Asian market nerves ease

By R M Cutler

MONTREAL - Asian equity markets, which started the week in a mood of trepidation, followed the North American markets' reaction to world financial developments. They thus tracked the hopes and fears of the international credit markets, conditioned by the realization that the February 9 Tokyo meeting of Group of Seven (G-7) countries' finance chiefs only confirmed their inability to coordinate national fiscal policies and their unwillingness to do anything about exchange rates.

The markets' evolution during this period began on the downside amid trepidation over the financial sector coupled with increasing prices for oil and metal. They then hemmed and hawed for a few days. In contrast to the previous week, however, neither euphoria nor dysphoria in East Asia had knock-on effects rippling across the globe through Europe back to the United States and Canada.

Mainly unchanged through Wednesday, the Asian markets were up strongly on Thursday, February 14, as the Nikkei 225 had its biggest daily percentage spurt in six years. The Hang Seng gained 3.7%, and Chinese exchanges were up as well. The Thursday rise in Asia was driven partly by the psychological impact of Warren Buffett's Wednesday announcement of his willingness to assume the risk from the tax-free municipal part (US$800 billion) of the portfolios of the three major bond insurers - Ambac, MBIA and FGIC - for a 50% additional charge above their premiums.

It was almost immediately clear, however, that tax-free municipals are the only instruments preventing these bond insurers from sinking irretrievably under the quicksand of subprime mortgage debt.

Buffett's gesture was akin to an offer to snatch away the only rope that could possibly save them. So by midday Friday the main exchanges worldwide had lost over half their Thursday gains, particularly following Wall Street's downturn in response to Federal Reserve chairman Ben Bernanke's Congressional testimony, in which he warned of the danger of the US entering a period of stagflation (low growth combined with inflation).

Bernanke also warned that, given his expectation of "sluggish growth [over the next six to nine months], followed by a somewhat stronger pace of growth" towards the end of the year, he thought that the Fed would be less aggressive in subsequent rate cuts. Nevertheless, futures traders are still expecting the current rate of 3.0% to undergo at least another half-point cut on March 18, with even a another three-quarters-point cut possible, and with further cuts bringing the rate to 2.0% by summer.

A good question, if this expectation persists, is whether Bernanke and the Fed will follow expectations. They seem to have noticed that the quarter-point cut last October 31, in the face of half-point expectations, engendered an immediate and precipitous decline into the trading ranges that the main indexes now inhabit. And it was that drop which conditioned the psychology making the extraordinary three-quarters-point cut necessary on January 22.

If the markets remain in their current trading ranges for the next month, and if expectations inferred from futures markets do not change over that time, then anything less than another half-point cut could produce a dive through the floor of the current trading ranges in search of new lows. This purely technical and psychological danger will find a basis in world market fundamentals if for any reason more bad news about the international financial sector's liquidity crisis comes out at the wrong time.

Unfortunately, we can be fairly certain that some bad news will be coming out periodically, since the subprime crisis still requires months to unwind. Macro-economic indicators will not save market sentiment in the meantime, even if Asian production for the Asian market does not flag, and China and India continue their spectacular growth. A revaluation of the yuan is not in the cards, but an announcement of larger permitted fluctuations against the dollar could have a short-term positive psychological effect in summer.

Returning to this past week, the Australian All Ordinaries index (tracked closely by the other major Australian index, the S&P/ASX 200) showed typically greater volatility yet has not visibly responded to increasing indications that the Australian dollar might turn around against the American currency due to the strength of the country's primary materials sector and unflagging demand from East Asia for these goods. On the other hand, due mainly to metals and oils, the Toronto S&P/TSX Composite continues its outperformance of Wall Street and many European markets.

Indeed the Canadian markets, because of the heavy primary-materials weighting, have in the recent short term significantly outperformed not only the Australian exchange and Wall Street, but also the Shanghai SSE Composite, which it had lagged for most of the last six months, until the last three weeks. The financial sector in Canada still has its problems but these appear to have been shaken out faster than in the US and Europe, due partly to the smaller number of players, relatively less subprime exposure, and a genuine effort (even if not yet wholly successful) at transparency after the initial writedowns.

The important BSE Sensex 30 index in Mumbai has been holding onto much of the exuberant relative gain it registered last autumn but has begun again to track the other Asian indexes in percentage terms, opening down, in sympathy with them, 2% on Friday after an almost 5% gain Thursday but immediately beginning to recover towards its Thursday close, as the Nikkei closed Friday near its own open. The Indian index bears watching, as recent fluctuations suggest it may become a leading short-term or medium-term indicator for other Asian, especially East Asian, exchanges.

R M Cutler is a Canadian international affairs analyst.