For the week, the Dow dropped 4.4% (down 8.2% y-t-d) and the S&P500 fell 4.6% (down 9.3%). The Transports declined 2% (up 3.1%), and the Morgan Stanley Cyclical index sank 5.5% (down 7.1%). The Morgan Stanley Consumer index declined 2.3% (down 7.6%), and the Utilities slipped 3.1% (down 8.3%). The small cap Russell 2000 fell 4.3% (down 8.8%), and the S&P400 Mid-Caps declined 3.6% (down 7.5%). The NASDAQ100 dropped 4.4% (down 14.9%), and the Morgan Stanley High Tech index sank 5.1% (down 14.6%). The Semiconductors were hammered for 7.9% (down 14.3%). The Street.com Internet Index fell 4.5% (down 11.4%), and the NASDAQ Telecommunications index was hit for 4.4% (down 12.1%). The Biotechs dropped 4.5% (down 7.6%). The rally in financials reversed abruptly. The Broker/Dealers sank 8.1% (down 6.1%) and the Banks 8.4% (down 0.7%). Although Bullion was up $17.50, the HUI Gold index declined 1.7% (up 8.4%).
Three-month Treasury bill rates rose 9 bps this past week to 2.22%. Two-year government yields sank 13 bps to 1.93%. Five-year T-note yields declined 5.5 bps to 2.685%, while ten-year yields rose 5 bps to 3.64%. Long-bond yields jumped 11 bps to 4.42%. The 2yr/10yr spread ended the week at 167 bps. The implied yield on 3-month December ’08 Eurodollars sank 16 bps to 2.36%. Benchmark Fannie MBS yields jumped 12 bps to 5.20%, this week under-performing Treasuries. The spread on Fannie’s 5% 2017 note widened 3 to 56 bps and Freddie’s 5% 2017 note widened about 3 to 57 bps. The 10-year dollar swap spread increased 3.2 to 66.5., the highest level since year-end. Corporate bond spreads were wider, with an index of junk bonds this week 16 wider.
Investment grade issuance included Verizon $4.0bn, Wachovia $3.5bn, United Health $3.0bn, Kinder Morgan $1.45bn, Sysco $750 million, Ace Ina Holdings $300 million, and Ecolab $250 million.
Junk issuance included Forbes Energy $205 million.
Convert issuance included AAR Corp $225 million, Chiquita Brands $200 million, and Radisys $55 million.
Foreign dollar debt issuance included British Sky Broadcasting $750 million.
German 10-year bund yields declined 5 bps to 3.86%, while the DAX equities index declined 2.9% (down 16.1% y-t-d). Japanese “JGB” yields dipped one basis point to 1.415%. The Nikkei 225 sank 3.6% (down 15% y-t-d and 24.7% y-o-y). Emerging equities markets were weak, while debt markets were weaker. Brazil’s benchmark dollar bond yields surged 30 bps to 5.99% (high since September). Brazil’s Bovespa equities index fell 2.0% (down 7.5% y-t-d). The Mexican Bolsa dropped 2.3% (down 4.8% y-t-d). Mexico’s 10-year $ yields rose 11 bps to 5.23%. Russia’s RTS equities index sank 5.0% (down 18.3% y-t-d). India’s Sensex equities index fell 4.3% (down 13.9% y-t-d). China’s Shanghai Exchange rallied sharply early in the week before the exchange closed for the holidays (down 12.6% y-t-d).
Freddie Mac posted 30-year fixed mortgage rates dipped one basis point this week to 5.67% (down 61bps y-o-y). Fifteen-year fixed rates declined 2 bps to 5.15% (down 87bps y-o-y). One-year adjustable rates fell 2 bps to 5.03% (down 46bps y-o-y).
Bank Credit declined $42.1bn during the most recent data week (1/30) to $9.291 TN, reversing a majority of the previous week's $74.2bn increase. Bank Credit has posted a 28-week surge of $647bn (13.9% annualized) and a 52-week rise of $961bn, or 11.5%. For the week, Securities Credit sank $52.9bn. Loans & Leases rose $10.9bn to a record $6.879 TN (28-wk gain of $554bn). C&I loans gained $5.5bn, with one-year growth of 22%. Real Estate loans rose $8.4bn (up 7.4% y-o-y). Consumer loans declined $3.8bn. Securities loans fell $6.3bn, while Other loans added $7.1bn. Examining the liability side, Deposits declined $27.9bn.
M2 (narrow) “money” supply jumped $37.6bn to a record $7.529TN (week of 1/28). Narrow “money” expanded $66.7bn over the past four weeks, with a y-o-y rise of $432bn, or 6.1%. For the week, Currency slipped $0.7bn and Demand & Checkable Deposits declined $9.0bn. Savings Deposits jumped $29.1bn, and Small Denominated Deposits gained $3.9bn. Retail Money Fund assets rose $14.3bn.
Total Money Market Fund assets (from Invest. Co Inst) surged another $46.3bn last week (5-wk gain $248bn) to a record $3.315 TN. Money Fund assets have posted a 28-week rise of $777bn (56% annualized) and a one-year increase of $978bn (41%).
