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02 February 2011

Higher Yields Drive Pound Higher vs. the USD

Written by dslmpartners
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Global equity markets extend their run, encouraged by ideas that the recovery in the major economies is strengthening and the highest close in the Dow Jones Industrials since June 2008 and a three-year low in the VIX. Many Asian markets are closed for the Lunar New Year celebration, but the markets that were open posted healthy gains with the MSCI Asia-Pacific Index rising 1.3%, its largest gain in a couple of months. European shares are also mostly higher, with the FTSE leading the way among the major markets.

There are two key developments in the debt markets today. First, peripheral bonds are rallying strongly. Ten-year yields are off 8-10 basis points in Portugal and Italy, 17-18 basis points in Spain and Ireland and almost 30 basis points lower in Greece. The market has taken in stride S&P’s downgrade of Ireland’s rating and maintenance of a negative outlook. This is being driven by ideas that a “comprehensive” plan is in the works and will be discussed this weekend. Second, the UK data has increased the market’s confidence that the BOE will hike rates and this has UK interest rates broadly higher, with the short-sterling futures strip yields rising 6-9 basis points and the 2-year gilt yield rising 7 basis points. Separately, Iceland cut their key rate by 25 basis points to 4.25%. This drove the Pound higher.