Economic tsunami warning signs

Global sharemarkets’ rapid rebound to record levels following the emergence of the global credit crisis lend support to Treasurer Peter Costello’s comments late last week that Australia could be heading for an “economic tsunami,” leading market watchers say.

St George Bank head of economic research Steven Milch says Costello’s bearish remarks “have some merit”, even taking into account the clearly political context in which they were made.

The initial falls in sharemarkets and currencies caused by the US sub-prime crisis have been reversed too dramatically, too quickly, Milch says.

“Equity markets have charged upwards, the Australian dollar is higher and commodity prices are at record highs – the risk aversion lasted five minutes, but really it needs to be more pronounced,” he says.

The consequence, he says, is that there is still a lot of speculative money floating around the global economy – suggesting very little risk aversion remains in markets that, just two months ago, were rapidly contracting as the credit crunch hit.

And, worryingly, Milch says there are a wide range of possible triggers for a possible slow down.

“It could come from anywhere – China is growing incredibly quickly at around 11% and the central bank there is trying to slow it down without much success. Or if we were to see inflation starting to rise in US that would be a very difficult scenario. Oil markets are incredibly strong at the moment, so there are no end of candidates,” Milch says.

One very experienced market watcher, Magellan Financial Group chairman Hamish Douglass, identifies renewed strife on global financial markets as a potential cause of economic trouble.

Banks around the world currently have $US1.4 trillion in off-balance sheet financing that they will need to roll over, Douglass says, either by placing on financial markets or bringing on to their own books, in the months ahead.

Douglass says he does not believe banks will be able to roll over much of this funding – the effect of which could be a renewed credit squeeze that could hit financial markets and sharemarkets around the world.

“If that scenario came out, we would see massive repricing of debt and equity markets around the world and that could flow to the real economy. If markets come off, consumers generally pull their head in,” Douglass says.

“People need to be cautious – the risk of it is still very material, we think there is a 25% of a crunch happening, people are saying its 0% risk and we argue that is unrealistic.”