The downturn in Asian markets on Tuesday was an eloquent signal that cold, hard reality is setting in after an initial wave of relief over the EU and IMF’s mega-bailout plan drove Monday’s rally in regional stock markets.
The Nikkei was down 1.1 per cent at pixel time, with the Hang Seng down 1.5 per cent.
Europe and the US may not care that much (indeed, why should they?). But clearly, many Asian countries – not least, Japan and China – now feel they have much to fear.
After a day to digest developments, a tidal wave of Asia commentary has emerged on the impact of the European rescue package.
Among the numerous views, MF Global’s Japan research director Nicholas Smith warned on Tuesday of the impact on China and Japan.
An end to the Greek debt crisis will come “not when Greece and the other Med states get financing, but when a solution to the structural imbalances that caused it is found, along with a strategy for reducing debt”, he says.
The impact on China, and thus Japan
In the meantime, inevitable euro weakness, he notes, will depress European demand for Japanese products and “puts a potent weapon in the hands of internationally-competitive European exporters that compete with Japan – particularly German manufacturers”.
China is significantly more exposed to Europe than the US, and is also Japan’s biggest trade partner. Indirectly, then, Europe is “far more important to Japan than it appears”, he argues, noting that when the euro plunged, one of the hardest-hit stock markets was China (“because China now sells around a quarter more to Europe than to the US, and is highly sensitive to a slowdown in exports”).
A large proportion of what China sells to the rest of Asia also ends up getting processed and sold on to Europe, so, notes Smith, “the Chinese stock market’s violent reaction to the euro crisis is very understandable”.
The European endgame for Asia
Smith sees three likely scenarios arising from Europe’s bail-out plan that will affect key Asian economies:
• Europe will buy less from Japanese companies.
• European companies, particularly German ones, will be made incomparably stronger and more competitive by the weak currency.
• Europe will buy less from China, which will damage Chinese growth and hence depress the prices of commodities, which “anyway tend to follow a similar dynamic to the euro exchange rate”:
In the end, says Smith, expect Greece to exit the euro and bring back the drachma:
Perhaps if it does do, the EU and IMF rescue plan won’t end up as having thrown good money after bad. The euro is likely to have an L-shaped recovery, hurting stocks exposed to that market.
That however, won’t happen before Asia takes a big hit on its exports, in Smith’s view.
Asia is Lehman-fied
Meanwhile, Richard Katz at Oriental Economist Alert evokes parallels with the period following the collapse of Lehman Brothers in 2008 — parallels we’ve also noted in a series of posts.
While highlighting Japan’s concerns about yen strength, however, Katz argues that the big risk is liquidity fears that could drive a possible wave of inventory liquidation. This would therefore cause a significant downturn in world trade – hitting Japan’s (and indeed, emerging markets’) vital export industries.
On currencies, meanwhile, the yen weakened further on Tuesday, feeding market expectations for even further weakening, as the spread between US and Japanese interest rates widened again.
Katz notes:
“Even on Friday, indicators of credit panic were not even in the same ballpark as they were after the Lehman shock of 2008, when the TED spread (the gap between yields on three-month US government securities and the rate banks charge each other for three month loans) eased to 28 basis points from the 31 basis points it reached Friday. While the Friday peak was the highest since July 2009, it was [small] compared to the 460 basis points it reached in October 2008 after the Lehman shock.
Back in the post-Lehman era, Katz notes, the LIBOR-OIS spread hit a peak of 364bp. It is true, he adds, that the crisis did cause the yen to strengthen from the ¥95/$ range to the ¥91/$ range, as the “carry trade” unwound. But following Europe’s massive weekend bailout package, the yen weakened again to about Y93 to the dollar by Monday afternoon in New York, where it settled back after an overnight rise at the end of Asia’s trading day on Tuesday.
Related links:
How bad in Europe? Your cut-and-paste guide – FT Alphaville
The smell of burnt fingers wafts across Europe… – FT Alphaville
Wer soll das belhazen - FT Alphaville