International Financial Markets
The introduction of the euro on 1 January 1999 created a major financial market in Europe denominated in one currency. This contributed to a significant increase in corporate bond issues. The euro weakened against the dollar and the yen in 1999.
The financial markets were characterised by stabilisation after the turbulence in 1998. Together with the accelerating growth during the year this contributed to a significant increase in long-term government-bond yields. However, investors still prefer liquid government bonds issued by industrialised countries to securities associated with a higher credit and liquidity risk.
Prices on the stock markets generally rose strongly in 1999. Primarily shares in IT-related business enterprises were subject to rising prices.
The transition to the year 2000 progressed smoothly without significant problems in the financial markets.
Foreign-Exchange Markets
In 1999 the dollar strengthened by 16 per cent against the euro, cf. Chart 18. In the 1st half-year the strengthening could be attributed to continued high growth in the USA and a delayed upswing in Europe. The strengthening was less pronounced in the 2nd half of 1999 as the growth prospects for the euro area improved. The exchange rates between the large economies show considerable year-on-year fluctuations. On comparison with the exchange rates between the D-mark and the dollar the movements between the dollar and the euro in 1999 are thus not extraordinarily strong in historical terms.
Chart 18 Dollar Vis-à-vis Yen and D-mark/Euro
| Note: | The exchange rates between dollar and D-mark in 1998 have been converted to euro using the official conversion rate between euro and D-mark as of 31 December 1998. Weekly observations. |
In 1999 the dollar weakened by 10 per cent against the Japanese yen. Against the background of Japan's improved cyclical position the yen strengthened during the 2nd half of the year. Surprisingly good growth data for the 1st half-year boosted confidence in the Japanese economy and business earnings, leading to increased demand for Japanese stocks. On several occasions the Bank of Japan sold yen in the foreign-exchange market in an attempt to dampen the currency's appreciation. However, these interventions appear to have had a relatively limited and short- lived impact on the exchange rate.
The pound sterling generally followed the dollar and strengthened by 13 per cent against the euro in 1999, cf. Chart 19.
Swedish krona, norwegian krone and pound sterling
Chart 19 Vis-à-vis D-mark/Euro
| Note: | Exchange rates vis-à-vis D-mark until end-1998, and then exchange rates vis-à-vis euro. The exchange rates vis-à-vis D-mark have been converted to euro using the official conversion rate as of 31 December 1998. Weekly observations. |
The Norwegian krone and the Swedish krona strengthened by respectively 10 per cent and 11 per cent against the euro during 1999, cf. Chart 19. The background to the Norwegian krone's strengthening was the strong oil price increases, whereas the growth rate was moderate after several years of high economic activity. The continued high growth rate in the Swedish economy was the basis for the Swedish krona's strengthening.
Since the Brazilian government abandoned its fixed-exchange-rate policy in January 1999, exchange rates in the key emerging markets have stabilised, cf. Chart 20. Southeast Asia in particular experienced satisfactory growth in economic activity, while the South American economies have been less stable. The Russian economy improved compared to 1998, but in this case too the foundation is fragile.
Chart 20 Exchange Rates of Selected Emerging Markets Vis-à-vis the Dollar
Interest Rates
Development in interest rates
Both short-term and long-term interest rates rose considerably in most industrialised countries in 1999, cf. Chart 21. The yield curve in the USA had a slightly positive slope at the end of 1999, whereas the positive slope of the German yield curve was more pronounced. This reflects expectations that in the long term the European Central Bank, ECB, will raise its rate of interest for main refinancing operations by a higher percentage than is expected for the Federal Reserve's raising of the federal funds target rate. However, in historical terms the slope of the German yield curve has
been steeper than the US yield curve.
Chart 21 Government-Bond Yields in Germany and the USA at Various Maturities
In the USA the Federal Reserve raised the official short-term US interest rate, the federal funds target rate, in June, August and November 1999 and in February 2000 by a total of 1 per cent to 5.75 per cent. This more than offset the reductions of interest rates at the end of 1998. The continued favourable key economic indicators for the US economy, a tight labour market and increases in commodity prices have led to expectations of a further tightening of monetary policy in order to curb rising inflation. In 1999 the yield on 10-year US government bonds rose by around 1.8 per cent and was 6.5 per cent at the end of the year, cf. Chart 22.
