Perfect storm sparks global market sell-off
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Emerging Markets

Perfect storm sparks global market sell-off

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Global markets tumbled Friday amid jitters over a Chinese interest rate hike and an Irish sovereign debt crisis, while global tensions on trade imbalances, intensified by a lackluster G20 summit, dented risk appetite

“We have had four important reminders this week – the European sovereign debt crisis, the faster-than-expected pace of monetary tightening in China, currency tensions and capital controls – of big risks to global markets,” said Michael Ganske, head of emerging markets research at Commerzbank.

A sharp sell-off hit Asian markets amid speculation of another interest rate hike by the People’s Bank of China (PBOC), to arrest spiraling inflation. China on Thursday reported higher-than-expected annual consumer price inflation in October at 4.4%. The Shanghai Composite Index, subsequently, fell 5.2% Friday, its worst daily performance in over a year, puncturing global commodity prices. In aggregate, emerging Asian bourses fell 1.5%, while the South Korean won dropped 1.6% and the Indian rupee 0.3%.

European stock markets recovered some of their losses, with the benchmark FTSE closing 0.3% lower, amid hopes European leaders will thrash out a rescue package for debt-burdened European governments. Bank stocks soared Friday after Eurozone finance ministers confirmed that existing sovereign bondholders would not take the hit in any new sovereign bailout mechanism. The European Commission meanwhile denied market speculation that Ireland had applied for a bailout.

US markets hit new lows in early trading, with risk aversion governing equity and debt markets, as investors focused on European sovereign debt concerns. The prospect of slower Asian growth, as Chinese authorities eye tighter monetary policy, also weighed heavy on US market sentiment.

G20 leaders in Seoul failed to reconcile currency and trade imbalance tensions, raising the risk of trade protectionism and exchange rate instability. “The lack of progress on key issues at the G20 summit was not a major surprise, however, it still undermines market confidence and underscores the global policy risks,” said Paul Biszko, senior emerging markets analyst at RBC Capital markets.

The spectre of growing financial protectionism intensified yesterday, as a South Korean ruling party lawmaker said the country may revive by next January a 14% tax on foreign holdings of domestic treasury and central bank bonds to curb foreign-exchange volatility.

Nevertheless, a global bear market is not on the cards as the US Federal Reserve’s quantitative easing strategy continues to create excess liquidity, said Ganske at Commerzbank. The move has also driven down US bond yields to historic lows, forcing investors to chase higher-returns in emerging bond and equity markets.

Emerging market equity funds this week yanked in $5.44 billion, according to fund-tracker Emerging Portfolio Fund Research (EPFR). These funds have now taken in $79.9 billion so far in 2010 and are “on the verge of exceeding last year’s record $83.3 billion inflow,” it said in its weekly survey today.

But Ganske said the new inflows into emerging market equity and debt funds are likely to cool in the coming weeks, with investors locking in profits, as portfolio managers typically reduce their risk exposures by the end of any given year.

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