Triple whammy darkens mood as rally ends

Markets rose for much of the autumn as they got ready for another dose of liquidity from the US Federal Reserve. But now the trend is changing as "the mood has darkened considerably", said Lena Komileva of Tullett Prebon. Already rattled by the prospect of China clamping down on inflation and Europe's sovereign debt crisis, markets were hit by another outbreak of hostilities on the Korean peninsula this week. North Korea shelled a South Korean island, targeting both the military and civilians; Russia said it saw a "colossal danger" of the situation escalating.

Markets slid, with the Hang Seng index losing 2.7% on Tuesday alone. The FTSE 100 has hit a seven-week low. The CRB index of commodities is near its lowest level in a month and gold has recovered from its recent correction. It is close to its record highs of $1,400.

What the commentators said

When it comes to Europe, "one gets this terrible feeling of dj vu", said Buttonwood on Economist.com. In 2008, rescue plan followed rescue plan and the consequent rallies "got shorter and shorter".

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Relief over support for Ireland proved extremely short-lived this week. Government debt yields kept climbing, with Spain's ten-year yield reaching a record spread over German bunds. Now along comes the "roguest of rogue states", North Korea, whose next move is always utterly unpredictable, said Allister Heath in City AM. This uncertainty, and the possibility of a war that could devastate the region, is sending "shivers down everyone's spine".

The latest news from China has also prompted a stark shift in investor sentiment from "maximum bullish" to "extremely wary", said JP Morgan's Jing Ulrich. Inflation is at a "worrying" 4.4%, said Lex in the FT. Food inflation's rise to 10% is especially worrying as much of the population "still lives close to the edge". Last week, China raised bank reserve requirements, limiting how much they can lend, for the fifth time this year. It will also trim the overall amount of bank lending next year. But "it could be more aggressive the credit brakes are being tapped, not slammed".

China's tightrope walk between cooling the overheating economy and keeping growth high enough to prevent social unrest could end in "a messy crash", said Lex. Note too, added Dylan Grice of Socit Gnrale, that every financial crisis since the 1870s has been preceded by rampant credit growth. In the meantime, investors have to gauge the impact of a slowing China on its domestic asset markets and global commodities markets, said Ian Campbell on Breakingviews.com. Markets look set to struggle from here as rattled investors book profits before the end of the year.