Global Overview: Interest rate expectations reassessed

Global Overview: Interest rate expectations reassessed
By Dave Shellock
Copyright The Financial Times Limited 2007
Published: May 25 2007 17:45 | Last updated: May 25 2007 21:16


US and European stock markets retreated this week and government bond yields rose as investors reassessed their expectations for global interest rates.

Higher oil prices added to the pressure on equities, although losses were limited by continued merger and acquisition activity. One of the biggest surprises of the week came from a 16.2 per cent increase in new US home sales last month.

The rise, the biggest monthly increase for 14 years, raised the prospect that the housing market might be emerging from an 18-month slump and added to optimism about the US growth outlook. However, some of the shine came off the data with the release of soft existing home sales figures on Friday.

“In the US, the latest series of firmer economic data has led to a reduction in market expectations for rate cuts, especially as inflationary pressures remain above the Federal Reserve’s preferred range,” said Thanos Papasavvas, head of currency management at Investec.

But Dominic Wilson, economist at Goldman Sachs, warned against over-optimism about the economy.

“While significant parts of the US data have looked better recently, the economy is certainly not showing uniform strength,” he cautioned. “Most recent consumer data remain soft, the picture on housing remains quite mixed and, while the labour market still looks quite stable, there are important risks here.”

Meanwhile, robust economic data from the eurozone – including the key German Ifo index of business sentiment – added weight to the argument that eurozone interest rates still have some way to go before peaking.

“The market expects the European Central Bank to tighten to 4 per cent by June [from 3.75 per cent at the moment] and then to pause . . . for the remainder of the year, whereas we expect another rate hike before year-end taking rates to 4.25 per cent,” Mr Papasavvas said.

World stock markets had a volatile week. On Wall Street, the Dow Jones Industrial Average touched a lifetime high of 13,624.55 before coming off to trade 0.4 per cent down on the week in New York on Friday.

The S&P 500 index came within a whisker of setting a record closing high but then fell back to stand 0.5 per cent lower over the week.

The Dow and S&P made their first weekly declines in seven weeks.

The Nasdaq Composite slipped from a six-year peak to trade a fraction lower for the five-day period, for its third successive weekly drop.

In Europe, the FTSE Eurofirst 300 index recorded its highest close since December 2000 before easing back to end the week with a loss of 0.2 per cent.

Alan Greenspan prompted a midweek equity market wobble after warning that recent gains for Chinese stocks were unsustainable and he feared a significant correction to the market.

But the Shanghai market recovered from an initial drop and ended the week within striking distance of its all-time high. Several other markets in the region also set new highs.

In Tokyo, the Nikkei 225 Average inched up 0.5 per cent over the week, although Hong Kong ended 1.8 per cent softer.

Government bonds extended their recent losses, with the yield on the 10-year Treasury climbing back to 4.9 per cent at one stage – its highest since January.

The yield subsequently slipped back to 4.86 per cent, up 5 basis points over the week.

The 10-year Bund yield touched a three-year high, rising 7 basis points over the week to 4.39 per cent.

In the currency markets, the dollar continued to attract buyers as it extended its recent rally against the euro and the yen. But sterling was the stand-out gainer as expectations that UK interest rates would rise at least once more were heightened by the release of hawkish minutes from the Bank of England’s last policy meeting.

In commodities, oil prices touched a nine-month high amid escalating political tensions in the Middle East.

July Brent – currently seen as the global benchmark oil price – touched $71.80 a barrel during the week and was holding above $70 in late trade on Friday.