U.S. credit crunch spreads abroad

The U.S. Fed has said it predicts moderate economic growth for the U.S. economy – a more positive forecast than many analysts expected, though tightening credit conditions has become a major task, alongside controlling inflation.

That news is providing some optimism for equity market investors, both in and outside the U.S., as they struggle through a volatile period, kicked off by the U.S. mortgage crisis.

But market watchers say they expect the instability to last for at least another fortnight.

The troubles that began with the U.S. mortgage market and loans to poorer borrowers have spread to the corporate sector, as lenders lose their appetite for risk and with companies finding it harder to borrow.

The credit crunch is no longer confined to the U.S. markets and has leapt international borders.

“The U.S. is still the leading financial market and many companies and banks and investors have invested in the U.S. markets. Many have invested in those instruments backed by sub-prime mortgages in the U.S. Therefore these funds, these portfolios, will be hit, which actually sends shock-waves throughout the global economy,” says Sergey Guriev, Director of the Economic Research Institute, Moscow.

These shock-waves are keenly felt by the emerging markets, such as Russia, India and China. The less-developed economies are not as equipped as the U.S. to handle a credit crisis.  In particular, they lack established structures to measure risk.

With investors all over the world concerned by the credit squeeze, they are looking for other ways to store or hedge their wealth. U.S. Treasury bonds have traditionally been a safe heaven when equities gets risky. But a significant shift to bonds could carry its own risks, this time.

“Then the big issue is to what extent the dollar as a reserve currency is going to survive this. If reserve-holding central banks rebalance their portfolios and move their assets from  the U.S. dollar to other currencies, that could undermine the dollar's purchasing power, and therefore the U.S. Treasury bonds would become less risk-free than they have always been,” Mr Guriev added.

But it may be worth the risk for investors anxious to move their money out of global equity markets. Any long-term flight from equities would be bad news for Russia and the other emerging economies as these markets, still considered to be risky, are usually among the first to suffer.