1.

Market news & comment

CARRY TRADE FALLS OUT OF FAVOR
By Neil Dennis

Financial Times (UK)
November 10, 2007

http://www.ft.com/cms/s/0/3dd7db3a-8f30-11dc-87ee-0000779fd2ac.html

High-yielding currencies were on the end of a severe thumping yesterday as equity market turmoil caused a retreat from carry trade positions.

The carry trade, where low-yielding currencies such as the yen are sold to fund higher-yielding purchases, is a risky strategy, as yield-based gains can be wiped out instantly by volatile price swings.

The sense of panic caused by tumbling global stock indices left the Australian dollar down 3.5 per cent against the yen, even though the currency was supported by this week's 25 basis point increase in Australian interest rates to 6.75 per cent.

Over the week, the Aussie fell 4.2 per cent to Y101.39. The New Zealand dollar fell 2.7 per cent yesterday, and was off 3.1 per cent over the week. Sterling fell 3.3 per cent over the week to Y231.96 and the euro was off 2.5 per cent to Y162.40.

Switzerland's low-yielding franc, another favored funding currency for the carry trade, rose 2.8 per cent against the dollar to SFr1.1218 over the week and by 2.3 per cent to SFr2.3543 against the pound.

The dollar fell 3.4 per cent to Y110.88 on the week amid rising concerns that the market turmoil would weaken the U.S. economy and force the Federal Reserve into further interest rate cuts.

Ben Bernanke, Fed chairman, speaking on Thursday to the Congressional Joint Economic Committee, expressed heightened concerns that weakness facing the financial and housing markets could hurt U.S. economic growth.

Although inflation was still a concern, Mr. Bernanke said growth would slow "markedly" this quarter and would remain "sluggish" during early 2008. His comments raised expectations of further near-term rate cuts.

"We believe that the risk posed by continued dislocation in financial markets, and subsequent tightening credit conditions will prompt the Fed to ease more than is currently expected," said Lee Hardman, at Bank of Tokyo-Mitsubishi UFJ.

The European Central Bank, on the other hand, was not expected to cut rates any time soon after Jean-Claude Trichet, ECB president, said on Thursday that the bank was still concerned over inflation. This verdict on the eurozone economy came after the ECB announced it was keeping interest rates at 4 per cent.

The euro was up 1.3 per cent over the week at $1.4692, having reached a new record yesterday of $1.4752.

The dollar was sold most heavily on Wednesday after a Chinese politician said the country's central bank should take advantage of strong currencies to counter the weakness of the dollar in China's $1,430bn reserves.

U.S. economic data was mixed. The trade deficit narrowed unexpectedly sharply to $56.4bn in September. "We expect the deficit will continue to narrow as the weak dollar boosts exports and weakens import demand," said Richard Snook, at the Center for Economics and Business Research.

Sentiment was dented after consumer confidence measured by Michigan University fell to a 25-month low.

The Bank of England also resisted calls to lower its main interest rate on Thursday, holding at 5.75 per cent, amid continued worries about high inflation.

Sterling rose 0.9 per cent over the week to $2.1004, having hit a 26-year peak of $2.1161 yesterday.

The pound was down against the euro as data, including house prices and trade figures, came in on the weak side.

The euro was up 0.8 per cent over the week to £0.7001.

2.

Markets

GLOBAL OVERVIEW: CREDIT TURMOIL DENTS SENTIMENT
By Dave Shellock

Financial Times (UK)
November 9, 2007

http://www.ft.com/cms/s/0/339fe314-8eeb-11dc-87ee-0000779fd2ac.html

The mood in financial markets took a turn for the worse this week as mounting worries about credit losses were exacerbated by inflation fears as commodities prices soared and the dollar plunged.

“The crisis in the financial sector is deepening and this is being reflected in the markets,” said Peter Oppenheimer, European strategist at Goldman Sachs.

“There is growing uncertainty about how deep the exposure of banks is to the credit market and subprime problems.”

Wachovia, the fourth-biggest U.S. bank, warned on Friday of about $1.1bn of losses on mortgage securities in October alone, and Barclays shares came under intense pressure from persistent rumours that it had suffered huge losses in the credit markets. The U.K. bank denied the talk but financial stocks across the globe suffered steep losses.

However, Julian Jessop at Capital Economics pointed out that the recent grim headlines from the financial sector should not have come as that much of a surprise.

“After all, the total losses facing the financial sector were put as high as $200bn by the International Monetary Fund as early as September, and Barclays -- recently ranked the world’s second-biggest bank by asset size -- might reasonably be expected to take a fair share,” he said. “The bigger picture therefore does not seem to be significantly worse than originally feared.

“Nonetheless, it looks like equity markets will continue to be rattled by headlines and rumors about what the crisis means in practice for individual banks.”

The weakness in financial stocks was the main factor behind sharp losses for global equity markets this week.

On Wall Street, the S&P 500 index was down 3.2 per cent over the week and the Dow Jones Industrial Average was 3.4 per cent weaker. However, technology stocks, previously largely immune to the credit nerves, were also hit as fears of a slowdown in capital spending accelerated. The Nasdaq Composite index shed 5.9 per cent.

In Europe, the FTSE Eurofirst 300 fell 3.1 per cent over the five-day period, while the Nikkei 225 Average in Tokyo shed 5.5 per cent.

Meanwhile, inflation concerns were stoked by strong gains for commodity prices. December West Texas Intermediate, the U.S. crude benchmark, touched a record high of $98.62 on Wednesday before easing. Gold hit a 28-year peak of $844.65 an ounce -- within a whisker of the record high of $850 struck in 1980. Silver reached a 27-year high and platinum reached a record peak.

These gains were helped by a renewed slide for the dollar, which fell to a record low against the euro and multi-year peaks against most other leading currencies amid mounting expectations of further U.S. interest rate cuts.

The interest rate futures market was yesterday fully pricing in a 25bp cut in the Fed funds rate to 4.25 per cent in December. A week ago, it was pricing in about a 60 per cent chance of such a move.

The heightened expectations came despite a speech to Congress by Federal Reserve chairman Ben Bernanke in which he reiterated concerns about mounting inflationary pressures.

“The Fed is watching inflation expectations very closely, which have been climbing according to Treasury Inflation Protected Securities break-even rates,” said Camilla Sutton, currency strategist at Scotia Capital.

“However, Mr. Bernanke said nothing to suggest that a rate cut isn’t on the table at next month’s meeting should conditions warrant.”

The Bank of England and the European Central Bank both kept interest rates on hold this week, as expected by the markets.

Government bonds were the main beneficiaries from the turmoil. The yield on the rate sensitive two-year U.S. Treasury tumbled 20 basis points over the week and yesterday touched its lowest since February 2005.

The 10-year Treasury yield also fell to a two-year low as it retreated 9bp to 4.22 per cent. The difference between the two- and 10-year yields reached its highest for two years

The 10-year Bund yield fell 8bp to 4.17 per cent and the 10-year Japanese government bond shed 6.5bp to 1.525 per cent.