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Frenzied trading takes its toll on markets

By Christopher Brown-Humes and Gillian Tett in London

Published: March 1 2007 19:26 | Last updated: March 2 2007 01:41

Financial markets swung wildly on Thursday in volatile trading marked by further selling of equities and fears about an unravelling of the global carry trade.

An unexpected rebound in US manufacturing helped steady nerves after heavy early selling of equities that was apparently triggered by a strengthening of the yen. A stronger yen puts pressure on global carry trades, which involve borrowing at low yen interest rates to buy stocks, bonds or other assets in higher-yielding currencies.

At the same time, trading in US and European credit markets was exceptionally heavy for a third consecutive day. London trading was marked by particularly wild swings in the prices of credit derivatives, used to insure investors against corporate defaults.

Wall Street – where the Dow Jones Industrial Average plunged more than 200 points in the opening minutes and the S&P 500 recorded a corresponding percentage fall – partly recovered after the publication of slightly stronger-than-expected manufacturing data.

The Dow closed down 0.28 per cent, or 34.3 points, at 12,234.34, while the broader S&P 500 index was 0.26 per cent lower.

The same pattern was seen in Europe, where the FTSE Eurofirst 300 index, which was up 0.9 per cent in morning trade and down 2.4 per cent at its worst, partially recovered to end 0.9 per cent lower at 1,469.02. In London there was a near 200-point swing on the FTSE 100 index, which closed down 0.9 per cent at 6,116.0.

In Asia, the Nikkei 225 Average closed 0.9 per cent lower and the Shanghai Composite in China fell a further 2.9 per cent. After opening on Friday morning, the Nikkei fell a further 1.4 per cent.

US and European government bond markets rallied as investors sought a safe haven in the face of the equity sell-off. The yield on the benchmark 10-year Treasury was 2.4bp lower on Thursday at 4.55 per cent, down from 4.63 per cent at the start of the week.

The three days of market turbulence was initially triggered by a 9 per cent fall in the Chinese stock market on Tuesday.

Although the scale of market movements remain relatively small compared with historical crises, volatility now appears to be forcing investors to reassess their positions.

Asset prices have been so stable that investors have adopted trading strategies based on the assumption that volatility will remain low – an assumption undermined this week.

Ronan Carr, European equity strategist at Morgan Stanley, said: “People initially thought we were only going to see a small pullback in equity markets, with no major correction. But it seems they are starting to doubt that.”

Albert Edwards, at Dresdner Kleinwort, said: “We believe the long and widely awaited equity correction is upon us. We expect government bonds to be the safe haven.”

The credit market moves suggest that the sentiment shift now under way in that sector could be more violent than anything occurring in the equity world.

The so-called iTraxx Crossover Index, an indicator of sentiment in European markets, has moved at least 15 per cent in each of the past three days. In the US the Dow Jones CDX Crossover index was slightly higher on the day – indicating greater perceived risk – but still below Tuesday’s peak.

http://www.ft.com/cms/s/e9f68980-c829-11db-b0dc-000b5df10621.html