httpvh://www.youtube.com/watch?v=aTHvwL2d-ng

The Irish financial crisis has been dominating headlines over the weekend, and what is bothering the UK is – how will this affect us? Aside from the apparent selfishness of this comment, the worries of contamination are very real, it is clear that if the situation in Ireland gets worse than the eurozone will be damaged. It is becoming clearer that the UK will not be able to get away scot free, partly because we have 149 banks which would lose out should Ireland fail to stand by its obligations. On top of this if the eurozone crumbles we would have trade issues as it accounts for half of our exports. However, damage to the UK would be muted as Ireland only accounts for a tiny bit of our exports, but still enough to beat the combined exports to Brazil, China, Russia and India. Osborne confirmed this morning that the UK is about to commit 7bn to help stabilise our ‘closest economic neighbour’.

Inflation worries could intensify over the next few months, and because of this UK gilt market is looking nervous, especially with the Irish issue being so close to home. Both international and domestic factors would have had a part to play in the rising yields. The recent US QE for example, caused levels to rise almost directly in line with our friends across the Atlantic. Back in the UK we saw GDP get stronger for Q3, and this created a mediocre boost which helped calm double-dip fears. Gilt yields do not look likely to rise much further but there is always that possibility in light of the current economic forecast.

Osborne has cooled on the plans for transparency in the City when it comes to pay and bonuses, much to the delight of larger banks, and the horror of Vince Cable. The decision for Britain to not act unilaterally came after Sir David Walker spoke in the FT that it would be a mistake to take this road alone. Bankers can’t breathe a sigh of relief just yet, it is certain that the fiercely opposed Cable will do everything he can to make sure that the promise of greater transparency cannot be ignored.

I imagine that most of the attention will remain on Ireland this week, but on Wednesday there is the second estimate of UK GDP being released. This looks likely to stay at 0.8% but the figure is reliant on unsustainable sources, like household and construction spending. Even so, the recent output data has been promising so it would be surprising if the figure was revised to the downside.

Jeremy’s Trade of the Week

This week’s trade of the week is a ‘Risk Reversal Plus’. This differs from the usual risk reversal in that, for an increased risk, your strike improves from 1.55 to 1.57. The client decided to hedge his next 6 months of exposure via this trade.

The client will benefit in all upward movement up to a capped level. Should the GBPUSD rate be below 1.57 and above 1.52 on expiry they are able to buy dollars at 1.57, if it is below 1.52 however then for every percentage point below 1.52 they lose the same off their strike of 1.57. The capped level is at 1.64 for the first month and then increases by 1 cent every month i.e. month two’s is 1.65, month three’s is 1.66.

This strategy has an upfront cost of 0.75% and allows a hedge with a nominal WCR of only 2.2 cents from current market price while a normal risk reversal would see a WCR at least 2 further cents lower for, we believe, a manageable risk.