Global overview: Equities and dollar slump
Fresh turmoil erupted in the credit markets this week following further grim news on US subprime mortgage lending, prompting a sell-off in equities, a safe-haven flight to bonds and further weakness for the dollar.
Credit markets were hit by Bear Stearns' revelation that two of its hedge funds with heavy exposure to subprime mortgages were virtually worthless.
Ben Bernanke, the chairman of the Federal Reserve, further darkened the mood when he warned that subprime losses could reach $100bn and acknowledged for the first time that credit concerns were spreading beyond the subprime arena.
"The situation for the subprime US mortgage market looks dire, and it may well be dire enough to have macroeconomic implications," said Toby Nangle, fixed income investment manager at Baring Asset Management.
The cost of insuring European junk bonds against default — as measured by the iTraxx Crossover index - rose to its highest for more than two years.
Geraud Charpin, a strategist at UBS, said investors were worried that the subprime fallout might trigger a hefty unwinding of leveraged positions right across credit assets. He added that problems with landmark deals such as the Chrysler and Alliance Boots financings could force bonds to reprice even wider.
"Equity markets, on the other hand, seem to be ignoring these distractions to focus on resilient earnings and ever-larger leveraged buy-out announcements," Mr Charpin said.
The bulk of the week's US earnings reports were positive and drove the Dow Jones Industrial Average above 14,000 for the first time. However, the blue-chip benchmark retreated to show a loss over the week of 0.4 per cent. Similarly, the S&P 500 hit a record high before retreating to show a weekly loss of 1.1 per cent. The Nasdaq Composite index fell 0.9 per cent.
Elsewhere in equities, the FTSE Eurofirst 300 index touched a fresh 6½-year peak before easing back to end the week with a decline of 0.5 per cent. Asia was mixed, with the Nikkei 225 in Tokyo slipping 0.4 per cent but Hong Kong rose 0.8 per cent to a new peak.
Emerging market equities had a good week, with the Brazilian, Indian and Russian stock markets all setting record highs. Turkish shares hit a lifetime peak and the lira rose amid expectations of a market-friendly outcome to this weekend's elections.
Government bonds gained as investors sought safe havens from the turbulence in the credit markets. The yield on the 10-year US Treasury dipped below 5 per cent to a six-week low of 4.96 per cent, down 15 basis points on the week. The 10-year Bund yield shed 18bp to 4.44 per cent
On the currency markets, the dollar fell to a fresh lifetime low against the euro and was also down sharply against a basket of currencies. Jens Nordvig, senior currency strategist at Goldman Sachs, said credit market weakness affected the dollar in two main ways.
"Negative sentiment in credit markets is currently creating renewed expectations for Fed easing, and this is impacting the dollar through narrowing rate differentials," he said.
"Second, there is the flow channel. Foreign demand for US credit products appears to have moderated. Given the previous magnitude of foreign inflows into US corporate bonds even a moderate decline could be a significant negative for the dollar."
In commodities, Brent crude rose to within a whisker of its all-time high amid continued signs of a tight oil market. Weekly US inventories data showed an unexpected decline in crude and products inventories and increasing demand.
Both base and precious metals advanced. Lead and tin rose to record highs and copper pushed back above the key $8,000 a tonne level.
Gold touched a 10-week high above $684 an ounce as the dollar fell back. Silver hit a six-week peak and platinum touched its best level for two months.
A 27 basis point rise in Chinese interest rates on Friday went largely unheeded by the markets. The move had been expected following the release of strong growth data on Thursday.
