A retreat for oil prices and some positive news on US housing paved the way for a tentative rebound on Wall Street on Monday, although lingering concerns about the banking sector continued to hang over financial markets.
Those worries came as Lehman Brothers reported its first-ever quarterly loss and unveiled plans to raise $6bn to strengthen its balance sheet.
Lehman’s shares fell more than 8 per cent in New York, even as the S&P 500 rose 0.3 per cent. European equity markets were less sanguine, with the FTSE Eurofirst 300 index shedding 0.3 per cent. Those Asian stock markets that were not closed for holiday were broadly lower, with Tokyo’s Nikkei 225 falling 2.1 per cent.
Equity volatility, as measured by the CBOE’s Vix index, fell after surging 26.5 per cent on Friday, its biggest one-day rise since markets plunged on March 13.
Credit markets recovered after a weak start. The iTraxx Crossover index, a closely watched barometer of credit quality, threatened to break back above the
psychologically important 500 basis point level before ending the day 1bp lower at 487bp.
In commodity markets, oil fell $2.50 to $136.04 a barrel after touching a record high of $139.12 on Friday following its biggest-ever single-day advance.
Julian Jessop at Capital Economics said the latest oil price spike looked like a bubble about to burst.
“What is striking is the lack of any decent justification in terms of fundamental supply or demand,” he said.
“We are sticking to our view that rising spare capacity and a sustained recovery in the dollar will undermine oil prices in the second half of the year.”
Indeed, the dollar managed a modest rally on the currency markets after some surprisingly positive US housing market data.
Pending home sales, a barometer of future housing activity, rose by 6.3 per cent in April to the highest level in six months – although they were still down 13.1 per cent on a year earlier.
Alan Ruskin, international strategist at RBS Greenwich Capital, said the data were consistent with some future bottoming in existing home sales, although he ruled out any rebound at this stage.
“The mix of higher oil prices and its stagflationary influence that shows up in a mix of higher mortgage rates, lower equities and a vulnerable labour market does not suggest the start of any sustained strength,” Mr Ruskin said.
But US government bonds fell sharply as some in the markets took the view that the worst might be over for the housing market.
The yield on the rate-sensitive two-year US Treasury note jumped 22bp to 2.6 per cent, while the yield on the 10-year bond rose 8bp to 4.02 per cent.
European government bonds remained on the back foot as investors continued to get to grips with European Central Bank president Jean-Claude Trichet’s shock warning that eurozone interest rates might rise next month.
The yield on the 10-year Bund climbed 7bp to 4.49 per cent and the two-year added 5bp to 4.7 per cent.
Peter Vanden Houte, chief eurozone economist at ING Financial Markets, said that even if the ECB pulled the trigger in July, eurozone interest rates were more likely to be lower by the end of the year than they are currently.
“If the ECB does decide to hike 25bp in July, growth and underlying inflation will slow enough to trigger a 50bp rate cut in December,” he said. “We therefore see the market’s expectation of a 75bp rate hike by mid-2009 as misplaced.”
Gilts were even harder hit following the release of some worrying UK producer prices data. The yield on the two-year gilt leapt 32bp to 5.38 per cent.
Michael Saunders, analyst at Citigroup, said that while the markets were pricing in three UK interest rate rises by the end of the year, he doubted that the Bank of England would tighten rates.
“The economy is slowing sharply and likely to weaken further in response to the credit crunch, housing weakness and the erosion of real incomes from strong inflation,” he said.
Money markets continued to exhibit signs of stress as expectations of an ECB rate rise next month – plus a robust set of UK wholesale price data – helped drive euro and sterling interbank rates higher. Three-month euro Libor was set at 4.96125 per cent, the highest level since December 2000.