Mon, May 22, 2006 - Page 11 News List

Market chaos leads to worldwide jitters

BAD NEWS After a torrid week when fears over US interest rates shook stock markets some experts fear that we may now be on the brink of a world recession

THE OBSERVER , LONDON

Traders work on the floor of the New York Stock Exchange at the end of trading in New York on Thursday one day after the market's biggest one-day drop in three years.

PHOTO: EPA

From Stockholm to Tokyo, New York to Istanbul, market mayhem swept across the world last week, unleashing violent movements on stock markets and foreign exchanges everywhere, and hammering down the price of commodities such as copper and gold.

In London, the FTSE 100 suffered its worst day for more than three years on Wednesday, before ending the week at 5,672, more than 4 percent down in five days' trading.

After a febrile fortnight, analysts are asking themselves if the turmoil is over -- or whether the sell-off marked the end of the three-year bull market and the dawn of a much more volatile era.

Stephen Lewis, of bankers Insinger de Beaufort, says it's too early to write off the risk that the events of the past few days could be the trigger for a full-blown financial crisis.

"Volatility rises, to the extent that it has in equity and commodity markets in recent days, when emotions take over; when actions in the markets are forced; when survival is at stake," Lewis said.

"In such circumstances, there can be no reliable forecasts of how far markets will move," he warned.

The worldwide wobble started with the US dollar. A warning from G7 finance ministers last month about imbalances in the global economy, a hint from Federal Reserve Chairman Ben Bernanke that he might halt the rise in interest rates, brought the greenback bears out of hiding, and triggered a frenzy of selling.

But over the past few tumultuous days alarm has spread far beyond the currency markets.

"The equity markets were standing rather naively on the sidelines, and suddenly they've woken up," said David Bloom, currency strategist at HSBC, who has long predicted a US dollar shake-out.

"Markets have been looking very vulnerable," said Julian Jessop, international economist at Capital Economics.

"There have been some bubbles developing, particularly in commodities," he said.

All investors are waking up to an alarming new world. After five years in which credit has been plentiful as central banks kept the cash taps on, the cost of borrowing has gradually begun to grind upwards.

In the US, the Federal Reserve has raised interest rates 16 times, to 5 percent, from 1 percent two years ago.

The European Central Bank has also raised borrowing costs, and even Japan, the home of the zero interest rate for many years, has responded to a stronger economy by promising to start tightening monetary policy.

risky positions

In this new climate, with money rapidly becoming more expensive, investors will be less enthusiastic about taking enormous bets using borrowed cash. The unwinding of some of these risky positions was responsible for some of last week's upheaval.

"Everyone and his dog has leveraged up to the eyeballs buying everything they can get their hands on," said Charles Dumas, of Lombard Street Research.

"Now liquidity's drying up because interest rates are high; bond yields are high; everyone's finding their funding drying up," he said.

One extreme example of this is what analysts call the "yen carry trade:" investors have been taking advantage of zero interest rates in Japan, borrowing the money to take bets in other markets.

With rates in Japan on the way up, they have been hurriedly extricating themselves: and that has hit risky but high-yielding assets, such as emerging market bonds.

Turkey took a pounding last week, for example, as nervous investors pulled their cash back home.

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