Shaky times to continue for markets

We are now two months into 1999 and, although events in the financial markets have not been quite as dramatic as the final quarter of 1998, it has been an eventful beginning to the year on the world's stock markets.

Stock markets were generally weak during February with the notable exception of Britain which rose by 4.7 per cent in sterling terms.

The table summarises the returns from the major markets for February and year-to-date.

Equity Market Returns (Local Currency)

February % Year-to-date %

US -3.3 -3.3 Japan -0.5 4.2 Britain 4.7 5.0 Germany -4.8 -1.8 France -3.7 3.8 Ireland 3.7 6.7

February proved to be a particularly difficult month in many markets. The US, Germany and France all declined by more than 3 per cent during the month. In contrast, the Irish market outperformed its European peers as financial results continue to show rapid profits growth.

AIB, CRH and Grafton Group, among others, produced buoyant profit figures for 1998 and all companies indicated that 1999 has got off to a good start.

At the broader level, there were a number of significant financial and economic developments over the past month. Data from the US showed that the economy is continuing to grow at a rapid pace which has surprised both policymakers and economic analysts. This has led to strength in the US dollar against both the yen and the euro as expectations rise that the US Federal Reserve may have to raise interest rates later in the year.

A major surprise to most analysts has been the weakness in the euro which has resulted from evidence of faltering economic growth in Europe's major economies and, in particular, the German economy continues to grow slowly. Therefore most analysts are now predicting that European interest rates will be lowered to below 3 per cent sometime this year despite protestations from the European Central Bank (ECB) that interest rates of 3 per cent are historically low and appropriate for current economic circumstances. Clearly the weakness in the euro will be a factor inhibiting the ECB from lowering European interest rates since lower rates could cause further weakness in the currency.

Another surprise on the currency markets has been strength in the yen against the US dollar despite the persistent weakness in the Japanese economy. Strange financial circumstances exist in Japan. At the same time as short-term interest rates were halved from 0.5 per cent to 0.25 per cent, longer term bond yields were doubling to more than 2 per cent. In order to refinance the banking system and generate economic activity, the Japanese authorities are having to borrow enormous sums of money financed through issuing huge amounts of yen-denominated bonds. This would seem to be having some effect on the US bond market since Japanese investors have bought large amounts of US treasuries in recent years. If Japanese investors switch their allegiance to their domestic market, as seems to be happening, the fall off in demand for US treasuries will lead to a rise in US bond yields.

This seems to be occurring already as US long bond yields have recently risen to more than 5.5 per cent. These higher yields are putting pressure on high equity values as US investors begin to switch their attention to the higher yielding bond market and away from the equity market.

For the remainder of 1999 all that can be said with any degree of certainty is the current economic and financial cross currents are likely to result in continued volatility in the world's stock markets.