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Risk repulsion suddenly set in once again yesterday in response to a truly awful Philly Fed survey for August, renewed concerns over Europe’s debt crisis and significant disagreements among FOMC members regarding the direction of Fed policy. As a result, stocks swooned, and bond prices soared. In Europe, the DAX dropped nearly 6%, the FTSE lost 4.5%, and the Euro Stoxx 50 shed 5.3%. On Wall St, the Dow was down more than 500 points at one stage before ending 420 points lower, while in Asia overnight the main indices are down by around 3% with the Kospi more than 6% down.

With investors still minded to protect capital and avoid risk, the allure of ‘safe’ government bonds strengthened still further yesterday. In Switzerland, the 10yr yield fell to just 0.83%, a 17yr low; the 10yr gilt yield continued to plunge, down another 19bp at one stage to a multi-decade low of just 2.24%; the Swedish 10yr yield fell to just 1.90%, the Canadian 10yr yield fell to a record low of 2.26%, and the 10yr Treasury yield traded below 2.00% at one point. These days, investors seem to believe that government bonds offer the best protection for capital in these uncertain times, despite the fact that they pay virtually no interest and that most sovereigns are lumbered with massive debt burdens. In some instances, investors are actually paying for the privilege of lodging money with the government or major banks (that is, interest rates are negative). Should negative interest rates become a more common experience, it will be interesting to observe how investors will then perceive the trade-off between risk and reward with regard to asset classes like equities and property.

Guest post by FxPro

Commentary

High-beta currencies suffer once more. As usual the high-beta currencies suffered as risk appetite vanished – both the Aussie and the Norwegian krone lost around 1.5% yesterday for instance. Safe-haven currencies such as the Swiss franc, the Japanese yen and the dollar excelled. Gold was also in its element, the gold price reaching $1,850 an ounce. In contrast, oil fell sharply, with WTI collapsing $5 over the past 24 hours to $106.  

Fed policy-spat triggers risk aversion. The growing policy-spat within the FOMC was one of the major factors which triggered yesterday’s latest bout of risk aversion. Following the FOMC’s unprecedented commitment earlier this month not to raise the funds rate from the current level of 0.5% for the next two years, a group of Fed policy-makers have publicly voiced their opposition to this announcement. On Wednesday night, Philly Fed President Plosser described the Fed’s action as “inappropriate policy at an inappropriate time”. He also stated that keeping rates low for two years would achieve very little because the problems being experienced by the economy can’t be rectified by monetary policy. His contention is that the Fed will probably need to lift rates before mid-2013, and that the Fed’s growth outlook is “excessively negative”. Plosser, Dallas Fed President Fisher and Minneapolis Fed chief Kocherlakota voted against the decision of the FOMC to commit to two years of unchanged policy, believing that it tied the hands of the US central bank unnecessarily. It must be said that Plosser’s candour (and not just on this occasion) is extremely refreshing. However, the fact that there are some vocal Fed policy-makers who do not agree with the current policy stance is somewhat unsettling at a very sensitive time. Both Plosser and Fisher have suggested that making such a cast-iron guarantee on rates during the market meltdown risked creating the perception that the Fed was attempting to contain losses for equity investors. They have a point. If the economy fails to avoid the recession trapdoor, then the Fed’s credibility may suffer a further blow by implementing policies that are ineffective.

The comatose British consumer. Further confirmation yesterday that the British consumer remains bereft of the ability to spend. In the three months ended July, and in the year ended July, the volume of retail sales was unchanged. With inflation running at more than 4%, and wages growth barely 2%, declining real disposable income continues to seriously impinge on living standards and spending. Unfortunately, this sorry state of affairs looks set to continue for a while longer. It is not just a summer of discontent here in the UK, but a decade of discontent.

Germany’s growing aversion to Eurobonds. News that the vast majority of Germans are highly averse to the issue of Eurobonds is concerning but also hardly surprising. According to a poll of Germany voters undertaken by Emnid for a German broadcaster, more than three-quarters of Germans are opposed to the introduction of joint euro-area borrowing, while 37% favour the re-introduction of the deutschmark.