close to the brink

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    Market Wrap from AFR lunchtime.

    Market Wrap: Close to the brink
    Author: Jim Parker
    Date: 25/02/2003 11:27:12
    Publication: The Australian Financial Review
    Source: AFRBreaking

    The looming showdown over Iraq pushed world financial markets closer to the brink on Tuesday. Share prices sank, while oil, gold and bond prices soared as the latest moves at the United Nations set the scene for war. Yield hungry investors sent the Australian dollar up through US60¢ for the first time since mid-2000.

    The US and Britain circulated a resolution, declaring Iraq in violation of UN demands to disarm peacefully. Of the other permanent Security Council members, Russia and China back a rival French proposal to extend weapons inspections.

    The apparent impasse unnerved markets, undercutting stocks, sending bond yields to two-month lows and propelling oil and gold prices sharply higher.

    Nerves were frayed even further in Asian trade after the South Korean military reported that North Korea had test fired a missile into the Sea of Japan yesterday.

    "Higher oil prices are emblematic of a world in considerably greater disarray than was the case during earlier oil shocks," Morgan Stanley's global chief economist, Stephen Roach, said in his overnight web commentary.

    "While few doubt the outcome of the looming war in Iraq, there is great concern and uncertainty over the path to that endgame."

    The Australian sharemarket's benchmark S&P/ASX-200 index reversed Monday's strong gains to fall 1 per cent in the morning session in a broad sell-off encompassing nearly all blue-chip leaders, except BHP Billiton.

    Even the banks went into retreat after hopeful signs had emerged in recent days that investors were seeing them as good value again.

    "We've had a few good days, powered by speculative buying, but it is still not convincing," said Shaw Stockbroking senior dealer Jamie Spiteri. "The offshore weakness isn't helping, but we're also seeing some indifferent earnings results."

    The latest company in the dock was winemaker Southcorp, whose shares dived 16 per cent to six-and-a-half-year lows in heavy trade after it reported a 97 per cent slump in half-year profit and warned it would not meet its full-year forecasts.

    The market is showing no mercy to any company that disappoints with its earnings outlook. Others to have felt the wrath of the investment community recently include Telstra, Wesfarmers, Qantas, Lend Lease, CSL and AMP.

    But while Australian equities are in the doghouse, the bond market is still proving attractive to offshore investors tempted by Australia's relatively high interest rates. It is this factor, more than any other, powering the $A to near three-year highs.

    "Australian bonds are expensive based on economic fundamentals, but are still attractive to investors, because of their relatively high yields, and it is hard to see this situation changing in a hurry," said ICAP economist Michael Thomas.

    Local 10-year bond yields were three basis points lower at 5.16 per cent on Tuesday, still around 130 basis points above equivalent US yields. Short-term bonds offer a yield 300 basis points above the US.

    $A finally breaks US60¢

    The Australian dollar's break above US60¢ to two-and-a-half-year highs at US60.64¢ has been met with cheers from many local analysts, who had long argued that the currency was ridiculously undervalued.

    The $A is now getting close to what most economists consider to be fair value - at around US63-65¢ - and is a long way from the record lows beneath US48¢ that it reached in April, 2001.

    The psychological break also opens up the risk of increased hedging by exporters and local super funds, who so far have proved reluctant to lock in

    "Now that it is above US60¢, you might start to see corporate Australia start to take a bit of notice, although most of the interest so far has been from option-related accounts and short-term players," said ANZ's head of currency trading, Paul McNee.

    Since its long decline began back in late 1996, the Australian dollar has been the currency markets' whipping boy, punished as a proxy for Asia, the "old economy", global growth expectations and as a measure of risk aversion.

    But in the past year, as the $US bubble finally deflated, US interest rates hit 40-year lows and investors grew disenchanted with American assets, funds have cottoned onto the high yields on offer in Australia and New Zealand.

    Commodity prices, as measured by the influential US CRB index, are at their highest levels in seven years, and while the Australian economy is slowing, it is still growing faster than most of the other major economies.

    Analysts say that all adds up to the potential for further gains, although most expect a period of consolidation now before another push higher. In the short term, the $A faces key technical resistance at US60.9¢.

    Investors cling to safe havens

    Aside from war fears, Wall Street was spooked overnight by corporate governance concerns as European retailer Ahold reported accounting irregularities. US retailers were also pressured after warning that recent blizzards had hit sales.

    The money fleeing the stockmarket found its way back into safe haven bonds, which were further underpinned by increasing speculation that the European Central Bank next week will bow to pressure and cut interest rates again.

    "It appears the ECB is beginning to grasp that Europe with Germany in recession is Europe with a looming recession. Germany is too big to be ignored," said Deutsche Bank international economist Mark Jolley.

    Hopes for more radical monetary policy measures out of Japan, meanwhile, were dashed by the announcement that the new governor of the Bank of Japan will be Toshihiko Fukui, a policy conservative.

    "This means that there will be no break in the BoJ's monetary stance and that the adoption of unconventional policy measures is extremely unlikely," HSBC economists said in a market briefing note

    The announcement sent the yen to one-month highs against the $US and the euro.

    Gold prices extended their overnight gains in Asia, pushing to around US$359 from $US351 in local trade on Monday. US oil futures for April delivery held steady at $US35.56 after rallying 2.5 per cent higher overnight.

    Offshore overnight

    The US has consumer confidence numbers for February and existing home sales for January. While confidence levels have recently sunk to nine-year lows, home sales have been at record highs as consumers take advantage of low interest rates.

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