Weekly Economic Commentary and Market update – 19 August 2007
I guess the question everyone is asking is what is happening in the Financial Markets around the world this past week? The newspaper headlines have mentioned “Market Crash”, “Blood on the Street” and “Massive loses”.
Some wise guy once commented that the markets are mainly influenced by two things, FEAR and GREED. Well this last week pretty much showed us the effect of Fear.
Well, let’s start off with what caused all this turmoil. The last few years have seen some good times across the Atlantic. Rising house prices, good gains in the stock markets and generally people have had access to money, easy access to personal loans, credit cards, you name it. This resulted in many people wanting to get their hands on easy money even if they had bad credit ratings and records. The credit market was fearless and gave funds to all and sundry. Many of these people with bad credit ratings received loans and credit from companies that were branded ‘sub prime lenders’. Thus the sub prime markets existed and began lending money to people who were not able to get funds through conventional banking and lending means. This sub prime market makes up around 20% of the US lending market. That is rather large when put into perspective.
Then along came a succession of interest rate rises. And surprise, surprise people had a bad credit rating for a reason. These folks could not repay their loans and debts to the lenders. These lenders themselves could then not repay their loans to other lenders. And so the story began. Once the truth came out and the market realised what was happening, it got nervous. Especially once the size of this market was realised and its far reaching effect.
How does all this affect the Stock market?
The stock market success is governed by the share prices of companies which in turn are a reflection of the value of these companies, so when companies start owning up to having lost money by lending it to people and companies that can’t pay it back, then those companies will earn less profit and there value will be less than expected. The share price will then decrease.
We have seen investors around the world trying to sell their stocks and looking to minimize their exposure and risk to these fears and losses throughout the world. In times like this, investors look to move their investments away from higher risk emerging markets like South Africa and move their funds to investments deemed to be less risky such as US bonds. They would look to sell their South African investments and move their funds to cash in the USD.
Thus we see the ZARUSD being affected in the way it was last week. You then can apply some economics 101 using the simple supply and demand theory. If we have more sellers of something then the price is going to drop. Thus we saw the USDZAR move from 7.17 to 7.50 during the week.
We saw this happen in a number of currencies especially in the AUD, NZD and ZAR.
The currency markets were also affected by the unwinding of carry trades. This is where investors borrow funds in low interest countries such as Japan and invest in high yielding countries like NZD and GBP.
We then had inflation figures come out of the UK which showed that the recent interest rate rise had caused a slow down in the inflation. With a decrease in the inflation figures to such an extent, in such a short space of time, the market started to discount further interest rate hikes in the UK. Good news for UK home owners.
Not so lucky for home owners in South Africa with the reserve bank raising interest rates by half a percent in SA. We have discussed this issue numerous times.
We then witnessed a surprise interest rate cut in the US. The Fed stepped into cut rates in order to ease the credit worries in the US.
When you take all this happening, and add in some panic, you witness what we have witnessed in the last week. The FX markets have been extremely volatile. We can expect some sort of correction in the markets as sanity tries to return. However we expect the volatility to continue into the next week no doubt as the market tries to work out its next step.
Good luck and all the best for the week ahead.
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