Market convulsions could trigger a financial crisis

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Somewhere along the way, more likely sooner than later, a major speculative investor or financial institution could take a hit from market swings, with far-reaching consequences for the global financial system.

Even before the Russian invasion of Ukraine, financial markets were the most fragile since March 2020, at the start of the pandemic, due to fears of what interest rate hikes and a tightening of monetary policy would produce. of the US Fed and other central banks.

The Wall St. street sign is framed by American flags flying in front of the New York Stock Exchange, Friday, Jan. 14, 2022, in the Financial District. (AP Photo/Mary Altaffer)

The sanctions imposed on the Russian banking and financial system by the United States and NATO, as well as the bans on Russian oil by the United States, have caused commodity prices to skyrocket, not only for oil and natural gas, but also for wheat and other cereals as well as for industrial metals.

Oil hit $139 a barrel. Gas prices in Europe at one point reached €345 per megawatt hour before falling back to €241. A year ago the price was €16.

The financial flow effects of escalating commodity prices were clearly demonstrated this week in the nickel market, of which Russia is a major producer.

On Monday, the price of nickel on the London Metal Exchange (LME) rose 75% to $50,000 a tonne. The next day, it doubled to $100,000, then fell back to $80,000 before the LME halted trading in the metal.

Nickel prices typically move at a maximum of a few percent per day and longtime LME traders said they have never seen anything like this before.

The financial impact was quickly revealed. Chinese billionaire Xiang Guangda, founder of the country’s top stainless steel producer, Tsingshan Holding Group, had sold nickel, that is, entered into contracts on the assumption that its price would fall.

The reverse move left the company with paper losses totaling billions of dollars. According to the first estimates of the Chinese media, the losses could reach 8 billion dollars.

Announcing the suspension of nickel trading, which is not expected to resume until the end of this week, the LME said the decision was taken for “orderly market reasons”.

The extreme turbulence extends far beyond commodity markets and the institutions that trade them, often making big bets depending on how prices move. This also has an impact on banks that have invested in Russian financial markets.

Italian bank UniCredit, 34th in the world, has warned it will face losses of around €7 billion in an “extreme scenario” in which all of its Russian business is wiped out. The firm said yesterday it had loans of around €7.8bn in its Russian consumer unit and cross-border corporate exposures of €4.5bn, of which around 5% had been minted by penalties.

The effect of sanctions goes well beyond the companies and financial institutions directly affected.

In an article earlier this week, the the wall street journal quoted the words of Christopher Smart, former special assistant to President Obama. He said the situation facing global businesses following the sanctions was reminiscent of that which accompanied the bankruptcy of Lehman Brothers in 2008.

“We have never seen anything so comprehensive, so powerful and so suddenly imposed on an economy of this size and importance to the global economy,” he said.

He recalled Lehman Brothers due to uncertainty over who had exposure to Russia. “I know maybe I’m not exposed, but I don’t really know who among my clients may be exposed, who has investments that they’re going to… have to write down,” Smart commented.

Soaring commodity prices, which are already driving up the rate of inflation around the world, have enormously complicated the situation facing the world’s major central banks.

Before the crisis of the war, they were on track to start tightening their monetary policy – an already tricky operation given that financial markets have become so dependent on cheap money that even a small hike could cause turbulence. in the markets and even a recession.

Today, inflation is skyrocketing and the financial system has become even more unstable. The first indication of how they intend to react will come today when the European Central Bank (ECB) announces its future monetary policy stance.

Last month, the ECB’s governing council said it would undertake a “gradual normalization” of monetary policy, including a possible reduction in its asset purchase program and an interest rate hike in less by the end of the year.

According to indications from ECB President Christine Lagarde and ECB Chief Economist Philip Lane, these plans could be put on hold.

As the FinancialTimes noted, Lagarde said the bank would “take all necessary steps” in response to the situation in Ukraine. Lane said it could accept inflation above its 2% target in the face of “an adverse supply shock” and that the bank could consider “new policy instruments” to support financial markets.

However, such moves could widen already existing divisions within the bank’s board. Some members may insist that the policy of “normalization” must continue under conditions where inflation hit a euro zone record high of 5.8% in February and is expected to reach 7% later this year.

The FT quoted a board ‘hawk’ as saying: ‘Obviously inflation will stay with us so we have to do something. We can’t just say we’ll wait and see.

The Fed will determine its monetary policy next week, having already forecast a 0.25% hike, with further hikes of the same magnitude over the course of the year and starting to reduce its $9 trillion in financial assets.

The expectation of higher interest rates has already had a major impact on Wall Street, with the tech-heavy NASDAQ index now down nearly 20% so far this year.

Shares of tech companies, many of which have yet to make a profit, are highly sensitive to interest rate increases as their “expectations” of future earnings are discounted at the prevailing interest rate to determine their market value. current – the higher the rate. lower the value.

An article by Robin Wigglesworth in the FT noted: “In dollar terms, the tech-heavy market has now lost well over $5 trillion since its peak in November, more than NASDAQ’s dollar losses for the entire the Internet bubble that unfolded in 2000-2002.

The relatively stronger position of Big Tech companies – household names like Apple, Google and Microsoft – masked the extent of the damage. But the rapid fall in shares of Meta (the owner of Facebook) indicates that even Big Tech is not immune.

Nearly two-thirds of NADAQ’s 3,000 members are estimated to have fallen at least 25% from their 52-week highs. Nearly 43% lost more than half their value and a fifth fell more than 75%.

“The $5.15 trillion that has evaporated from NASDAQ in recent weeks feels like the whole UK stock market is going ‘poof’,” Wigglesworth wrote.

Goldman Sachs estimated that if the Fed decides to forcefully tighten monetary policy – ​​and it may decide to do so with inflation expected to rise further in the United States, possibly reaching double-digit levels – the NASDAQ could fall. an additional 17%.

Wigglesworth concluded that a repeat of the dotcom meltdown may not occur, but added that “the scale of wealth destruction is already enormous” and that “the wider repercussions are still unknowable and could be important”.

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