MARKET RAP Beware the wings of
the butterfly R M Cutler
MONTREAL - It was on the Asian equity
markets, not the American or European exchanges,
where the danger of failure of the bond insurer
Ambac first made itself felt. The prospect of
there being a real plan for saving it, made public
30 minutes before the close of New York trading on
Friday 22, had given American equity markets heart
at a time when major indexes were beginning to
test their lows in the recent decline.
The
euphoria lasted through the weekend as newspaper
articles gave details, and the positive market
jolt lasted through Monday and even Tuesday. Then
on Wednesday, Asian stocks shook off unexpectedly
weak US economic data to hit six-week highs before
pulling back on Thursday and Friday. The fear that
an
American
downturn will significantly hurt Asian corporate
earnings seems paradoxically to have been at least
temporarily overcome.
This is paradoxical
because for a time earlier this year the notion of
"decoupling" of Asian and American markets was in
vogue. Over the past few weeks, however,
opinion-leaders and decision-makers in the
international financial community have been
playing down the idea. They have instead
emphasized the integration and mutual
interdependence of national equity markets and
macro-economic systems worldwide.
The head
of the European Central Bank (ECB), Jean-Claude
Trichet, is one of these. While earlier in the
month observers gained the impression that he
might follow a lax euro policy, he tempered his
expression of views over the last week. In
particular, he emphasized more than once the ECB's
responsibility to control inflation and provide
price stability through monetarist policies, while
providing incentives to structural reforms that
would promote growth and employment.
In
other words, as Merrill Lynch concluded, it is
possible that he will not raise interest rates all
year. Perhaps not coincidentally, the euro reached
this past week its historical high against the
American currency, breaking the $1.50
psychological barrier.
The Canadian
markets and its dollar (the value of which some
investors appear to use as a surrogate for the
price of oil itself) surged accordingly, helped
along by reports that Enbridge had found enough
Asian refiners and Southeast Asian consumers to
revive its $4 billion "Gateway" pipeline from the
Alberta oil sands to the Pacific Ocean coast. The
ultimate consumers for oil from the Gateway
pipeline have not been officially named, but
Japan, Singapore and South Korea are those most
frequently mentioned. This project had been
put on hold several months ago after Chinese
national oil company PetroChina (which was to have
purchased half the entire production) withdrew in
frustration at the slow pace of development,
accusing Ottawa of foot-dragging in the promotion
of the project. However, in Canada, jurisdiction
over all exploration and development of
nonrenewable resources lies in the hands of the
provinces, unless federal lands are concerned. The
Canadian federal government's authority is limited
principally to regulating trade and commerce
between provinces and internationally.
Weakness in the US dollar fueled strength
in metals as well as oil, which of course had to
rise in dollar denomination just to maintain a
stable price in other currencies. Silver rose and
palladium soared. Major aluminum companies
continued to coast on the 10% bump their shares
received at the beginning of month, when Chinalco
and Alcoa coordinated the purchase of 12% of Rio
Tinto's shares in order to block BHP Billiton's
bid for the company.
In conclusion, the
divergence between economic projections of the US
Federal Reserve Bank and those of the IMF gives
pause. A new Fed scenario published in the course
of the week cut US growth projections by a
half-point down to the 1.3%-2.0% range and
increased estimations for inflation. This may
still be too rosy a scenario, as the IMF projected
US growth at only 0.8%.
Europe's official
financial institutions altered projections of 2008
EU economic growth downward in line with the Fed's
revisions. Trichet understands the implications of
this. That is why he stressed in public remarks in
Frankfurt on Monday 25 that it is "particularly
important at the current juncture" that the world
economy should be "able to rely on the dynamism of
the Asia-Pacific region" if Europe and America
should falter.
Yet East Asian equity
markets are often the first to feel effects of the
continuing liquidity crisis in the world banking
sector. Now that collateralized debt obligations
(CDOs) have been mostly addressed, the next
elephant in the room is structured investment
vehicles (SIVs). No one can predict whether or
when their ratings (which are still excellent
despite all known problems) may be downgraded.
However, if this happens, then as with the CDO and
mortgage crises it may well occur in response to a
trivial stimulus or none at all, the proverbial
butterfly's wings flapping on the other side of
the world.
If indeed this does occur, then
it will engender yet another crisis that may well
require some months to work through the global
financial system and in the meantime preoccupy the
equity markets with, at a minimum, additional
chronic worry. Or perhaps those who run the
tailors’ guild are working feverishly even now, in
preparation for the announcement that the emperor
has no clothes: if they have the time for this.
R M
Cutler (http://www.robertcutler.org)
is a Canadian international affairs
analyst.
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