Why the world still dances to Wall Street's tune
Monday, 20 August 2007
John Authers
HERE is a paradox. The world's economy is steadily "decoupling" from the US. The extent of the effect can be overstated, but it is plain that a new engine of growth is rising, in China and India, and that the importance of the US thereby diminishes.
And yet there is no such decoupling of world markets. Quite the reverse. I have commented on this paradox before, but the panic-driven volatility of the past month has made it even more glaring.
For stretches over the last few weeks, it has been as though the only market that mattered in the world was in New York. The huge and growing bourses of Europe and Asia seemed powerless to do anything more than react to the latest swing on Wall Street, that had happened as they slept. How can we explain this?
The evidence for some economic decoupling, despite the forces of globalisation, grows stronger. The US is at a different point in the cycle to anywhere else in the developing world. The statement from the US Federal Reserve on August 07, brought the bank closer to cutting its benchmark Fed Funds rate, which has been on hold at 5.25 per cent for more than a year.
Contrast this with the UK, which suffers the most entrenched inflation expectations in the developed world, and where the Bank of England's latest inflation report increased the chances of another rate rise. Or with the eurozone, where the European Central Bank has virtually promised that it will raise rates once more next month (even as it has resorted to intervention in the market to maintain liquidity). In Asia, Korea's central bank last week surprised the markets with an interest rate rise, to 5.0 per cent -- its highest level since 2001. Australians also had to contend with a rate rise, though that was less surprising. In emerging markets, particularly China, the challenge is to rein in rampant growth.
So if the US is still the world's consumer of last resort, it has a strange way of showing up in the data. However, Wall Street seems ever more central to the world's capital markets. A look at minute-by-minute price movements in the S&P 500 and the FTSE-100, the main benchmarks for New York and London, over the recent weeks, allows no other conclusion.
The two lines look much the same. They have risen and fallen together as global markets have responded to the steady flow of news about the US subprime mortgage crisis. But the FTSE is punctuated by gaps.
Day after day, Wall Street saves its decisive move until after European markets have closed. The FTSE (and other European indices) respond by "gapping," to use the market argot. In other words, there is a break in the continuous flow of prices. Instead, prices are simply marked drastically up or down at the opening in London, in an attempt to catch up with Wall Street. Why does Europe follow Wall Street's lead so slavishly when its economies seem to be at a different stage in the cycle?
Globalisation has something to do with it. Standard & Poor's companies increasingly draw revenues and profits from outside the US. FTSE companies are even more international. For large companies, at least, the country where they are listed is becoming less and less relevant to their share price performance.
But more importantly, markets themselves are more international, with technology making it easy to trade across asset classes, and across continents. It makes less sense to talk about coupled markets than to refer to one, ever more homogeneous market. The US still has the world's largest economy so it will be the major force.
Finally, the sole factor that is driving world market volatility emanates from the US. The debacle of subprime mortgages, made to people with poor credit histories, is a US problem. Globalised markets have allowed companies in Australia, France or Germany, to share in the losses. But the greatest fears attach to the big US banks and hedge funds, and to the health of the US financial system. The subprime sell-off might yet quite easily prove to be a healthy correction, but it might also turn into a full-blown systemic crisis.
The latter could happen if liquidity dries up in US markets, or if a big US institution collapses. Hence huge swings in the Wall Street afternoon as traders, who are in any case very close to the institutions allegedly at risk, respond to the latest rumour.
It is a sad state of affairs for the US. Once the fulcrum of world markets because it was the engine of global growth, it now holds that position because it is the epicentre of global risk. Recent weeks should also dampen triumphalism in London over its growth as a financial centre. It is in vogue to describe London, without caveat, as the world's "financial capital".
The City of London hosts many more transactions than it did a decade ago. This has generated great wealth for the city, and for the UK. But we can see from the recent weeks that London's role in global markets is still essentially passive. The decisions, and the trades, that determine whether the summer credit crunch turns into a full-blown crisis will be made in Manhattan, not the Square Mile.
