Saturday, November 10, 2007

Gloom Envelops World Markets

Stock markets on both sides of the Atlantic concluded their worst week in months on Friday as deepening economic gloom raised expectations that the US Federal Reserve would be forced to cut rates again in the face of mounting credit losses.

The S&P 500 was down 3 per cent for the week. In London, the FTSE 100 fell 3.7 per cent on the week, while the FTSE Eurofirst 300 was down 3.1 per cent, their worst performances since the credit squeeze took hold at the end of July.

The technology-heavy Nasdaq 100 experienced its worst week since April 2002, losing 6.8 per cent as market turmoil hit a sector that has been a haven from the credit crisis.

Bond markets priced in the near certainty of a quarter-point interest rate cut when the Fed meets in December, and a 75 per cent chance of a second such cut at its January meeting. The yield on the two-year Treasury note fell to 3.41 per cent, its lowest level since February 2005.

"Treasuries are strictly in flight-to-quality mode, and investors are waiting for the next shoe to drop," said Kevin Flanagan, fixed-income strategist at Morgan Stanley. "This is round two and there will probably be a round three."

Rate cut expectations helped push the dollar index to a record low of 74.978. The dollar set a fresh low of $1.4752 versus the euro and fell to Y110.52 against the yen.

The turmoil was fuelled by mounting credit turmoil. Fire sales of mortgage assets from complex debt vehicles began in earnest after the trustee of a $1.5bn complex debt deal managed by State Street Global Advisors started liquidating its portfolio.

Ratings downgrades for mortgage securities have pushed a clutch of such deals into default. Trustees have issued default notices for more than 14 collateralised debt obligation deals in recent weeks, representing securities with a face value of more than $10bn.

A default means the most senior investors in the CDO can liquidate the underlying assets to get their money back. Analysts say more deals are on the brink of default.

Wachovia (NYSE:WB), fourth-largest US bank, estimated that the value of its sub-prime mortgage securities fell $1.1bn in October and said it was increasing loan loss provisions because of "dramatic declines" in house prices in some parts of the US.

Bank of America and JPMorgan Chase also warned in a regulatory filings that they could face further writedowns in the fourth quarter.

Fannie Mae (NYSE:FNM), the government-sponsored mortgage company, said its third-quarter loss doubled to $1.52bn. Capital One (NYSE:COF), the leading credit card issuer, said more customers had difficulty paying their bills in October than in the third quarter.

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