Sharemarkets around the globe now stand on an important cusp.
If the bulls are correct, the recent 7% drop in the US sharemarket into Thursday morning’s low is a long-overdue correction that clears the way for share prices to climb even higher. But the bears warn that recent sharemarket wobbles — the first major sell-off in risk assets since QE2 was announced last August — are a portent of troubles ahead, with higher oil prices about to derail the global economic recovery.
In the short-term, at least, markets appear cheered by news that a no-fly zone has been imposed over Libya, and are shrugging off fears that oil prices will rise even higher if Libyan oil production is further disrupted.
And concerns about a possible nuclear emergency in Japan have subsided, with signs that the Japanese were making progress in bringing the troubled Fukushima Daiichi nuclear power plant under control.
Certainly, last Friday’s decision by the Group of Seven major industrialised countries to mount a co-ordinated campaign to drive the yen lower boosted investors’ courage. Their intervention pushed the yen back through the psychologically important ¥80 to the dollar mark and, importantly, rescued hedge funds and other speculators in the yen-carry trade who earn huge profits by borrowing yen at close to zero interest rates, and using the proceeds to invest in higher-yielding assets, such as Australian bonds. But faced with a steep rise in the yen, these investors would have had little option but to sell off their risk assets around the globe, creating financial market turbulence, and pushing down the price of risk assets — including global share prices.
At the same time, markets expect that the Bank of Japan will continue to pump liquidity into money markets in order to ensure there are no funding pressures, even after last week’s record $US600 billion injection.
But others warn that the global economic recovery is about to be dragged down by higher oil prices. Already several central banks — such as India and China — are responding to signs of growing inflationary pressures by raising interest rates in a bid to rein in economic activity. And even the European Central Bank is expected to raise rates soon.
And US households are being hit by rising oil prices at a time when many are already facing financial strains, struggling to pay down their debts and improve their balance sheets. The impact of higher oil prices is all the harsher because most US workers are seeing little growth in their weekly pay-packets, but are still having to contend with rising petrol and heating costs. And inflationary pressures are spreading through the economy. Recently several big US companies such as Kimberly-Clark, P&G and Colgate-Palmolive have signalled that they intend to lift their prices, which means that the average US household not only has to pay more for food and energy, but also faces higher prices for basic necessities such as soap and toothpaste. Faced with rising prices for basic necessities, US consumers will have little choice but to cut their discretionary spending.
Rising oil prices, the bears warn, are already sounding the death-knell for the latest bull market rally.
*This first appeared on Business Spectator.