Sunday, May 30, 2010

Return of market volatility and threat to world economy?

There is a growing fear that the crisis in Eurozone will rock the global financial markets and drag the world economy into a double-dip recession. The financial markets have been spooked by the prospect of sovereign-debt defaults and fiscal austerity measures that could strangulate any signs of economic growth in these economies. The precarious nature of the US economic recovery, with its persisting unemployment challenge, and the growing uncertainty about China (coupled with its continued aversion to domestic consumption and reluctance to revalue yuan), means that the prospects in all the major engines of global economic growth in recent years does not look very bright.

The bellwether TED spread (difference between the three-month T-bill interest rate and three-month LIBOR) shows a clear rising trend since March.

The Economist has a series of charts that graphically illustrates the first signs of danger lurking ahead. After a spectacular rally since March 2009, equity markets across the world have started falling since April. This decline has mirrored similar falls in commodity and other asset prices.

After falling continuously for a year, the CBOE VIX is on the rise again. The Nifty-based India VIX too has been showing signs of heightened volatility.

In a reflection of the growing concerns about sovereign defaults in Euro-zone, despite the recent trillion dollar bailout, the CDS spreads have been rising steeply. Echoing the concerns in the credit markets and about health of the banking system, the rates in the inter-bank lending markets have been rocketing up.

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