Basal Analysis for next week

After an opening surge on Monday, markets had a mixed time of it for the remainder of the week. President elect Barrack Obama’s announcement of a huge public works program helped virtually every market rally against the main trends of the last few weeks. Equities and commodities were higher, while the dollar, bonds, and CDS levels all eased. Unfortunately the optimism didn’t last, with the refusal of congress to ratify the Automaker bailout becoming the catalyst for the selling seen at the end of the week.

US pending home sales fell less than expected, and this provided good cheer to markets as it may indicate that the US housing decline is slowing. With so many mortgage backed securities still out there, a steadying of the US housing market could help alleviate some of the pressure on global financial institutions. The UK economy is still showing few signs of improvement though with October production figures falling more aggressively than expected.

There was increasing chatter about a ‘Treasuries’ bubble last week. The yield and 5 and 10 year notes plumbed to new depths, as traders continued their flight to quality. The yield on 3 month US Treasuries turned negative, meaning that investors were literally willing to pay to put their money somewhere that is perceived to be safe. Another unusual act to add to the ever growing pile of ‘once in a generation’ events, were reports that the Federal reserve is considering selling bonds under its own name.

The Pound held its ground against the Dollar, but was well and truly smashed by the Euro, which today set yet another record high against Sterling. The Euro even kissed the underside of its synthetic high of 0.9000 based on the old Deutsche Mark from 1996.
Friday’s, news of HBOS’s dreadful £8bn write-down hit the general banking sector hard. Many economists predict that the UK economy won’t recovery until the back of 2009 at least, which means that lending conditions could get even worse for the UK banks.

Until recently, the ‘independence’ premium hadn’t worked its way through in the banking sector. However, there are signs today that independence from the UK Treasury could start to become a significant advantage. On Friday, Lloyds, HBOS and RBS closed down 18%, 23% and 15% respectively. The remaining two major UK banks not to seek government assistance; Barclays and HSBC finished down just 8% and 2% respectively.

The banks have an almost impossible task of providing shareholder (and taxpayer) value, whist at the same time being seen to re-start lending to home owners and small businesses. Northern Rock shows precisely why these two competing aims are difficult to align. Northern Rock’s management team has been hell bent on repaying the government’s loan as quickly as possible, and it is making good progress in this regard. The problem is that to do this, it has reversed its lending policy, and is now lending out less than is being paid in. This is good news for taxpayers, but bad news for consumers.

The economic landscape will be dominated by the US interest rate statement due on Tuesday. Analysts are expecting a fresh round of cuts from the Fed. Fed fund futures are currently implying a 60% probability of cut down to 0.25%, with a 30% probability of a cut down to 0.5%. On the same theme, UK rates are expected to push lower soon, and Wednesday’s MPC meeting minutes will help traders determinate the size of the likely cut.

Last week, Sterling took a beating against the Euro, but the European economy isn’t exactly a bed of roses outside of Germany and France. Arguably interest rates in Europe have further to fall than those from the UK. EUR/ GBP have moved incredibly quickly over the last month, but there could be a period of congestion to come. A no touch trade predicting that the EUR/ GBP won’t touch 0.9200 at any time during the next 60 days could return 121%.(By Jmoco