The DJIA collapse and the beginning of the second wave of crisis

The global financial crisis began with the Dow Jones Industrial Average

In brief: Defaults in the euro area, reducing the blue-chip Dow Jones Industrial Average and the weakening of the euro are harbingers of the second wave of the crisis.

Dow Jones Industrial Average fell victim to a combination of circumstances today. Fears about the pace of global growth hit financial markets hard Tuesday, with stocks sliding and investors stampeding into the safety of the dollar and U.S. government bonds. Concerns about euro zone sovereign debt were once again partly driving the weaker sentiment, as the European Central Bank scrambled to reassure markets that Thursday’s expiration of a EUR442 billion bank-lending program won’t destabilize the financial system.

Markets also were spooked by the prospect of a slowdown in China as a surprise revision to a leading indicator contributed to a sharp fall in Chinese equities. They were knocked even weaker by a dismal reading of U.S. consumer confidence released at 10 a.m. The Conference Board, a private research group, said its index of consumer confidence for June dropped to 52.9 compared with the 62.7 seen in May, a figure that was revised down from a previously reported 63.3, reports WSJ. The current month’s reading was far below economists’ expectations for 62.5, according to a survey conducted by Dow Jones Newswires.

“Increasing uncertainty and apprehension about the future state of the economy and labor market, no doubt a result of the recent slowdown in job growth, are the primary reasons for the sharp reversal in confidence,” said Lynn Franco, director of the Conference Board Consumer Research Center. “Until the pace of job growth picks up, consumer confidence is not likely to pick up.”

The Dow Jones Industrial Average was down 275 points in recent trade while the S&P 500 fell below key support at 1050. The benchmark 10-year Treasury yield dropped below 3% to the lowest level since April 2009, while the 30-year bond’s yield fell below 4% to the weakest level since October 2009. In overnight trade, the two-year note’s yield shattered the record low seen in mid-December 2008 after the collapse of Lehman Brothers. Bond yields move inversely to prices. “People think the global economy is slipping again and Treasurys are the safest bet,” said Thomas Roth, executive director in the U.S. government bond trading group at Mitsubishi UFJ Securities (USA) Inc. in New York.

In recent trade, the 10-year note was 17/32 higher to yield 2.969% while the two-year note was 2/32 higher to yield 0.605%. Stuart Thomson, a fund manager who overseas the equivalent of about $100 billion at Ignis Asset Management in Glasgow, Scotland, said fears about a slowdown in the second half are pushing bond yields lower. “We have bought Treasurys in recent weeks and plan to buy more, especially in longer-dated bonds,” he said. “Growth is slowing and the rate of inflation is falling. This is a friendly backdrop for Treasurys.”

To be sure, the drop in Treasury yields to levels last seen during the financial crisis isn’t a sign of similar market strains. For one, long-term yields are falling faster than short-term ones: in times of stress, investors tend to prefer short-dated maturities as they are the closest to holding cash.

In addition, rates on interest rate swaps–highly sensitive to worries about the credit risk of banks’ counterparties–are little changed. The risk premium to swap fixed for floating rate payments for two years–known as the two-year swap spread–is less than 0.01 percentage point wider at 0.3575 point, while the 10-year swap spread is unchanged at 0.055 percentage point. There’s potentially a quarter end factor at work also. The large moves in the Treasurys market come ahead of the end of the month and quarter, when banks and corporations often move into safer assets as they prepare for quarterly earnings.

The dollar gained against key rivals, with the euro and currencies most sensitive to global growth falling sharply. The euro was trading at $1.2158, from $1.2274 late Monday in New York. “The latest string of data that we’ve seen out of most major economies, particularly in the U.S., has pointed to a notable loss of momentum in the recovery,” said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. “That’s fanning some concerns about the diminishing impact of stimulus, and the potential for a double-dip recession,” he said, benefiting the dollar, yen and Swiss franc as investors unwind bets on assets closely tied to global growth, such as the Australian dollar, which sank more than 2.15% against the greenback by morning trading. The euro hit its lowest point against the pound since late 2008 and fell to a fresh record low against the Swiss franc and its weakest points against the yen since 2001.

Renewed worries about the European banking system ahead of the expiry of the large ECB lending facility also helped push the cost of insuring European sovereign bonds higher. The ECB introduced the 12-month lending facility last summer to encourage private-sector lending and ensure adequate liquidity within the currency bloc. Some investors worry that vulnerable euro-area banks, unable to borrow in the interbank market, could have difficulty replacing that funding.

Commodities markets were lower across the board, with the more actively traded industrial materials such as crude oil and copper posting losses of 3%. Grain and other agricultural futures contracts were more defensive, as they aren’t seen to be as vulnerable to weakness in the global economy. “There are still lingering concerns about the economic recovery, and that’s keeping a lid on fundamentals,” said Amrita Sen, commodities analyst at Barclays Capital in London, referring to oil futures, which recently traded at $75.58 a barrel. Gold, which is classified as a commodity but often traded more like an alternative currency, was down 0.4% and continued to trade near all-time highs in New York at $1,232.90 an ounce.

Ukrainian Globalist
2010-06-29 16:18, Economics.

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