FT Syndication Service
HERE is a paradox. The world's economy is steadily "decoupling" from the US. The extent of the effect can be overstated, but it is plain that a new engine of growth is rising, in China and India, and that the importance of the US thereby diminishes.
And yet there is no such decoupling of world markets. Quite the reverse. I have commented on this paradox before, but the panic-driven volatility of the past month has made it even more glaring.
For stretches over the last few weeks, it has been as though the only market that mattered in the world was in New York. The huge and growing bourses of Europe and Asia seemed powerless to do anything more than react to the latest swing on Wall Street, that had happened as they slept. How can we explain this?
The evidence for some economic decoupling, despite the forces of globalisation, grows stronger. The US is at a different point in the cycle to anywhere else in the developing world. The statement from the US Federal Reserve on August 07, brought the bank closer to cutting its benchmark Fed Funds rate, which has been on hold at 5.25 per cent for more than a year.
Contrast this with the UK, which suffers the most entrenched inflation expectations in the developed world, and where the Bank of England's latest inflation report increased the chances of another rate rise. Or with the eurozone, where the European Central Bank has virtually promised that it will raise rates once more next month (even as it has resorted to intervention in the market to maintain liquidity). In Asia, Korea's central bank last week surprised the markets with an interest rate rise, to 5.0 per cent -- its highest level since 2001. Australians also had to contend with a rate rise, though that was less surprising. In emerging markets, particularly China, the challenge is to rein in rampant growth.
So if the US is still the world's consumer of last resort, it has a strange way of showing up in the data. However, Wall Street seems ever more central to the world's capital markets. A look at minute-by-minute price movements in the S&P 500 and the FTSE-100, the main benchmarks for New York and London, over the recent weeks, allows no other conclusion.
The two lines look much the same. They have risen and fallen together as global markets have responded to the steady flow of news about the US subprime mortgage crisis. But the FTSE is punctuated by gaps.
Day after day, Wall Street saves its decisive move until after European markets have closed. The FTSE (and other European indices) respond by "gapping," to use the market argot. In other words, there is a break in the continuous flow of prices. Instead, prices are simply marked drastically up or down at the opening in London, in an attempt to catch up with Wall Street. Why does Europe follow Wall Street's lead so slavishly when its economies seem to be at a different stage in the cycle?
Globalisation has something to do with it. Standard & Poor's companies increasingly draw revenues and profits from outside the US. FTSE companies are even more international. For large companies, at least, the country where they are listed is becoming less and less relevant to their share price performance.
But more importantly, markets themselves are more international, with technology making it easy to trade across asset classes, and across continents. It makes less sense to talk about coupled markets than to refer to one, ever more homogeneous market. The US still has the world's largest economy so it will be the major force.
Finally, the sole factor that is driving world market volatility emanates from the US. The debacle of subprime mortgages, made to people with poor credit histories, is a US problem. Globalised markets have allowed companies in Australia, France or Germany, to share in the losses. But the greatest fears attach to the big US banks and hedge funds, and to the health of the US financial system. The subprime sell-off might yet quite easily prove to be a healthy correction, but it might also turn into a full-blown systemic crisis.
The latter could happen if liquidity dries up in US markets, or if a big US institution collapses. Hence huge swings in the Wall Street afternoon as traders, who are in any case very close to the institutions allegedly at risk, respond to the latest rumour.
It is a sad state of affairs for the US. Once the fulcrum of world markets because it was the engine of global growth, it now holds that position because it is the epicentre of global risk. Recent weeks should also dampen triumphalism in London over its growth as a financial centre. It is in vogue to describe London, without caveat, as the world's "financial capital".
The City of London hosts many more transactions than it did a decade ago. This has generated great wealth for the city, and for the UK. But we can see from the recent weeks that London's role in global markets is still essentially passive. The decisions, and the trades, that determine whether the summer credit crunch turns into a full-blown crisis will be made in Manhattan, not the Square Mile.
FT Syndication Service