A tough week for investors

It all started on May 6 when Greece’s election result came out and the pro-bailout political parties were left too weakened to form a government without the radical left-wing party who made their intention very clear that they will not join any government that will follow through on the austerity policies agreed with international creditors under Greece’s latest rescue package.

Back in January the market was already sceptical of the fiscal tightening that Greece will have to comply with to continue to receive the rescue package. The threat of backtracking on the fiscal tightening will not only negate all the previous work that was done but will exacerbate the European debt crisis. All the previous concerns – recession in Europe, debt contagion to other European nations and systematic risk to the banking system – will be on the table again. And depending on how the Greek political picture plays out, what we saw last week may just be a preview of what is to come.

Last week as investors went into risk-averse mode, oil dropped 8 per cent, gold dropped 4 per cent and equity markets around the world fell around 3-5 per cent. Currencies like the euro and Australian dollar dropped 1.5 per cent against the US dollar. The sell off is broad based because if Greece’s debt crisis is not quickly resolved, the situation may not be contained to just Greece. Greece may be just the first piece in a domino effect. 

Firstly whenever there is heightened risk, investors’ first reaction is to pull money out of investments and preserve their liquidity. The liquidity is then usually parked into some sort of US dollar denominated investment, usually US Treasury bonds, and thus the rise of US dollar against most currencies.

Secondly, the longer the Greek debt situation is unresolved, the probability of the contagion effect spreading to heavily indebted European countries like Spain and Italy escalates. The worst case scenario is that if the debt crisis widens, European banks that have large exposure to European sovereign debts will weaken and this will cause systemic risk to the financial system. Consequently what started out as sovereign debt risk may broaden to the private sector.

Locally, the baht broke out of its narrow two-month range of 30.60-31.00 and weakened to close at 31.20 last week. The baht, along with other Asian currencies, weakened due to the rise of the US dollar. However, local gold trading activities also contribute to the rise of the US dollar against the baht. As the gold price dropped substantially from 1640 to 1580, around 4 per cent, local gold investors, who are still bullish, buy physical gold.  When the drop in the gold price is meaningful, the demand will outweigh supply of physical gold in the local market. Thus the gold wholesaler will import gold from overseas and need to pay with US dollars – hence there will be demand for US dollars whenever the gold price drops.

 

Thiti Tantikulanun is head of the Capital Markets Division at Kasikornbank.