Calm could return to global financial and currency markets sooner than expected.
Sure, the problems of the subprime mortgage market are likely to rumble on for some time to come, but with central banks remaining ready to inject liquidity, the global economic backdrop remaining favorable and with most corporate balance sheets remaining healthy, there appears to be little reason for serious pessimism. "There is a good chance things will settle down and the bull market will resume its course," said Peter Berezin, a senior currency strategist with Goldman Sachs in New York. Like others, he suggests that there is plenty to distinguish the current market shakeout from the financial crisis of 1998, when markets were rocked by Russia's debt default and the collapse of Long Term Capital Management. In a paper entitled "Seven Reasons Not To Panic," Julian Jessop, chief international at Capital Economics in London, also suggests that current market conditions aren't as bad as they appear. "Talk of a market meltdown is wildly overdone," he said. "We still see troubles ahead for the U.S. as a result of the housing slump and remain concerned about carry trades. But there are seven reasons why it is right not to panic," Jessop argued. Very much like the crisis in 1998 during which liquidity levels plummeted and equity markets tumbled, this episode features great uncertainty over just how deep the problems go and how many financial institutions are exposed. As a result, volatility has soared, with the Chicago Board Options Exchange's VIX index rising about the same amount that it did back in 1998. Goldman Sachs' Berezin suggested that the state of the U.S. economy could also be of some concern as it was on a much stronger footing back in 1998 and thus better able to deal with the financial fall out. "Today, with the housing market in dire straights and several indicators pointing to a slowdown in productivity, the resilience of the U.S. economy is more in doubt," Berezin said. With the U.S. Federal Reserve remaining concerned about inflation pressures, the chances of the bank cutting rates three times as it did back in 1998 aren't so high either. | |
| Emerging Markets More Resilient Now | |
| On the other hand, emerging markets are much healthier this time round. "During the most recent episode of market jitters, emerging markets have not imploded," the Goldman Sacs' strategist said, suggesting that they may "now appear to be part of the solution rather than part of the problem." Even the performance of equity markets - that keen barometer of global risk appetite - suggests that selling pressure isn't that heavy. Although heavy losses were sustained at the end of last week, in markets where turnover is already low because of the August summer holidays, the S&P 500 still closed last Friday 1.3% up on the week. Capital Economics' Jessop suggested that as the holidays probably exacerbated the losses, "we should read rather less into them." Also he noted, this decline is the third since the start of 2006 and the previous two failed to have a significant impact on the wider economy. Jessop's confidence that the fallout will be limited also comes from the fact that equity market valuations were relatively fair before the selloff started. "We are not starting from a position where equities are set up for a major bear market," he said. As far as the sharp rebound in risk aversion, Jessop suggests this was part of a correction for a period where risk appetite was too high and the risk premia on a wide range of assets had fallen to unsustainably low levels. | |
| Central Banks Have More Room For Rate Cuts | |
Whether or not major central banks are prepared to continue easing monetary policy by cutting interest rates remains to be seen. Jessop says he doubts that lower rates will be required but that central banks probably have more room to reduce them now that rates in both Europe and the U.S. are at neutral levels rather than too low. If anything, he reckons that bond markets could be doing the job as the recent sharp fall in yields means that the borrowing costs for creditworthy companies and households have fallen in the last month. Finally, Jessop points to the subprime problem spreading to European banks as good news and the seventh reason not to panic. "It means that the U.S. financial system and economy is not going to have to bear the entire burden on its own," he said. Early Tuesday, evidence of normality returning came from the Bank of Japan and the Reserve Bank of Australia both draining funds from their money markets - rather than having to add liquidity as they have in recent days. However, the lingering concerns about subprime were evident in the Japanese sell-off of the dollar and the euro ahead of expected U.S. Treasury redemptions Wednesday and euro-denominated bond redemptions Friday. This helped to ensure that the dollar was pushed down to Y117.84 by 0645 GMT from Y118.21 late Monday in New York, according to EBS. The euro was down at Y160.53 from Y160.87. However, the single currency was able to stage a small rally to $1.3618 from $1.3610, even though the euro is being additionally undermined by suggestions that the European Central Bank won't be able to hike rates next month after all. | |
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