TWN Info Service on Finance and Development (Aug07/06)
21 August 2007
was another roller-coaster ride for financial markets last week, with
global markets have been behaving like a malaria patient, with bouts
of high fever alternating with cold chills. Last week started rather
well, with gains in most markets after injections of funds by the Central
Banks of Europe, the
The following is an analysis of the current turmoil in financial markets worldwide. It was published as part of the ‘Global Trends’ series in the Malaysian daily, The Star on Monday 20 August.
Financial Turbulence Continues
By Martin Khor
world went through another week of roller coaster movements in stock
markets as investors were overcome by fears fuelled by more bad news,
while Central Banks continued their attempts to calm the markets with
more injections of funds and finally a reduction in an important interest
rate in the
The global markets have been behaving like a malaria patient, with bouts of high fever alternating with cold chills.
week started rather well, with gains in most markets after injections
of funds by the Central Banks of Europe, the
the jitters returned, as more bad news of corporate failings emerged.
Shares on Wall Street fell on Tuesday and Wednesday. This set the stage
for the trauma of last Thursday, as panic selling swept through Asia
and share prices plunged for the second day (the stock indices fell
Friday was another bad day for Asia, with the Kuala Lumpur index closing 1.5% lower (after plunging 5% at one stage), and falls of 5.4% in Japan, 3.1% in South Korea and 2.3% in China.
Then came news of the US Federal Reserve’s emergency measure of cutting its discount rate (the rate at which it lends to banks) by 0.5 points to 5.75%. As this will lower the cost of borrowing, it was good news for the markets.
Fed’s move came too late to revive Asia, but it was like a shot of medicine
for Europe on Friday (the
The week’s turbulence was partly sparked by more bad news. The US’ biggest mortgage lender Countrywide Financial was reported by a rating agency as facing possible bankruptcy; the KKR Financial firm disclosed it may lose up to US$250 million due to the mortgage crisis; a Goldman Sachs hedge fund lost US$1.8 billion and required an internal rescue; Canadian bank CIBC had to write off C$290 million; and an Australian hedge fund (Basis Capital) with US$1 billion revealed it had lost 80% of its value.
Will the cooling effect of the Fed’s interest reduction last? Most analysts believe the problems are so serious that Central Bank measures such as pumping funds into the system and reducing interest rates may calm the markets for a few days, but the fears will return to spook the markets.
major problem is that the effects have spread far beyond the institutions
that are directly hit by losses caused by the
the funds face higher redemption demands in their home countries, they
have to pull their money back from investments they have made abroad,
for example in stock markets in
Another complication is the “unwinding” of the “carry trade”, in which funds have borrowed heavily in Japanese yen (that carries low interest rates) to invest or lend in assets in countries with higher interest rates.
The current crisis has increased the value of the yen, thus reducing or wiping out the advantage gained in the difference in interest rates by the “carry traders”, since more of the currencies invested in has to be spent when buying back yen to re-pay the yen-denominated loans.
The hedge funds and others involved in the carry trade have started “unwinding”, by selling off their assets in countries with high interest rates, and returning their yen-denominated loans.
“The carry trade, particularly using the low-yield yen, has been a huge source of funding for speculative trades across asset classes,” according to a Financial Times article. But now the yen is surging as traders take bets off the table. “All of a sudden, the carry trade is frightening and a big sell”, it quoted a financial analyst.
As the yen carry trade unwinds, and more yen is in demand to pay back the loans, this sends the Japanese currency’s value even higher, which in turn makes it more urgent for more “unwinding” to take place.
These two factors – higher redemption demand and the unwinding of the carry trade – may account significantly for the shares sell off in at least some of the Asian stock markets.
An article in International Herald Tribune last Saturday said that “the market volatility created by the unwinding of carry trades, which has ripped through all kinds of assets, is something most people can do without. And it feeds on itself: volatility in exchange rates makes cheap-yen borrowing increasingly risky, necessitating more unwinding…
“Many of the market declines are the result of forced selling by find managers. As investors lose money, they begin to cash in their holdings in funds, forcing managers to sell stocks even if they do not believe it is wise to do so.
“Falling asset prices compel many brokers to ask investors to deposit more cash, which forces more investors to sell their holdings to raise cash. All this selling exacerbates the pace of declines, creating a vicious cycle in which more selling begets even more selling.”
many Asian countries, including
Thus, if the current crisis were to be played out only within the sphere of those involved in the sub-prime market, the region should be spared from adverse effects.
there is now such a high degree of inter-dependence between different
types of markets, and between different financial institutions and companies,
linked through many layers of exposure, many types of financial instruments,
and through many leveraged and speculative funds, that
The roller coaster ride in the financial markets looks set to continue next week and into the foreseeable future.