INSIGHT: Loss of confidence threatens chems as stocks crumble

10 August 2011 20:01  [Source: ICIS news]

By Joseph Chang

NEW YORK (ICIS)--Wild swings in global stock markets are emblematic of chaos in the collective mindset. Confusion reigns, and who can blame the participants?

Monday’s market meltdown, led by a 5.6% plunge in the US Dow Jones Industrial Average, followed an unprecedented credit downgrade of US sovereign debt by global ratings agency Standard & Poor’s (S&P). In Europe, the central bank’s initial tepid response to plunging Spanish and Italian bond prices failed to inspire confidence.

On Tuesday, the US stock market mounted a sharp rally in the last hour of trading to close up 4.0%. But by mid-day, it plunged again, closing at a loss of 520 points.

Caught in the overall market downdraft were crude oil prices, that had fallen to about $80/bbl earlier in the week on the New York Mercantile Exchange (NYMEX) - a far cry from $100/bbl as recently as late July. Oil prices tanked as players lowered their expectations for economic growth.

Petrochemical and polymer prices are poised to fall on the back of lower crude and diminished economic growth expectations. And the dire economic outlook is being reflected in chemical stock prices – few sectors have been hit harder than the industrial group.

For the month of August thus far, US bellwether Dow Chemical’s stock is down almost 19% while US-based Huntsman has lost a staggering 35% of its value. Germany’s BASF, the world’s largest chemical company, is down 22%, and Netherlands-based petrochemical and polymers giant LyondellBasell is down 21%.

The greatest threat to the global economy today is the loss of confidence – confidence that the US can get its fiscal house in order and reinvigorate its stalling economy, confidence that Europe can halt the spread of its growing sovereign debt crisis, and confidence that China can get a handle on inflation without stamping out growth.

The S&P downgrade of US debt from AAA to AA+ did not cause interest rates to rise - not yet. In fact, US bonds rallied, driving down yields even further as the market shifted its focus to the growing likelihood of a recession.

Expectations for slowing or negative economic growth tends to lead to rising bond prices (and thus lower interest rates) as players anticipate lower levels of inflation and central bank policies to keep benchmark rates low.

Indeed, the US Fed made an explicit statement to keep interest rates low for at least two years to come to support the economy.

The bigger blow of the downgrade is to consumer and business confidence. US government debt - as close to a “sure thing” than anything - is that no longer.

You can indeed talk your way into a recession. Negative sentiment can trigger behaviour that leads to a double-dip downturn. Watching stocks dive and sovereign credit ratings cut with no coherent policy response from governments and central banks might make you think twice about eating out for dinner, buying that new car or building that cracker.

Leadership is needed in times of crisis. The European Central Bank (ECB) must act as the buyer of last resort for the sovereign debt of its members. Indeed, it swept in to buy Spanish and Italian bonds on Tuesday, fuelling a rise in European stock markets as well. And the US must come up with a plan to boost its economy.

Much has been made of the point that policy-makers are “running out of bullets”, or “running out of rabbits to pull from the hat” to make things better. The US has already cut interest rates to near zero and completed its second round of quantitative easing (QE2), featuring the purchase of $600bn (€420bn) in debt securities, in June.

But it is time to reload the gun. There is no reason the ECB cannot reverse its tightening bias and lower interest rates. It has raised rates twice this year even in the face of severe fiscal austerity for some of its members. There is room to ease from its current stated level of 1.5%.

The US has a stated interest rate target (Fed Funds rate) of 0–0.25%. The ECB can also embark on a round of QE, an increasingly likely scenario.

The US needs a plan to revive the economy, and this will require investment. So far, the world is waiting.

($1 = €0.70)

Paul Hodges studies key influencers shaping the chemical industry in Chemicals and the Economy

By: Joseph Chang
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