The US economy may be stumbling into the sunlight, well behind rapidly growing South Korea and Australia, the great survivor, but the sharp falls in local markets Friday and today are a reminder that when it comes to confidence in the global financial system, the world remains firmly coupled to the US.

So forget China, South Korea, even Japan, which has seen two months of falling unemployment. Forget also that Australia found out today the economy is now officially out of danger and growing, and the Reserve Bank is about to lift interest rates for a second month in a row tomorrow; and then gives us its (upgraded) view on growth and inflation on Friday.

All that is nice, but it doesn’t matter when the market lemmings take fright as they did Friday night. After slumbering since March as the bulls had their way, the bears re-emerged last week and did some damage to confidence.

The reason are concerns about the state of the American economy, (and banks), or rather the way the US Federal Reserve sees it at its two-day meeting this week, which ends early Thursday, and then the October jobless figures on Friday.

With the European Central Bank and the Bank of England are also holding monetary policy meetings, as well as the RBA’s decision, it’s no longer the rebound that is important, but what the central bankers say about the low interest rate regime that has helped power the rebound since March in a sort of financial shell game.

Specifically, it’s the wording of the Fed’s post-meeting statement that has seen markets, investors, commentators and analysts go all nervy. That statement will be issued about 6.15am Thursday.

There are concerns that statement will see some signal that the Fed is starting to think about raising interest rates from the current record lows: These worries helped drive the big sell-off on Friday in Europe and the US, which quickly reversed the optimism from the OK US third-quarter GDP figures the day before.

Helped by the biggest fall in US consumer spending since last December and a poor reading on consumer confidence from the final Reuters/Bank of Michigan survey of the month, markets simply tanked.

Shares and commodities (especially oil and gold) fell sharply as the US dollar rose; bond yields dropped sharply as well and the US dollar rose as nervous investors headed for a bit of insurance in a currency that they had been actively selling a day before.

The Australian dollar lost more than 1.5 cents Friday night and Saturday morning, Wall Street fell 2.5%; other markets were down more in Europe. Overall, the falls Friday (and earlier in the week) converted October into the first losing month since March. Even Australia fell, despite the strong day Friday on the market.

There were worries that Citigroup might have a $US10 billion ($A11.1 billion) loss to reveal for this quarter for some of its risky assets; and in the US nine banks failed as a privately owned bank holding group was seized by regulators and sold off in what was the fourth biggest bank collapse this year. A total of 115 banks have failed in the US.

Mid-level financier CIT went into a pre-arranged bankruptcy a few hours ago with $US71 billion in assets and $US65 billion in debt, a week after Capmark, a commercial property funder, went belly up. That it was known means CIT’s failure shouldn’t worry the markets, but with nerves taut, and trading profits and bonuses at risk, who knows?

It’s those fears that the Fed might be about to signal the end the great cheap money game that has helped finance the rebound in markets this year; those big profits for many banks, the huge bank staff bonuses and pay and the welcome improvement in confidence in many countries.

Australia has played a big part in these concerns: ever since the RBA’s October rate rise, the rest of the financial world has been asking who would be next? Norway obliged with a rate rise last week and now Australia is set to raise again tomorrow. It some ways the Australian rate rise has helped set in train the loss of confidence that saw October turn into the first negative month for most markets since the rally started in March.

And on Thursday morning, so the story goes, the Fed might change the wording in one important sentence in its last post meeting statements.

“The committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

In particular, it’s the statement “that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period” that markets will be looking to be repeated exactly word for word.

This new concern about a tightening in the very accommodating monetary policy around the world was given a push late last week by the International Monetary Fund, which seemed to suggest that the strong growth in the economies of India, China and Australia might mean those countries need to tighten monetary policy ahead of others.

The Reserve Bank of India last week put the markets on notice for a monetary policy tightening; Australia is, of course, tightening, but China’s central bank made it clear Friday that it saw no change in its easy policy with the forecast that it sees bank credit rising again this quarter, an indication it doesn’t see any need to tighten.

“Medium and long-term credit will increase substantially, and the bill-financing, which facilitates short-term credits, will continue to fall after the central bank tightened rules to ensure the money flow into the real economy other than stock market speculation,” the central bank said in a statement.

But the rising in concern, however, has become extensive; after all, money’s blog, the Financial Times, weighed in over the weekend with an editorial urging no change to current policies.

“Thanks to public policy, the global economy has stabilised. Growth is returning. But, even so, it is too early to declare victory over the recession. There is a real — and justified — fear that this easy policy will stoke the next crisis. The call for tighter policy has already begun. Fear of inflation is always and everywhere a constant. Even, it appears, during periods of deflation. But it would be madness to deepen this crisis, which is here now, to fend off a hypothetical future disaster that still exists only in the imagination.”

But probably the strongest comments came on Saturday from a senior minister in the Chinese government whose analysts are now talking of economic growth of 9.5% or better in the current quarter.

Chinese commerce minister Chen Deming, in a speech made in Shanghai, warned against withdrawing economic stimulus measures, citing the risk of another world slump.

“There are increasing signs that the global economy is heading in a positive direction, but there are still many uncertainties,” Chen said at a forum on Saturday. He said that if countries “withdraw the stimulus measures now, the global economy will plunge”.

And we shouldn’t forget Friday jobs figures from the US: about 150,000-170,000 is the tip for the number of jobs to be lost in October, with the unemployment rate rising to 10%.

The participation rate will be vital: a fall will indicate more people have lost confidence and stopped looking for work (a rise, that people are more confident to look for work).

September’s figures disappointed on the downside and started markets refocusing on consumer confidence and spending. The third-quarter growth figures showed a big hit from government spending, and a strong rise in consumer spending (which will be trimmed now September’s spending fell).

A week for strong nerves, but a long way from the edge-of-the-cliff feeling a year ago, thankfully; that’s if there’s no change in policy. If there is …?

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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