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Risk assets ran into heavy weather on Thursday as big central banks moved to scale back emergency lending programmes, signalling the start of the gradual removal of extraordinary measures taken to prop up the financial system since the start of the crisis.
Equities fell sharply on both sides of the Atlantic, oil prices hit their lowest level in almost two months and gold broke below $1,000 an ounce as the dollar rallied strongly.
As the G20 meeting kicked off in Pittsburgh, the Federal Reserve said it would start scaling back short-term cash auctions early next year. The European Central Bank, the Swiss National Bank and the Bank of England all said they would curtail steps taken to ensure dollar liquidity.
Chris Turner, head of FX strategy at ING, said the co-ordinated moves suggested central banks felt the financial sector crisis was largely over. “Yet the Fed made it abundantly clear on Wednesday that low rates will be maintained for an extended period,” he said.
“And it is important to remember that the moves announced today do not represent a drain on liquidity. Thus in itself, we do not see these measures as significant enough to materially dent the risk trade and believe the dollar will stay under pressure.”
Meanwhile, risk appetite was also dented by signs of headwinds still facing the US economic recovery. Sales of previously-owned US homes unexpectedly fell in August, bucking a string of positive housing sector surprises in recent months.
Analysts said the markets had already turned cautious as the G20 got under way, and also noted the previous session’s negative response to optimistic comments by the Federal Reserve on Wednesday.
David Rosenberg, chief economist and strategist at Gluskin Sheff, suggested several reasons as to why US equities had sold off on Wednesday in spite of “what could only have been described as unabashed good news” from the tone of the Fed’s press statement.
“It could imply that the market has run out of buying power,” Mr Rosenberg said. “Or it could mean that the market has already overpaid for the ‘sweet spot’. It could also mean that the psychology of ‘buying the dips’ is over, and a ‘locking in the gains’ mentality may be setting in.
“This is the first time in this six-month rally that we have seen a reversal to the downside on a positive news day.”
But Barclays Capital remained bullish, saying it expected further upside in risky assets – although it cautioned that the market would grow more vulnerable to policy tightening.
“We believe that the global recovery is alive and well and will prove stronger than generally expected, particularly in countries such as the US that have lagged and where growth expectations remain low,” said Larry Kantor, Barclays’ head of research.
“The combination of strong cyclical growth and policy still at ‘crisis settings’ should be favourable for the prices of risky assets even from current levels. However, investors should be alert to signs of policy unwind, and be prepared to reduce exposure quickly.”
Investors certainly moved to take money off the equities table on Thursday.
In New York, the S&P 500 closed down 0.95 per cent, while the pan-European FTSE Eurofirst 300 index fell 1.9 per cent.
Tokyo played catch-up after three days of holidays, with the Nikkei 225 Average up 1.7 per cent, although most other Asian markets eased back.
Commodities suffered a broad retreat as US housing data underlined concerns about economic growth.
Crude oil closed below $66 a barrel in New York, down 4.5 per cent on the day, and gold dropped back through $1,000 an ounce.
Those declines came as the currency markets saw the dollar rally against the euro. The single currency dipped below $1.47.
Sterling, meanwhile, hit a fresh five-month low against the euro. Mervyn King, governor of the Bank of England, said the weak pound was helpful in rebalancing the UK economy to be more focused on exports.
Government bonds gained ground as equities fell, with the yield on the 10-year Treasury down 5 basis points at 3.36 per cent. The markets absorbed $112bn of new US bond supply this week.