Renewed fears of a US recession gripped financial markets this week, driving down global equities, sending credit spreads to record levels and boosting short-dated government bonds.
Weak service sector data and broadly disappointing corporate earnings in the US and Europe set the tone for the week’s trading, with ongoing worries about the outlook for bond insurers heightening the gloomy mood.
A 25 basis point cut in UK interest rates and hints from the European Central Bank that it would cut its growth forecasts – paving the way for lower eurozone rates – failed to soothe investors’ concerns.
Credit markets came under the spotlight on Friday as talk that a European fund was liquidating a structured credit product added to fears that economic slowdown would lead to companies defaulting on their debt.
The Markit iTraxx Europe index – a gauge of the cost of insuring against corporate default – hit a lifetime high of 98.75 while the CDX North America investment grade index touched 133. The iTraxx crossover index of mostly junk-rated credits – an important barometer of risk appetite – widened to a record 530.
It was a miserable week for equity markets. On Friday in New York, the S&P 500 index closed down 4.6 per cent over the five days, while the technology-heavy Nasdaq Composite was off 4.5 per cent.
The pan-European FTSE Eurofirst 300 fell 3.8 per cent and the FTSE 100 in London declined 4.1 per cent. Much of Asia was spared from the week’s sell-off because of market closures due to the Lunar New Year holiday. However, the Nikkei 225 Average in Tokyo fell 3.6 per cent – taking its fall since the start of the year to 15 per cent – and Australian stocks shed 3.2 per cent.
The euro was the chief focus in the currency markets as it suffered its biggest weekly decline against the dollar for 18 months.
The dramatic fall came as the European Central Bank appeared to give way to mounting pressure to soften its stance on interest rates.
“A new dawn has broken for European rates,” said David Brown, chief European economist at Bear Stearns.
“The ECB has U-turned on policy intentions and is sending out messages that weaker growth has now taken over from inflation as the number one priority.
“The market is now on ECB rate cut watch and the eurozone government debt curve should continue to pile on more steepening pressure.”
Investment bank Merrill Lynch took a different view. “We doubt that the ECB will cut rates over the forecasting horizon, given that the policy stance is in our judgment neutral, that there is practically no output gap, that inflation risks are on the upside and that money and especially credit continue to grow strongly,” it said in a research note.
Government bonds had a volatile week. The yield on the 10-year Treasury experienced its biggest one-day rise since 2004 on Thursday as investors gave a poor response to an auction of 30-year paper.
Although the 10-year yield eased back slightly on Friday as credit market turmoil prompted safe-haven buying, it was still up 5bp over the week at 3.65 per cent.
That compares with a 4½-year low of 3.29 per cent on January 23, the day after the Fed Reserve’s emergency 75bp rate cut.
But shorter-dated bonds were pushed higher in both the US and Europe on expectations of lower interest rates.
The two-year Treasury yield fell 15bp to 1.94 per cent – taking the gap between the two and 10-year yields to its widest since September 2004.
In Europe, the yield on the two-year Schatz tumbled 29bp to 3.09 per cent and the two-year UK gilt yield shed 27bp to 4.05 per cent.
In commodities, platinum hit a record $1,875 an ounce as it continued to defy gravity amid persistent worries about the impact of South Africa’s energy crisis on supplies of the metal.
Oil and gold edged higher but failed to retest their recent highs, although copper climbed to its highest for nearly three months.
Agricultural commodities were strong, with wheat, corn and soyabean prices hitting records.