In Japan, at the beginning of 1999 long-term yields continued to show the tendency to increase seen in 1998, cf. Chart 22. However, the interest rate fell and stabilised at a level below 2 per cent when it was announced that a proportion of the central government's planned issues of 10-year bonds would be restructured to shorter maturities and that the reduction in government institutions' purchases of long-term government bonds would be less than planned. The drop in interest rates was supported by the Bank of Japan with ample liquidity and a zero-interest-rate policy. In February 1999 the Bank of Japan cut the official interest rates by 0.10 per cent to 0.15 per cent, and at the same time announced its intention to keep the overnight interest rate as close to zero as possible.
Chart 22 10-year Government-Bond Yields
| Note: | Weekly observations. |
Against the background of low inflation and weak growth in the euro area the ECB lowered the rate of interest for main refinancing operations by 0.5 per cent to 2.5 per cent in April 1999. The upswing was stimulated by the expansionary monetary conditions. Against the background of ample liquidity and the improved cyclical conditions the ECB in November 1999 raised the rate of interest for main refinancing operations by 0.5 per cent to 3 per cent. The rate of interest was raised again by 0.25 per cent to 3.25 per cent in February 2000. Rising interest rates in the USA contributed to the increase in long-term interest rates in Europe. Long-term government-bond yields in Germany thus rose by around 1.5 per cent in 1999 to a level of around 5.25 per cent at the end of 1999.
In the UK the Bank of England eased the official interest rate by a total of 1.25 per cent to 5 per cent from January to June 1999 in order to counteract a dampening of the economy and a rate of price increases close to the lower limit of the government's target. The following expansion of economic activity and the low unemployment rate augmented the risk of rising inflation. Against this background the Bank of England in September and November 1999 and in January and February 2000 raised the official interest rate by 1.0 per cent in total to 6.0 per cent. The 10-year yield differential to the euro area member states gradually narrowed in 1999. Government-bond issues in the UK were reduced as a result of the growing government-budget surplus. Since a number of institutional investors prefer central-government securities with maturities of 15-30 years this pushed long-term interest rates down in the autumn. The 10-year yield was also affected, although it rose by around 1.25 per cent to 5.5 per cent over the year.
The euro and the bond market
The introduction of the euro created a large bond market in Europe denominated in one currency. The euro's introduction went smoothly without technical problems. Measured in terms of GDP the euro area is the second-largest economy in the world. Its share of total world exports at the end of 1998 was almost 20 per cent, which is the largest
share for one currency area [1].
The market for government bonds, which dominates the euro bond market, has become increasingly homogenous after the introduction of the euro. The euro area member states have thus redenominated virtu-ally all of their domestic government debt from national currencies to euro. Furthermore, a number of market conventions have been harmonised.
Even though the exchange-rate risk associated with the euro area member states' government bonds has been eliminated, yield differentials between the government bonds of euro area member states continue to exist, cf. Chart 23. This can be attributed to differences in particularly the market's perception of liquidity, but also of credit risk, i.e. the countries' ability to service their debt. Central governments have sought to influence liquidity in government bonds via their issuing policy, in order to achieve benchmark status. Issues have been concentrated on few maturities and buybacks of previously issued bonds have been utilized in order to make the series as large and liquid as possible [2] . In the 10-year segment, which includes a large proportion of central-government issues, German government bonds have achieved benchmark status for the euro area. The German series are some of the largest in the euro area and only German central-government securities are deliverable in the benchmark 10-year future [3]. This future contributes to increasing demand for the bonds which are deliverable under the contract.
Chart 23 10-year Government-Bond Yield Differentials in the Euro Area to Germany
| Note: | Weekly observations. |
There was a considerable increase in corporate bond issues in the European bond market in 1999. The establishment of a large financial market without exchange-rate risks has given issuers access to a larger base of potential investors. A high increase in the number of mergers and acquisitions, partly financed by bond issues, also contributed to increasing the volume of issues. Furthermore, it is likely that issues have been postponed from 1998 to 1999 so that business enterprises could benefit from the expected lower euro interest rate and avoid redenomination.
