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European and Global Markets Drop Ahead of Wall Street Opening

Friday, 05 August 2011 05:52 By Matthew Saltmarsh and Bettina Wassener, The New York Times News Service | Report
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London - Stock markets continued to slide Friday in Europe following sharp sell-offs in Asia and on Wall Street, as pessimism about weak growth in the United States combined with longstanding worries about debt levels in the euro area.

Futures on the Standard & Poor’s 500 were also down, indicating another weak opening in New York.

Investors continued to pull funds away from stocks — including in emerging markets despite their solidly growing economies — and shifted instead into the perceived safety of assets like U.S. Treasury bonds, German bunds and precious metals.

Slowing manufacturing and service activity and the prospect of spending cuts to reduce debt loads and balance budgets are raising questions about where future growth will come from on both sides of the Atlantic.

Traders in Europe were awaiting an important jobs report from Washington later in the day for more clues on the health of the U.S. economy. A weak number, they said, had the potential to intensify the downward selling spiral seen this week.

Luc Van Heden, chief strategist at KBC Asset Management in Brussels, said the prospect of a “double dip” in the United States, where the economic recovery falters and turns into a second recession, was becoming even more of a concern than the sovereign debt crisis in Europe.

“We’ve known about the euro’s debt crisis for months,” he said. “Fears of a double dip in the U.S. are making the market very, very nervous at the moment.”

Mr. Van Heden said he thought it would take a really strong labor report — perhaps with the addition of 150,000 or so jobs in July — to durably lift investor sentiment. The market consensus is for an increase of 85,000; the figure for June was 18,000.

China, as the United States’ largest foreign creditor, is closely watching developments and the impact these may have on the value of China’s holdings.

On Friday, the Chinese foreign minister, Yang Jiechi, said he hoped the United States would take “responsible monetary policies” to support the global economy, and “take tangible measures to protect the safety of assets” held by foreign nations.

China has increased its holdings of euro bonds in recent years, Mr. Yang said in a written response to questions from the Polish press during a visit to that country. He added that China believed Europe could overcome its “temporary difficulties,” and would continue to support Europe and the euro.

Chancellor Angela Merkel of Germany and the French president Nicholas Sarkozy were interrupting their vacations Friday to hold a telephone conference on the euro zone debt crisis. Mr. Sarkozy’s office also confirmed that he would speak by telephone with Prime Minister José Luis Rodríguez Zapatero of Spain to discuss market turmoil. There were no immediate details about the discussion.

Stock markets in Europe were lower after steep losses at the end of the trading day on Thursday, but then recovered some lost ground.

The FTSE-100 in London was down about 2.4 percent and the DAX in Frankfurt 2 percent in midday, while the CAC40 in Paris and the Euro Stoxx 50 Index of euro-zone blue chips were each down around 0.5 percent. Yields on Italy and Spanish 10-year yields whipsawed, as in recent days, but remained around the stressed level of 6 percent.

The Nikkei 225 in Tokyo and the Kospi in Seoul both closed 3.7 percent lower. The Taiex in Taipei slumped 5.6 percent, and the Australian market

shed 4 percent. The Hang Seng in Hong Kong closed down 4.3 percent.

Neither the Japanese central bank’s efforts on Thursday to dampen the rise of the yen, nor the European Central Bank’s move to buy bonds of some European countries served to reassure the markets.

The E.C.B. bought bonds of some smaller euro area countries, but not those of Italy and Spain, whose mounting troubles have been a focus for investors. This was taken as a sign that the recent rescue packages by Europe could soon be overwhelmed by the huge debt burdens in those two countries.

“One assumes the E.C.B. doesn’t want to give governments a free pass and wants them to make appropriate structural reforms first,” analysts at Deutsche Bank said in a research note. “The longer they leave it to intervene aggressively, the more they may actually have to do as more and more investors flee the euro government bond arena.”

This week, Germany, the biggest economy in Europe, saw its short bond yields drop below the inflation rate for first time since reunification. This suggests that investors were willing to sacrifice a return on their investment to hold the least risky bonds in Europe.

“One assumes the E.C.B. doesn’t want to give governments a free pass and wants them to make appropriate structural reforms first,” analysts at Deutsche Bank said in a research note. “The longer they leave it to intervene aggressively, the more they may actually have to do as more and more investors flee the euro government bond arena.”

