Global Sell-Off Shows Fed Reach Beyond the U.S
June 21, 2013
By Nathaniel Popper
Despite a partial recovery in the markets on Friday, tumbling stock, bond and commodity prices around the world over the past month are demonstrating just how reliant the global economy has become on the monetary policies of the Federal Reserve.
In the weeks since the Fed’s chairman, Ben S. Bernanke, first indicated that the central bank might start to pare back its support for the economy, markets in Asia, Europe and Latin America have fallen even more sharply than those in the United States, threatening economic growth in many countries.
While leading market measures in the United States have declined 4 percent over the last month, an index of the world’s stock markets has slumped more than 6 percent.
“The Fed isn’t just the U.S.’s central bank. It’s the world’s central bank,” said Mark Frey, the chief strategist at the Cambridge Mercantile Group.
The selling picked up in markets around the world on Thursday, a day after Mr. Bernanke’s latest comments on the Fed’s plan to wind down the stimulus. While the reason for the shift by the Fed is good — a strengthening of the recovery in the United States — investors are nervous that the global economy may not be ready.
On Friday, markets calmed down despite the prospect of slowing economic growth and rising interest rates. Asian stocks were mixed, with the Nikkei 225 index up 1.7 percent at the close of trading, European indexes were mostly higher in afternoon action and Wall Street futures suggested a higher opening in New York’s morning.
On Thursday, the benchmark Standard & Poor’s 500-stock index fell 2.5 percent, its steepest one-day decline since November 2011. Treasury prices also slumped, driving yields, which move in the opposite direction, to touch their highest levels in nearly two years. Gold, once a favorite of investors, slid to two-and-a-half-year lows.
Thursday’s damage was more pronounced in a wide array of markets outside the United States, like Philippine government bonds and the Norwegian currency. Stock indexes in China, Europe and Mexico fell more than 3 percent.
Investors were also rattled by reports that Chinese banks had become reluctant to lend to one another. And Europe’s debt woes came into focus again after the International Monetary Fund said it was considering suspending aid to Greece. But traders and investors cited the Fed’s changing policies as the main driver behind the big flows of money around the world.
“The trigger was clearly what is going on with the Fed,” said Ashish Goyal, the investment director at Eastspring Investments in Singapore.
The heavy selling was a sharp reversal after years when low interest rates in the United States encouraged investors to put their money into foreign countries. For investors in once-attractive foreign markets, the fear was that those markets may be on even less firm economic footing than the United States’, and consequently less able to absorb the decline in lending that comes along with rising interest rates.
“When the U.S. embarks upon policies that are appropriate for its own domestic circumstances, it can impose policies on the rest of the world that aren’t necessarily appropriate to them,” said Darren Williams, the senior European economist at AllianceBernstein in London.
Interest rates are a vital determinant and indicator of economic activity. To try to encourage borrowing and bolster the economy after the financial crisis, the Fed has pushed rates down by cutting the interest rates it offers banks and by buying more than $2 trillion of bonds. The extent of the intervention has put markets on a hair trigger for any hint of a change from the Fed.
Mr. Bernanke has indicated that the Fed will pare its bond purchases only very slowly and may increase them again if there are signs the economy is being hurt. That has some analysts calling this week’s market turmoil a panicked overreaction. For the year, the S.& P. 500 index is still up 11.4 percent.
But there are significant concerns that the Fed may not be able to control the convulsions in the markets that Mr. Bernanke has already set off with his comments.
“It’s a very significant moment,” said Sebastian Galy, a foreign exchange strategist at Société Générale. “It’s the end of an extremely aggressive phase of monetary policy globally.”
The American economy is probably not immune to these changes. After years of falling interest rates, which have encouraged a recovery in the housing market, banks have recently been asking for higher interest payments from home buyers. There are already signs that this is putting a damper on home sales. All of this helps explain the recent declines in American stocks. But Mr. Bernanke said that the United States economy was on firm enough footing to withstand the rising rates, and he has promised to intervene if that changes.
The outlook has not been so bright in much of the rest of the world. China and Brazil are wrestling with lower growth rates. Falling prices for commodities are hurting natural-resource-rich countries like Australia and Russia.
After the financial crisis, many of these markets became attractive to investors seeking higher returns in the face of paltry interest rates. Some 55 percent of the Mexican bond market, for example, is now owned by foreigners, up from 25 percent in 2010, according to Claudio Irigoyen, the Latin American strategist at Bank of America.
Hedge funds and other money managers have also been borrowing money on the cheap in the United States and using it to invest in foreign stock and bond markets offering higher returns. Now the prospect of higher interest rates in the United States is causing those investors to quickly unwind those trades.
Smaller investors are also retreating, pulling out of mutual funds and exchange-traded funds that own the bonds issued by developing countries. During the last week, these funds have had the largest outflow on record — $622 million — according to Lipper, a fund data company.
Such outflows may bring back memories of past periods of global financial tumult, when countries like Russia and Mexico defaulted on their government debt partly because of an exodus of foreign investors. But most developing countries are now on a much firmer financial footing than they were in the past, reducing the chances of a crisis stemming from the turmoil.
Still, the current upheaval is already causing pain for many investors. Brevan Howard Assert Management, a powerful hedge fund manager, has seen its emerging market fund drop nearly 12 percent, or $300 million, this year, according to people briefed on the fund’s performance.
“People are trying to figure out how to get out,” Mr. Irigoyen said.