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Financial markets started the year in a pessimistic mood amid growing concerns over the strength and sustainability of economic recovery and levels of sovereign debt in the developed world. The impending withdrawal of the Federal Reserves special liquidity programs combined with China's increase in reserve requirements for banks also had a dampening effect on markets. US equities were down on the month with the S&P and Dow Jones falling 3.7% and 3.46% respectively. The Nasdaq suffered an even sharper decline with a loss of 6.41% during the month. Returns were also poor in Europe where the DJ Eurostoxx 50 fell by 6.35% and the main UK, French and German indices were down -4.14%, -5% & -5.85% respectively. The sell-off also affected Asia and the emerging markets. In particular, Latin American as measured by the MSCI LATAM index was down almost 9% on the month while the Hang Seng in Asia fell by 8%. This apparent increase in risk aversion accompanied an increase in volatility with the VIX up 3 points to 24.62, although this was down from its intra month high of 27.3. Similarly, credit spreads were also wider with series 12 of the ITraxx crossover adding approx 22bps at 454. The iTraxx investment grade index was also wider by 7bps to 83. Commodities failed to escape the new year's marked change in sentiment, with many of the major benchmark items suffering a significant reverse in January. This was mainly attributed to the reduction in speculative positions which were affected by China's action in withdrawing liquidity from the banks. Both the Bloomberg Global Mining index and the S&P GSCI (Goldman Sachs Commodity Index) fell, by 8.81% and 7.9% during the month. Crude oil was one of the biggest losers, down over 8%, gold fell 1.47%, as did other metals with silver losing 4% and copper down by 8.54%. As risk aversion increased, government bonds were the main beneficiary with yields falling in major western markets. This 'flight to safety' was most apparent in the US with 10 yr treasury yields down from 3.84 to 3.58. This was also apparent in the shorter term issuances with 5 yr and 2 yr treasuries in by 36 and 33 bps, to 2.32 and 0.81 respectively. In Europe, UK 10 yr government bond yields were down 11bps to 3.91 and German Bund yields fell 19bps to 3.20. Despite the prospect of Central Bank actions to reduce excess liquidity, monetary policy in these regions remained broadly unchanged with no movements in base rates and no changes to programs such as quantitative easing. As such, funding costs remain at historically low levels, with 1m USD LIBOR at 23bps and 1m EURIBOR at 39bps. Eden Rock Capital Management LLP
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