This week, Germany, the biggest economy in Europe, saw its 10-year bond yields drop below the inflation rate of 2.5 percent for first time since the 1960s.

This suggests that investors were willing to sacrifice a return on their investment to hold the least risky bonds in Europe.

There are also new fears about whether France will have the resources to fund the bailout of its peers without suffering a downgrade of its AAA ratings. The spread between French and German 10-year bonds has been widening this week, hovering around 85 basis points Friday.

Likewise, Belgium’s 10-year bond spreads with Germany have also been widening, suggesting that country might soon be dragged into the fiscal crisis.

Both Italy and Spain have canceled debt auctions scheduled for this month.

Wall Street saw the worst day in more than two years Thursday, with the Dow Jones industrial average ending down 4.3 percent, and the broader Standard & Poor’s  500 finishing 4.8 percent lower. The S.& P. 500 has now fallen 10.7 percent from 1,345 on July 22, underlining the new negative investment sentiment.

Analysts said the market still might have further to fall, as investors reassess the dimming economic prospects, especially given the prospect of steep budget cuts in the United States in the coming years that were part of a deal this week in Washington to raise the government’s borrowing limit.

Some in the markets are already questioning whether  the Federal Reserve could soon take further steps to stimulate growth in the United States.

In a research report Friday, London based analysts at Credit Suisse revised down their forecasts for earnings per share growth in the United States and the euro area for this year and next.

As a result, they also cut their 2011 year-end forecast for the S.&P. 500 to 1,350 points, from 1,450. The 2012 estimate is 1,400 points.

But analysts also said credit markets were still healthy and the United States was now stronger than just a few years ago, so that a repeat of the financial crisis was unlikely. Many said the decline in equities did not yet look like a rout.

Reena Aggarwal, professor of finance at Georgetown University, said that during the financial crisis the banking sector broke down. “Right now it’s a crisis of confidence based on weak economies but the banking sector is not broken,” she said.

Ultimately, the negative real interest rates seen this week in Germany could spread across the yield curve and into other debt instruments, which would serve to alleviate the financing burden of indebted countries and ultimately force investors to take on more risk.

“There is a price for everything and I am thinking as much of opportunities now as I do of risks.” said Alexandra Hartmann, London-based manager of the Fidelity Funds Euro Blue Chip fund.

In Europe, data releases Friday underlined the weak state of  several economies.

The Bank of Spain said that the economy there expanded in the second quarter by 0.2 percent on the previous three months.  That was better than the 0.1 percent rate economists had expected, but down from 0.3 percent in the first quarter.

Preliminary data from the national statistics in Rome showed Italy’s economy grew 0.3 percent between April and June, in line with expectations, after 0.1 percent increase in each of the previous two quarters.

But industrial production in Italy fell 0.6 percent in June, having declined by the same amount a month earlier.

“These figures suggest sluggish domestic demand on the consumer front,” said Fabio Fois, an analyst at Barclays Capital. “That’s not good news for the Italian economy, which will have to rely on foreign demand to expand its real G.D.P. growth.”

The yen, which had weakened against  the dollar after the Japanese central bank intervened in the currency  markets on Thursday to halt the Japanese currency’s ascent, crawled higher  again on Friday, to 78.6 yen per dollar.

The Japanese economics minister, Kaoru Yosano, suggested on Friday that more interventions may follow. “We will continue to intervene at the most effective moments,” Mr. Yosano told reporters. “It would be rash to assume a one-off action, and we will continue to assess the situation going forward.”

Elsewhere in the region, the Australian central bank underlined the general unease by lowering its economic growth  forecast for this year.

Although ravenous demand from China will continue to  buoy Australia’s commodities sector,  the bank cited the sovereign debt problems in other parts of the world as a  risk.

Washington’s reaction to the market’s tumble was muted. The Treasury Department said it did not plan to issue any statements or provide officials to comment and the White House spokesman, Jay Carney, said, “Markets go up and down.”

This article, "As Wall Street Opens on High Note, Markets Still Fall as Global Worries Multiply," originally appeared in The New York Times.

Bettina Wassener

Bettina Wassener is a reporter for The International Herald Tribune and The New York Times in Hong Kong.

Matthew Saltmarsh

Matthew Saltmarsh is a staff reporter covering European affairs from London for both the International Herald-Tribune and The New York Times.

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