12.10.09 1
Market Snapshot: Summary of rate movements and important announcements Economics Watch: Contents: Monday: RICS housing market survey Equities 3 BRC quarterly economic survey Credit 4 BRC retail sales monitor (total %y/y) UK BoE 2022 ‐ 2034 reverse gilt auction Nominal Yields 5 Inflation 6 Tuesday: UK CPI, RPI and RPIX released (%m/m) Real Yields 7 BoE 2036 ‐ 2055 reverse gilt auction Appendix 8 Wednesday: Claimant Count unemployment (change, thousands) Manager Selection – Process 40 ILO unemployment rate (%) Ongoing Monitoring – Monthly Solvency 45 UK average earnings growth (%) Reporting UK BoE 2013 ‐ 2019 reverse gilt auction Redington Education – Setting a Level 51 Playing Field Thursday: ECB President Trichet speaks on “Lessons from the Crisis” “Another notable result was the consolidation of Redington’s position, ECB monthly bulletin published building from its impressive debut last year. It secured best overall asset liability management/liability driven investment (ALM/LDI) advice provider. In addition to being voted the best source for strategic advice, Redington matched its performance last year by coming third overall of the consultants, proving that youth is no barrier when it comes to pension consulting.” Source: Life & Pensions, September 2009 2 Source: Barclays Capital
“The rally continues once more...” Figure 1: Total Return on major Equity Indices 110 • Equity markets rebounded spectacularly this week. The S&P 500 and the FTSE 100 100 were up around 4.5% with the Eurstoxx 50 rising by around 6% 90 Total Return • A key driver for the rise in equity markets was the strong start in the Q3 US 80 reporting season. � 81% of the 31 S&P 500 companies having reported so far have beaten 70 estimates S&P 500 FTSE 100 60 � 18% of companies beat earnings per share (EPS) predictions 50 Sep 2008 Dec 2008 Mar 2009 Jun 2009 Sep 2009 • After aggressive government stimulus, markets are rallying in unison, there are important differences between the world’s major economies as the upturn Source: Bloomberg, Redington begins. Although the US and Europe have seen the most damage to credit markets, the US remains in a more precarious position. Factors that could hinder the rally in equity markets include: Figure 2: P/E versus Earnings Growth � High unemployment � The damage done to banks and securitised markets � The deterioration in household finances • Figure 2 demonstrates the difference in potential returns that can be made by selectively choosing which equity markets one invests in. Looking at the chart, the Price/Earnings (P/E) ratio ‐ the ratio of the price of the stock to the earnings per share ‐ and forward earnings growth are most favourable in Europe. Source: Bloomberg, Redington 3
“Q3 earnings will be important for credit...” • Corporate spreads as measured by the Barclays Sterling Non ‐ Gilt index remained Figure 3:Barclays Sterling Non ‐ Gilt Corporate by Rating constant for the AA and narrowed by 2 and 6bps for A and BBB. On a sector basis, spreads on senior financials and cyclicals narrowed by 2bps however sub ‐ financials 800 narrowed significantly by 16bps. Spreads on non cyclical and telecoms were slightly AAA AA 700 wider by 1 ‐ 2bps. 600 A BBB 500 • Despite the weak non ‐ farm payroll data and other economic releases in the weak Libor Spread ending on October 2 nd , tightening resumed at the beginning of last week and may 400 have been influenced by the release of the US ISM Non ‐ manufacturing data. This is 300 an indicator of the size of the US Services sector which showed growth as the index moved from 50.9 from 48.4 in August. (A reading of 50 or above means growth). 200 100 • The commencement of Q3 earnings season is likely to have a significant impact on 0 credit spreads. For the rally to continue, investors must see net income increases ‐ 100 from real end ‐ user demand increases as opposed to cost cutting. Credit is still likely Feb 2008 May 2008 Aug 2008 Nov 2008 Feb 2009 May 2009 Aug 2009 to be well supported as central bank policies help maintain liquidity in the markets and as such investor inflows to credit searching for high yields may continue. Source: Barclays Capital Figure 4: Barclays Sterling Non ‐ Gilt by Sector • The Bank of England’s Q3 Credit Conditions survey showed supply of credit to non ‐ financial corporates rose. An interesting point to note is that large companies are 1,200 choosing to access credit through bond issuance as opposed to through bank loans. 1,000 Figure 5: Lending to Non ‐ Financial Corporates 800 Libor Spread 600 400 200 0 Feb 2008 May 2008 Aug 2008 Nov 2008 Feb 2009 May 2009 Aug 2009 Cyclicals Non ‐ Cyclicals Senior ‐ Financials Sub ‐ Financials Telecoms ‐ Utilities 4 Source: Barclays Capital Source: IBoxx, Barclays Capital
“DMO announces UKT 2060 syndication...” Figure 6: Nominal Term Structure of Gilts vs. Swaps • Over the last week 30Y and 50Y gilt swap spreads have become more positive and are at 12bps and 18bps, as the respective gilt yields rose by 4 and 7 bps, whilst swap rates were largely unchanged at the long ‐ end. • Gilt rates still remain above swaps at all maturities after 25 years. Despite QE narrowing the swap spread, external supply and demand dynamics are still impacting the long ‐ end of the curve. • The past week has been a big week in fixed income supply: � On 6 th October DMO reopened UKT2013 for a notional amount of £5bn. Source: Bloomberg, Redington � On 14 th October there will be a £3.5bn auction of UKT 2020 Figure 7: Nominal Swap Spreads on Selected Gilts • The DMO has announced the syndication of an ultra long 2060 Gilt later this month, to follow a new coupon schedule 22 Jan/22 July. One would expect this issuance to erode the premium long ‐ dated investors are willing to pay fort he 2055, which following the syndication will no longer be the sole instrument offering duration to hedge ultra long dated liabilities. The Z ‐ spread of the UKT 55 increased by 7bps over the week. Source: Barclays Capital, Redington 5
“IL42 auction goes well...” Figure 8: Gilt breakeven inflation term structure vs. swaps • On the 7 th October the DMO reopened £750m notional of the IL42. There was sufficient demand to clear the additional supply. • Over the last week, gilt breakeven inflation has risen by 5 ‐ 9bps at the 20 ‐ 50Y tenors. Inflation swap levels at the long end have risen 2 ‐ 4bps over the week. Inflation swaps are now at a spread of 14.5bps and ‐ 4bps to Gilt breakevens at the 30Y and 50Y points. • The distortion between gilt breakeven and swap RPI inflation remains, particularly at the 20 year point and this is shown clearly in figures 8 and 9. Source: Bloomberg, Redington Figure 9: Swap Inflation ‐ Gilt Breakeven Inflation Source: Barclays Capital, Redington 6
“ Yield enhancements from switching to linkers have increased again...” Figure 10: Real Gilt yield term Structure vs. Swaps • Swap real yields remain negative at the short end for both gilts and swaps. The differential between swap and gilt real yields widens significantly across the middle of the curve due to the low levels of gilt breakeven inflation relative to swaps. The difference reduces at longer maturities. • Z ‐ Spreads are the weighted average constant spread added to the swap zero curve to get the market price of the gilt. They are used as a relative value measure between cash and the swap market. • Z ‐ spreads on linkers remain positive, but over the week there has been relatively little change. The IL20 remains flat over the week, the IL2037 and IL 2055 have risen 2.5 and 5.1 bps. However the impact of the upcoming Gilt 2060 syndication may be a significant factor affecting the 2055 Z ‐ spreads. Source: Bloomberg, Redington Figure 11: Z ‐ spread on selected linkers Source: Barclays Capital, Redington Source: Bloomberg 7
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