Overview: Volatility revived by more dire economic data

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Financial markets saw fresh volatility on Wednesday as investors absorbed further dire economic reports and braced for a series of interest rate decisions.

Weak US data heightened fears that the economy was in a deep recession and was capped by the Federal Reserve’s Beige Book survey which showed economic activity softened further across the country.

That followed a contraction in non-manufacturing activity to a record low last month. A record low employment reading in the report fanned worries that tomorrow’s non-farm payrolls report might be weaker than feared.

Paul Ashworth at Capital Economics said the slide in the Institute for Supply Management’s non-manufacturing index to 37.3 left it at a level consistent with a 3 per cent annual contraction in GDP.

He added that the ISM’s employment index slide to a record low of 31.3, potentially implied a loss of 500,000 service sector jobs.

“When you (conservatively) add on another 150,000 job losses in manufacturing and construction, that would work out at a 650,000 drop in overall non-farm payroll employment,” said Mr Ashworth.

The US data echoed earlier service sector reports in the UK and eurozone – which heightened expectations for aggressive interest rate cuts on Thursday from the Bank of England and European Central Bank.

The grim picture painted by the data drove European credit spreads to their widest levels on record.

The iTraxx Crossover index of companies with mainly sub-investment grade ratings broke above 1,000 basis points for the first time and hit record wides for the third successive day.

The investment grade iTraxx Europe index hit a record 198bp, while its US counterpart – the CDX North America index – reached its highest since November 20, when it touched a record 284bp.

US and European equity markets rallied, led by a late rebound on Wall Street after another volatile day. The S&P 500 closed up 2.6 per cent, reversing a drop of 2.5 per cent earlier in the day

The pan-European FTSE Eurofirst 300 index ended 0.6 per cent higher. Stephen Pope, chief global market strategist at Cantor Fitzgerald Europe said: “The market was starting to look oversold and stocks have become cheap enough to attract buyers.”

Asian markets moved broadly higher, with the Nikkei 225 Average in Tokyo rising 1.8 per cent, Hong Kong 1.4 per cent and Shanghai 4 per cent.

The firmer tone in equity markets was unable to halt further buying of US government bonds.

After an early rise, the 10-year Treasury was down 2bp at 2.67 per cent late in New York. The two-year yield was 3bp lower at 0.89 per cent. In Europe, the 10-year Bund yield dropped to within a whisker of the 3 per cent level last seen in September 2005.

The benchmark yield was flat at 3.04 per cent in late trade, with the two-year Schatz yield steady at 2.09 per cent.

In the UK, two- and 10-year Gilt yields touched fresh historic lows.

The renewed slide in Gilt yields was accompanied by further weakness for sterling in the currency markets. The pound fell more than 1 per cent against the dollar below $1.48 and moved to within striking distance of last month’s record low against the euro, as investors geared up for another hefty rate cut after the 150bp easing last month.

The euro also came under pressure against the dollar and the yen amid uncertainty about the size of an expected cut in eurozone borrowing costs.

The New Zealand dollar weakened as investors awaited an interest rate decision on Thursday that could entail a cut of up to 150bp.

The Swedish Riksbank is also expected to announce an aggressive rate cut, after it brought forward its scheduled policy meeting by nearly two weeks. Thailand on Wednesday slashed rates by 100bp to help offset the impact on the economy of the recent wave of political unrest in the country.

In commodities, the oil price bounced off a fresh 3½-year low of $46.26 after US data showed an unexpected drop in inventories of crude, gasoline and distillates last week.

But base metals remained under pressure, hitting multi-year lows amid fears that a deep global recession would hurt demand.

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