Market worries and volatility will outlast summer

September 6, 2011

By Agnes T. Crane and Richard Beales
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Investors who spent August on the beach were fortunate to miss a bout of rollercoaster trading. And they will be rested for the next round, a taste of which came on Friday. The concerns behind the last volatile patch still haven’t been addressed. European debt trouble, the weakness of U.S. economic growth — underlined by the zero jobs created in August — and political conflict spell more wild rides.

Out of 45 developed and emerging stock markets tracked by S&P Indices, August left all but two underwater, by an average of 7.7 percent globally. Anyone who packed up at the end of July, sold stocks and bought Treasuries can at least count themselves lucky. After all, even those who stuck around for live deals have seen IPOs abandoned and one huge M&A deal — AT&T’s $39 billion purchase of T-Mobile USA — put in jeopardy.

But returning finance types shouldn’t forget that 44 of those same 45 markets are also still down from the end of August 2008 (the exception is Peru’s). Then, the collapse of Lehman Brothers and the worst of the crisis were still, just, in the future. A lot can go wrong.

The euro zone remains a basket case — at least in places. That’s belied by its currency, which has remained remarkably strong against the dollar at around $1.42. Yet dodgy sovereign debt tucked away in the region’s banking system makes it the biggest potential flashpoint for global markets.

The crisis has moved well beyond Greece. There is a metaphorical bull’s-eye on too-big-to-rescue Italy. In August, 10-year Italian bond yields soared above 6 percent before the European Central Bank stepped in and agreed, reluctantly, to buy Italian debt. Italy has to refinance a record 62.4 billion euros of debt due for repayment in September, and that could put the ECB’s calming influence to the test.

And there’s still a question over European bank funding. In August, fear erupted again about banks’ access to short-term sources of finance like U.S. money market funds. The funds are still lending, but for shorter periods. The shorter the term of lending — and it can get down to day-by-day — the easier it is for the funds and other lenders to pull out, leaving European banks to scramble.

Between Europe’s sovereign debtors, its banks and its currency, there’s a credible systemic threat. And despite the ray of hope for private-sector answers provided by a Greek bank merger in the last days of August, no-one has come up with a comprehensive plan to right the European financial ship.

Meanwhile, worries over a double-dip recession in the United States are overshadowing earlier concerns about a slowdown in global growth. Chinese expansion has held up so far, though its policymakers face the challenge of maintaining that while trying to cool parts of the economy and control bank lending. But for America, the latest gloomy data point was the stark jobs report for August, released on Friday.

The Federal Reserve on Aug. 9 pledged to keep short-term interest rates near zero for at least two years, and it looks as if the U.S. central bank, chaired by Ben Bernanke, is mulling another round of quantitative easing. Any new measures are sure to be contentious given the brickbats the Fed took for its last $600 billion venture. The next policy-setting meeting has been extended to two days. With three Federal Open Market Committee dissents over the low-rate promise last month, Bernanke and his colleagues have plenty to debate. This month’s meeting, now running Sept. 20-21, will be scrutinized closely by investors.

Bernanke referred in an Aug. 26 speech to a third big theme for markets — the seeming inability of Washington’s political leaders to agree on anything. Such dysfunction played a part in Standard & Poor’s landmark downgrade of America’s debt at the end of July. And President Barack Obama and Republican leaders even managed to bicker over a date for Obama to tell Congress about new job-creation ideas, an event now set for Sept. 8.

But America isn’t the only place with a political credibility problem. Europe’s leaders, including Germany’s Angela Merkel and France’s Nicolas Sarkozy, are struggling to shape an escape from the region’s debt troubles. That’s partly because the disparate interests within the euro zone make it difficult to force weaklings like Greece to take austerity medicine, and just as tough to persuade the bloc to help out. With politicians everywhere as well as markets floundering, investors could be in for a bumpy ride.

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