Wednesday, June 14, 2006

What’s Driving International Markets Lower?

Over the past five weeks, major international equity funds have declined by more than 20 percent. Markets from developed nations such as the U.S to the developing such as India have been whipsawed by factors that most investors did not see coming. The correction has been particularly painful for new 2006 investors. The FTSE 100 (Great Britain) is now down 10 percent from its April peak, the Nikkei 225 (Japan) has dropped nearly 20 percent and the Dow Jones (U.S.) has lost around 8 percent. And emerging markets have even experienced larger losses. India's Sensex index has fallen 28 percent from its peak, while Brazil's Bovespa has plummeted 22 percent.

However, the truly clairvoyant investor should have seen this coming. The cries from the inflation mongers have been heard stretching from Brussels to New York to Singapore. As a result, central banks across the globe have been raising interest rates over the past several months to slew this dragon. For example, the Reserve Bank of New Zealand raised the benchmark interest rate nine times since January 2004, to 7.25 percent. As a result, the latest growth forecasts for New Zealand are the lowest since 1999.

And just last week the European Central Bank raised rates by 25 basis points due to a fear of inflation. This sounds a bit strange to us on this side of the Atlantic with the EU likely to grow by little more than one percent this year. Nothing like inflationary fears and slow growth to wilt any stock market.

And today, the Russian Finance Minister, Alexei Kudrin, stated that bank liquidity (balances at banks' accounts) amounted to RUR860m (approx. USD31.75m) as of June 5, 2006 and stressed that these high levels were due to high Russian interest rates restraining borrowing by businesses.

And as U.S. investors know all too well, the Federal Reserve Open Market Committee has been raising rates over the past two years with rates advancing short-term rates by a full four percent.

An additional factor driving markets lower has been a more credible fear of slower economic growth. Expected slower growth in the U.S. and Europe has certainly driven South Korea’s markets lower. Though the South Korean market is up over the past several days, firms dependent on export sales continue to languish.

Remember the goods old days just four years ago when the FOMC was concerned about deflation and lowered U.S. rates to one percent. Just as the Fed was wrong then, it is wrong now. These higher U.S., EU, British and Japanese short-term rates will achieve their desired purpose—lower inflation but also slowing growth to unacceptably low levels.


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