The Hindu Business Line : Attack of nerves hits Western markets

THERE IS an eerie nervousness in Western financial markets and this was reflected in stock markets and hedge funds moving downwards, amid investor concern about the fiscal health of the US economy, the declining value of the dollar in the background of ever widening American trade and fiscal deficits.

Some analysts say the record deficits could trigger a disruptive decline in the value of the dollar followed by dramatic jump in the US interest rates, as buyers of American bonds — particularly in Asia and Western Europe — demand higher yields to compensate for their investment risk. How will the Bush administration respond to these challenges remains to be seen but the confidence of the average investor is fast declining.

To compound the crises, there is also much uncertainty about Western corporate bonds with auto, chemical and consumer goods majors reporting a dramatic decline in earnings. With a rise in interest rates, cost of mortgages will also go up and this can trigger a decline in the value of residential and commercial real-estate. Obviously, the psychological and financial impact of such a scenario could be devastating.

All this growing uncertainty has made the financial markets bearish as the US hedge funds hit the rockiest patch this year. For nearly a decade now these funds, essentially large investment pools, have been very popular. But within the last one year their performance has taken a hit triggering much speculation about their growth prospects and the possible impact on stock and bond markets on both sides of the Atlantic. Ironically, the hedge fund managers, often part owners of the funds, have been the biggest beneficiaries claiming a hefty 20 per cent of the profits.

The hedge fund investment is also a lightly regulated area according to financial analysts. In recent years hedge funds customers have included big financial institutions, pension funds and, above all, wealthy individuals with investment assets of a million-plus dollars. The debate now is if the hedge fund industry facing a slowdown after years of runaway growth.

Over the past four years, the average hedge fund has gained 6.4 per cent in value annually and over the same period the hedge funds assets have soared to $1 trillion from about $400 billion with influx of new investments and high returns. However today rumours of hedge fund woes have had an impact on the Western financial markets and investors are becoming skittish about their stability.

Prospects of rising oil prices and interest rates have compounded the crises with retail and housing sectors reporting fresh declines.

Obviously apart from the bearish mood of the market many investors are wondering if a full blown economic recession is in the offing. In the financial media columns, analysts are speculating about the pros and cons of a new economic recession. Credit rating agency Standard and Poor's the other day cut the rating of the bonds of General Motors' — the world's largest auto manufacturer — to "junk" status and there is speculation about similar prospects for Ford Motor and General Electric.

They enjoyed "blue chip" status not very long ago and, according to analysts, "many such surprises" are now in offing.

In this background, it is also ironical to note that only few weeks ago, global equity markets were calm, investor risk for appetite was high and, above all, the average investor was more confident of sustained world economic expansion. But in recent days markets have suffered a serious attack of nerves amid growing apprehension of a global economic recession.

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