment to the IMF using emergency SDR IMF reserves- so in effect the IMF paid itself. The emergency funds available to all nations that deal with the IMF are legitimate, but it’s doubtful the original intended use of the facility was for countries to pay the IMF itself. If anything, the fact that Greece couldn’t find the funds itself shows just how close to the brink it is.
Anecdotally, if any further evidence of bubbly asset prices were needed, one need not look any further than the fine art market with a Picasso painting selling for $179m, making it the most expensive painting ever.
The post-election rally in the FTSE 100 came to an abrupt end this week with price action on Tuesday taking the index below the open on Friday. Easyjet was a top faller, down over 10% after the airline said the disruption from the French air traffic control strikes in April cut profits by £25m.
US
US stocks opened lower in sympathy with those in Europe. The potential benefits of a weaker dollar for US-based international conglomerate exports meant the declines started to get eroded as the morning progressed.
A little M&A fever also helped with Verizon buying AOL for $4.4bn in a push to compete in the growing mobile TV / advertising industry currently dominated by the likes of Netflix (NASDAQ:NFLX).
FX
The British pound built on the positive momentum from general election, trading higher against the dollar and Japanese yen after industrial production data for March beat expectations. GBP/USD traded above 1.57 to the highest since before Christmas.
The pound was lower against the euro which was leading FX gains due to the spike in European government bond yields and narrowing yield differential with US treasuries. EUR/GBP made it above 0.72 but traded off its highs while EUR/USD was trading higher towards 1.13 after three days of declines.
Positive Australian housing data boosted speculation of no more rate cuts to come from the RBA following the 25 basis point cut this month and propelled the Aussie dollar higher. AUD/USD traded just shy of the 0.80 round number.
Commodities
The plunge in global equities coupled with rising inflation expectations finally had some impact on gold, which as a safe-haven and inflation hedge, traded as much as 1% higher on Tuesday.
Crude oil prices reached the highest in two days ahead of API inventories data as the fall in the US dollar helped most commodities higher.
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