The recent rally in global equity and credit markets juddered to a halt on Tuesday as investors focused on the mounting economic slowdown and renewed concerns about interbank lending conditions.
This boosted short dated government bond prices. Elsewhere, sterling fell to a new low against the euro amid signs that the UK housing market was continuing to weaken.
Sean Maloney at Nomura International said: “Sentiment has swung around somewhat, with credit and equity markets taking stock of recent gains and lending a bid to bonds.
The tone across credit and equities on Wall Street remained downbeat after the Federal Reserve meeting minutes for March 18 were released and underlined worries about the economy.
Stephen Stanley, Chief Economist at RBS Greenwich Capital, said: “Officials were concerned that an ‘adverse feedback loop’ was under way, in which tighter credit leads to a deterioration in the economy, which in turns leads to tighter credit, etc”.
Housing markets provided the economic backdrop to the day, after data from both the US and the UK confirmed slowing home sales.
TJ Marta, fixed income strategist at RBC Capital Markets, said: “The housing correction continues, with sales still faltering. The consumer is becoming conscious of this threat, as indicated by the lagging collapse of the perception about their personal finances.”
Credit markets ended their recent good run as interbank fears resurfaced. The iTraxx Crossover index, which tracks the cost of insuring the debt of mostly junk-rated companies in Europe, rose 19 basis points to 488, having fallen nearly 100 this month, and 200 since hitting a record high last month. The iTraxx Europe investment grade index widened 7.4bp to 93.4bp.
In the US, the Markit CDX index of high grade derivatives widened 10bp to 116bp.
A high rate for the Fed’s latest Term Auction Facility suggested that interbank lending stress was rising again said traders. The $50bn sale of 28-day loans to banks arrived at a high rate of 2.82 per cent, compared with 2.615 per cent at last month’s sale and above one-month Libor of 2.72 per cent.
“For some reason banks were either unwilling or unable to fully fund themselves at posted one-month Libor,” said Ted Wieseman, economist at Morgan Stanley. “It appears that the official term Libor fixing rates might not be an accurate reflection of the rates where a lot of interbank lending is actually taking place.”
Earnings fears drove equity markets lower with technology stocks hit hardest.
On Wall Street, the tech-heavy Nasdaq Composite index led the way and closed down 0.7 per cent as computer hardware, semiconductor and chipmaking equipment manufacturers retreated. The Dow Jones Industrial Average closed 0.3 per cent lower, while the S&P 500 lost 0.5 per cent.
The mounting economic slowdown and its impact on corporate earnings was a cause for concern among equity investors.
Aluminium producer Alcoa kicked off the first-quarter earnings season in the US late on Monday, revealing that its net profit had halved due to the weak dollar and higher raw materials and energy costs.
Tokyo’s Nikkei 225 fell 1.5 per cent to 13,250.43 as chip stocks were hit by a reduced sales forecast from research group iSuppli.
In Europe, TomTom, maker of navigation systems, cut its full-year revenue outlook, echoing a similar move by US rival Garmin last week.
Meanwhile, an overnight sales warning from US chipmaker Advanced Micro Devices and a profit warning from Novellus, the semiconductor equipment maker sent shockwaves through the global microchip market.
Credit Suisse made cautious comments about the semiconductor sector in Europe, saying it had significantly underperformed the market due to dollar weakness and slowing demand. The FTSE Eurofirst 300 fell 0.8 per cent to 1,318.39.
Sterling was the biggest casualty on the currency markets after Halifax, the UK mortgage lender, said British house prices had fallen 2.5 per cent in March - the largest monthly fall since September 1992. This brought the annual rate of house-price inflation down to a 12-year low of 1.1 per cent.
Most analysts now expect the Bank of England to cut the main UK interest rate by a quarter of a percentage point to 5 per cent on Thursday
However, Howard Archer at Global Insight warned: “This may only have a limited impact in bringing down mortgage rates, given the lack of liquidity and elevated money market interest rates.”
Sterling fell 1.1 per cent against the dollar and hit a record low of £0.7989 against the euro, down 1.2 per cent.
On the money markets, three-month sterling Libor fixed at 5.93 per cent, down from 5.9475 on Monday, after the UK central bank said it would inject three-month funds next week to ease liquidity concerns.
On commodity markets, oil eased back after making strong gains on Monday. Nymex West Texas Intermediate fell $0.59 to $108.50 a barrel. Gold was also weaker as the dollar remained largely flat. Spot gold fell 1 per cent to $910.70 an ounce.
Government bonds turned mixed after early housing data led gains. The yield on the two-year Treasury fell 6bp to 1.87 per cent, while the 10-year was steady at 3.56 per cent. In the UK, the yield on the 10-year Gilt fell 3.8bp to 4.49 per cent and the two-year yield fell 5bp to 3.96 per cent.