Banks fail to deliver on growth for markets

OPTIMISM THAT global policymakers would act to ease market stresses and stimulate economic growth helped buoy equity prices and ease flows into highly rated government bonds for much of this week.

However, the failure of the European Central Bank and the Bank of England to deliver on the market’s hopes – and Federal Reserve chairman Ben Bernanke’s lack of explicit commitment to further policy easing – ultimately left the markets disappointed.

“Co-ordinated policy intervention remains as elusive at this stage of the crisis as at any previous juncture in the last three years,” said Ralf Preusser at BofA-Merrill Lynch.

Instead, the week’s most significant policy move came from an unexpected quarter as the People’s Bank of China cut interest rates for the first time since 2008.

The decision came in response to recent signs of deteriorating growth in the world’s second-largest economy.

Qu Hongbin, co-head of Asian economics research at HSBC, said the rate cut had sent out a strong message. “Beijing is determined to take every possible measure to avoid a hard landing,” Mr Qu said. “Get ready for more aggressive easing to be delivered in the coming months – which should generate a modest rebound of GDP growth to above 8.5 per cent in the second half.”

China’s move came hard on the heels of rate cuts in Australia earlier in the week and Brazil at the end of last month that highlighted mounting concerns about the potential impact on the world economy of Europe’s sovereign debt crisis.

Inevitably, Spain remained at the heart of the action as fears for its sovereign finances and banks intensified. “Over the week, it has become even more evident that the difficulties facing the banking sector in Spain are likely to force Spain to accept some sort of bailout programme,” said analysts at Danske Bank. “It is likely this package will come with less strings attached than the previous programmes for EMU countries.”

A closely watched Spanish debt auction – while relatively small – was deemed a success this week as Madrid sold more bonds than its original target range. But the yield on the 10-year paper put up for sale increased to 6.04 per cent from 5.74 per cent at the previous auction in April.

“Obtaining funding from the market at those levels is clearly unsustainable,” said Oliver Wallin at Octopus Investments. The grim outlook for Spain was further highlighted by a three-notch credit rating downgrade on the country from Fitch on Thursday.

Meanwhile, analysts warned that Greece’s difficulties were likely to return to the top of the market agenda next week as the countdown to the June 17th election begins in earnest.

And there was no room for optimism on the broader euro zone economy as purchasing managers’ data for May showed the combined manufacturing and services output for the region contracting at the fastest pace for nearly three years.

German industrial output and manufacturing orders data were also less than inspiring. The concerns over global growth highlighted by such data, plus the previous week’s dismal US jobs report and recent worrying figures out of China – allied to the subsequent lack of fresh policy initiatives from the Fed and the ECB – made for a nervous end to the week for financial markets.

Industrial commodities, in particular, came under pressure as China’s rate cut served to highlight worries about raw material demand.

The Reuters-Jefferies CRB commodity index fell 1 per cent yesterday with Brent crude oil down more than $2 a barrel on the day and nursing a modest loss over the week. Copper sank below $7,300 a tonne to a six-month low.

Gold pared the strong gains recorded in the first part of the week and moved back below the $1,600 an ounce mark as its appeal as a hedge against further US monetary easing faded.

The euro also eased back after rising to a one-week high within striking distance of the $1.26 level.

However, the single currency did manage a modest gain over the week as a whole.

Equities had a more positive week – even as the initially positive impact from the Chinese rate cut soon began to fade.

By midday yesterday in New York, the SP 500 was heading for a weekly rise of 3.5 per cent while the FTSE Eurofirst 300 index rose 2.9 per cent and the Spanish stock market leapt 8 per cent over the five-day period.

The Nikkei 225 Average in Tokyo, meanwhile, narrowly avoided a tenth successive weekly decline.

The improved sentiment towards stocks sent yields on highly rated government bonds in the US, Germany and Britain bouncing off recent record lows.

The yield on the 10-year Treasury climbed 14bp over the week to 1.61 per cent, that on the German Bund rose 15bp to 1.32 and that on the UK gilt added 9bp to 1.63 per cent.

Spain’s 10-year yield briefly fell to within sight of the 6 per cent following Madrid’s well-received debt auction.

But by the close yesterday, it was back at 6.24 per cent. – (Copyright The Financial Times Limited 2012)