Volatile local financial markets riveted by global events

The dollar-baht exchange rate was around 30.70. 

Since then, local financial markets have been swept up by a wave of panic impacting investors worldwide. Nearly all global stock markets have fallen. Emerging market currencies have weakened; the only currencies benefiting have been traditional safe havens such as the US dollar and the Japanese yen. 

The cause of this volatility is, once again, Europe. An inconclusive election led to renewed fears that Greece would ditch the euro and restart its own currency (a word has even been coined for this: “Grexit”). Spain’s banking system meanwhile increasingly tottered due to bad debt and investor fears about a lack of equity. 

There have been at least five episodes of European panic in the past two years. What all these episodes show is that the existing system of the euro zone – with 17 different countries using a single currency – is not sustainable. For the system to be more stable, there have to be steps to greater policy integration, and greater power given to euro-centric organisations (implying some loss of sovereignty for each of the nations). 

The different political environments in each euro-zone country, and the backdrop of an economic recession, make these steps extremely hard to take. But there has been progress in the past few years – for example in creating European rescue funds, and in unprecedented liquidity measures from the European Central Bank. 

The current panic will similarly end when markets realise European leaders are committed to further integration. There are already some signs that this is happening –Europe has just offered to provide a hefty ¤100 billion (Bt3.98 trillion) to recapitalise Spain’s banks. 

Other key upcoming events to monitor will be Greece’s elections this coming Sunday, the European finance ministers’ meetings on June 21-22, and the European Union summit on June 28-29.  

However, while further measures and announcements are likely, a full conversion of the euro zone into a financial or fiscal union remains some time away. Hence the current mood will improve and markets get back to normal, but more episodes of panic in the future are still quite likely. Empires are won through bloodshed, while full currency unions are produced from financial turmoil. 

There is an underrated issue on the sidelines. Expectations on US monetary policy have been shifting rapidly ever since the latest US jobs data was much weaker than expected. 

This is leading to speculation that the Federal Reserve (the US central bank) may have to implement a third round of quantitative easing. Popularly abbreviated as QE3, this means a large increase in money supply. As a result, any comments from senior Federal Reserve officials are being closely parsed and have even more of an impact than usual. 

A large QE3 programme would reverse some of the current market trends, by leading to a weaker dollar and boosting hard commodities such as gold. It is therefore a factor that can potentially add even more volatility to markets. 

 

Parson Singha is chief markets strategist, Global Markets Department, HSBC Thailand.