Global overview: Signs of abating risk aversion

By Dave Shellock

Published: August 23 2007 17:44 | Last updated: August 23 2007 22:12

There were clear signs of risk appetite returning to financial markets on Thursday as investors piled back into emerging market assets and took on fresh carry trade positions.

However, Wall Street’s attempts to build on Wednesday’s strong rally juddered to a halt after pessimistic comments from the chief executive of Countrywide, the ailing US mortgage lender.

Angelo Mozilo, speaking on US television, warned there were no signs of improvement in the housing market and said there had been no improvement in the commercial paper market. The comments came hard on the heels of Bank of America’s decision to invest $2bn in Countrywide – a move that had given a massive injection of confidence to the markets earlier in the day.

At the close, the Dow Jones Industrial Average was flat, the S&P 500 was 0.1 per cent lower and the Nasdaq Composite index was down 0.4 per cent. This took the shine off Europe’s early gains, and the FTSE Eurofirst 300 index ended just 0.3 per cent higher at 1,509.39.

Asian stocks had another day of strong gains. In Tokyo, the Nikkei 225 Average climbed 2.6 per cent and most other leading markets in the region gained between 2 and 3 per cent.

Chinese stocks had another record-breaking session, with the Shanghai Composite index climbing above the 5,000 level for the first time to end 1.1 per cent higher.

In emerging markets, debt spreads over US Treasuries tightened 11 basis points, taking the narrowing since last Thursday – when spreads hit the highest since November 2005 – to 27bp.

The MSCI emerging market equities index gained about 2 per cent, while the Turkish lira and the South African rand both touched one-week highs against the dollar.

The stuttering performance by US and European equities was accompanied by a rally in government bonds. The yield on the two-year US Treasury was at 4.22 per cent and in Europe, the two-year Schatz yield was also down 2bp at 4.01 per cent.

Meanwhile, the yield on the benchmark 10-year Japanese government bond tumbled 4.5bp to an 18-month low of 1.54 per cent.

The Bank of Japan left interest rates unchanged on Thursday after a two-day policy meeting but most analysts felt a tightening had merely been delayed due to the recent market turmoil.

“As we expect financial markets to remain volatile during the next month but gradually recover within the next three, we believe the BoJ is most likely to hike rates by 25bp to 0.75 per cent at its October 11 monetary meeting, but a rate hike on September 19 cannot be ruled out completely if financial markets recover quickly,” said Flemming Nielsen, analyst at Danske Bank.

Meanwhile, the outlook for US interest rates remained uppermost in many investor minds.

Rob Carnell, economist at ING, said he believed that much of the latest recovery in equities was due to a greater expectation that the Federal Reserve would step in and lower the Fed funds rate.

“We see the moves in the Treasury bill market and interest rate futures as echoing that [expectation], rather than driving it. At some stage, which might be a matter of days, or a matter of weeks, the Fed is going to have to address this expectation or suffer a major fall in confidence and a further market sell-off again.”

In the currency markets, the yen retreated virtually across the board, most notably against high-yielders such as the Australian and New Zealand dollars. But it also retreated against the dollar and suffered its worst two-day fall against the euro for three years.

The European Central Bank’s attempt to alleviate money market pressures by injecting €40bn ($54.2bn) into three-month funds triggered massive demand, but failed to bring down corresponding interest rates. At least one bank offered 5 per cent for ECB money.

But indicative prices for three-month lending were barely changed at 4.65-4.70 per cent.

Julian Callow, economist at Barclays Capital, said the outcome showed the market was “very thirsty”.

In commodities, US oil futures managed a modest advance back towards the $70 a barrel mark, while wheat prices hit a record high.