Global Market Overview

Last updated: August 8, 2014 9:13 pm

US stocks rally but mood remains fragile

Friday 21:00 BST. US equities rallied strongly at the end of a week that saw geopolitical factors replace concerns about US interest rates as a key driver of risk appetite.

“Economic fundamentals are off the table for a while until we have more clarification on the political developments,” said Allan von Mehren, chief analyst at Danske Bank.

Wall Street managed to overcome an initial bout of nerves that followed President Obama’s authorisation of US air strikes against Islamist militants in Iraq.

And the early rise for US stocks picked up pace as reports emerged that Russian military exercises near the Ukrainian border had ended, and troops would return to their bases.

But the mood in the markets remained fragile following this week’s sharp ratcheting up of tensions between Moscow and the west over Russia’s role in the Ukraine crisis.

European stocks remained under pressure while top-tier government bonds continued to attracted demand as nervous investors sought safety from the volatility that has swept through global markets in the past couple of weeks.

In New York, the S&P 500 index rose 1.2 per cent to 1,931, putting it in positive territory for the week.

However, the US equity benchmark was still down 2.9 per cent from the record closing high reached last month.

Across the Atlantic, the FTSE Eurofirst 300 fell 0.7 per cent for a five-day decline of 2 per cent. The Xetra Dax in Frankfurt pared an early fall to close 0.3 per cent lower, although the index was down 10 per cent from a record intraday peak in June.

That decline reflected worries about Germany’s exposure to the Russian economy, particularly after Moscow unveiled import restrictions in response to western sanctions.

“It’s important to remember that while flare-ups in Ukraine and Iraq will naturally result in negative kneejerk reactions, a more pronounced correction can only be expected if these events are perceived to provoke a slowdown in global growth,” said Adrian Miller, director of fixed income strategy at GMP Securities.

“And while the Ukraine situation has begun to show such ties to economic growth – due in large part to sanctions against Russia and their retaliatory measures – such ties are not evident with the Iraq situation.”

Indeed, a sharp early rally for German government bonds – which saw the 10-year Bund yield hit a record low for a third successive session, and the two-year yield briefly turn negative – faded by the close of trade.

The Bund yield ended 2 basis points lower on Friday at 1.05 per cent, having touched 1.02 per cent earlier. That left it 8bp lower over the week.

In a similar vein the 10-year US Treasury yield touched a 13-month trough of 2.35 per cent but was last trading flat at 2.40 per cent, for a weekly drop of 11bp.

Divyang Shah, global strategist at IFR Markets, noted that the drop in the Bund yield in the past three days had been almost as dramatic as the decline seen in May.

“The big difference between then and now is that we have a hefty correction on the Xetra Dax,” he said. “This is what makes the latest reduction in Bund yields and correction on peripheral yields more significant.

“It is important to remember equity markets have been leading the charge when it comes to de-risking. This is still an orderly trimming of risk positions as opposed to a dash for the exit, but we have seen in the past that a lack of liquidity/depth can see things escalate.”

The steady decline in US Treasury yields this week had relatively little impact on the dollar as the US currency climbed to a 10-month high against a basket of peers.

However, the dollar index was down 0.2 per cent on Friday as the US unit slipped slightly against the yen to Y102.06 and the euro rallied 0.4 per cent to $1.3411.

The single currency had touched a nine-month low versus the dollar after Mario Draghi, president of the European Central Bank, highlighted that eurozone and US monetary policy would remain on a divergent path for some time. Mr Draghi left the door open to further easing as he noted the risks to eurozone growth – already viewed by most as fragile – from rising geopolitical tensions.

Figures this week showed Italy slipping back into recession in the second quarter while hopes that German gross domestic product had held up over the period were undermined by a succession of weak data releases. Italy’s 10-year government bond yield rose 8bp to 2.73 per cent over the course of the week.

Gold was down $2 on Friday at $1,310 an ounce, although its traditional role as a bolt-hole for nervous investors was back in play as it rose $17, or 1.3 per cent, over the week.

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