Indicators of credit and liquidity risk
In 1999 the financial markets returned to more stable conditions after the unrest in the autumn of 1998. Yield differentials between e.g. dollar-denominated bonds issued by emerging markets and US government bonds, and between corporate bonds and government bonds, narrowed gradually in the 1st half of 1999, cf. Chart 24. However, a number of yield differentials widened again during the summer as large corporate bond issues in this period exerted upward pressure on yields on these bonds compared to government-bond yields. The levels are still higher than in the period up to the unrest on financial markets in 1998, reflecting that investors still prefer safe and liquid bonds.
Chart 24 10-year Yield Differentials to Government Bonds for Corporate Bonds and Swaps
| Note: | US bonds and USD interest-rate swaps. Weekly observations. |
Stock Markets
As a whole 1999 was characterised by rising equity prices. The general stock-market buoyancy continued after the New Year when several share indices reached new record-high levels in February 2000, cf. Charts 25 and 26. The US Dow Jones Index rose by 25 per cent in 1999. The higher equity prices were driven by high growth and moderate inflation in the US economy. Moreover, to an increasing degree, US households have invested in the stock market, thus boosting demand for equity securities. In addition, non-residents have also increased their holdings of US stocks. This contributed to a strong inflow of capital which in part financed the US current-account deficit. The net supply of stocks has decreased in recent years, primarily due to business enterprises' buying back their own stock and an increase in the number of mergers and acquisitions.
Chart 25 Stock Indices in Major Industrialised Countries
Chart 26 Nordic Stock Indices
Especially stocks in the computer and Internet industry saw strong price increases. According to conventional stock-market valuation methods strong future earnings increases are implied in the current prices for several stocks in the IT-sector. The two computer enterprises Microsoft and Intel were included in the 30 stocks in the Dow Jones index as from 1 November 1999, reflecting the growing significance of the computer and Internet industry to the US economy and the financial markets.
The US Nasdaq index, which compared to the Dow Jones index has an overweight of technology-related stocks, rose by 86 per cent in 1999, which was the strongest year-on-year rate of increase in the Nasdaq's 28-year lifetime. However, outstandingly high price increases for a few stocks accounted for a considerable proportion of this growth.
Particularly in the 2nd half-year stronger growth in Europe led to higher prices in the European stock markets. Technology-related stocks were also in focus in Europe, especially in the 4th quarter. The Neuer Markt index [4] which like Nasdaq has an overweight of technology-related stocks, rose by 71 per cent in the last three months of the year alone. This rate of increase significantly exceeded that seen in the Nasdaq index in the same period.
The stock market in Japan was driven primarily by market expectations of an improvement in the economy and the financial system. This pushed stock prices upwards, particularly at the start of the year.
The Nordic stock indices also developed positively in 1999. The KFX index in Denmark rose by 17 per cent in 1999 to a record high level in February 2000. Equity prices rose even more in Sweden and Finland, cf. Chart 26. In these countries price increases were related particularly to the trend for technology-related stocks such as Ericsson and Nokia.
The stock markets of the emerging economies were extremely positive in 1999 after strong price drops in 1998 as a consequence of the financial crisis, cf. Chart 27.
Stock indices for selected emerging markets Chart 27
Chart 27 Stock Indices for Selected Emerging Market
Footnotes
[1] Excluding intra-euro area trade, cf. ECB Monthly Bulletin, January 2000.
[2] See Lars Krogh Jessen and Anders Matzen, The Market for Government Bonds in the Euro Area, Danmarks Nationalbank, Monetary Review, 3rd Quarter 1999.
[3] A future is a standard contract for delivery of a bond on a certain date to a counterparty for the price agreed on conclusion of the contract. The bonds to be delivered are stated in the standard contract. In general, the value of a future fluctuates in parallel with the price of the bonds to be delivered. A future whereby the seller is obliged to deliver 10-year German government bonds can thus be used to hedge against price fluctuations in holdings of other 10-year bonds.
[4] The Neuer Markt index is based in Frankfurt and was created by Deutsche Börse in March 1997 to enable particularly small growth enterprises to obtain capital. In mid-1998 43 companies were registered. Today, the index includes more than 200, primarily German companies.
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Version 1.0 April 2000 Nationalbanken.
Published by Danmarks Nationalbank April 2000, http://www.nationalbanken.dk