Asset-Backed Securities (ABS) issuance slowed to about nothing this week. Year-to-date total US ABS issuance of $25bn (tallied by JPMorgan) is down 60% from comparable 2007. No Home Equity ABS deals have been sold thus far, compared to $38bn in comparable 2007. There has been less than $1bn of CDO issuance year-to-date, compared to $17bn this time last year.
Total Commercial Paper declined $8.6bn to $1.848 TN. CP has declined $375bn over the past 26 weeks. Asset-backed CP fell $9.9bn (26-wk drop of $393bn) to $802bn. Over the past year, total CP has contracted $163bn, or 8.1%, with ABCP down $252bn (23.9%).
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 2/6) increased $7.3bn to a record $2.118 TN. “Custody holdings” were up $61.2bn y-t-d, or 25.8% annualized, and $320bn year-over-year (17.8%). Federal Reserve Credit declined $2.9bn last week to $861.7bn. Fed Credit has contracted $6.1bn y-t-d, or 11.7% annualized, while expanding $20.2bn y-o-y (2.4%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.355 TN y-o-y, or 27.2%, to a record $6.331 TN.
Global Credit Market Dislocation Watch:
February 8 – Financial Times (Michael Mackenzie and Henny Sender): “Fears about corporate and commercial property debt reached new heights in the US and Europe on Friday as investors liquidated holdings in a sign of spreading credit turmoil. The markets were gripped by worries that economic weakness would affect corporate profits, leveraged buy-outs and commercial property. This represents an escalation of the crisis that began with concerns about US subprime mortgages. The trading was particularly heavy in leveraged loans – used by private equity firms to finance deals. Mutual funds that invest in these loans have been hit with redemptions, forcing them to dump some of their holdings. Hedge funds that bet on the likelihood of buy-out deals happening have been among the casualties. The turmoil has also put pressure on banks and other investors who are holding $200bn of leveraged loans that they had been hoping to sell. Kevin Cronin, portfolio manager at Putnam Investments, said: ‘The overhang of bank debt from last year’s leveraged buy-out activity is becoming more problematic. ‘Loans are being liquidated at distressed prices and banks are looking to reduce risk.’”
February 8 – Bloomberg (Abigail Moses): “The risk of companies defaulting soared to a record on speculation collateralized debt obligations packaging credit derivatives are being unwound, according to traders of credit-default swaps. Contracts on the benchmark Markit CDX North America Investment Grade Index jumped 4.25 bps to 128.5…the highest since the index started in 2004, according to Deutsche Bank AG. The Markit iTraxx Europe index rose 5.5 bps to a record 97.75, according to JPMorgan Chase & Co. ‘There is speculation structured products are being unwound,’ said Jim Reid, head of fundamental credit strategy at Deutsche Bank…”
February 5 – Financial Times (Stacy-Marie Ishmael and Henny Sender): “The leveraged loan market begins the week in ‘disarray’ following the collapse of efforts to syndicate $14bn of the debt used to finance the $27.8bn buy-out of Harrah’s Entertainment, bankers say. The group of banks backing buyers Apollo Management and Texas Pacific Group are having trouble selling on the leveraged buy-out debt to third parties. With the bulk of the debt remaining on their books, the banks are sitting on a sizeable loss. The freeze in the debt market means they now face larger potential losses on other big buy-outs…and will be more desperate to get out of the financing commitments on those deals. Banks are already saddled with more than $150bn of unsyndicated debt, most of it LBO related, according to S&P… Virtually every loan-backed buy-out deal done in the past few months is trading well below 90 cents on the dollar… The prospect of massive losses took its toll on the group of banks arranging the Harrah's financing. Credit Suisse…sold about $1bn of its share of the debt ahead of the agreed schedule, infuriating the other banks… ‘There is no contractual obligation,’ this person added. ‘We cannot concede control over our own capital.’ That may be the pattern in future deals. ‘The Harrah’s precedent frees other underwriters to deal with situations as they see fit,’ noted S&P's Weekly Wrap. ‘The market is in total disarray,’ said the head of debt capital markets at one major Wall Street firm. Another senior banker involved in the deal added: ‘The last 10 days have been the worst ever. There is a complete buyers’ strike.’”
February 8 – Bloomberg (Kabir Chibber): “Banks sitting on $160 billion of unsold leveraged loans may have to write down more losses after a plunge in the value of the debt, according to Bank of America Corp. analysts. Credit-default swaps showed the risk of leveraged buyout loan delinquencies rose to the highest on record today. Collateralized loan obligations that package the debt will be under pressure to wind down as the value of their assets falls, analysts led by Jeffrey Rosenberg wrote…”
February 5 – Financial Times (James Mackintosh and Paul J Davies): “Loans backing leveraged buy-outs are trading at levels not seen since the buyers’ strike of last summer, because a number of hedge funds and leveraged credit funds have been forced into firesales. Traders said loans used by private equity groups to support buy-outs had plunged in value as bank proprietary trading desks refused to buy them from these funds. A series of hedge funds that were big owners of leveraged loans have been frozen in the past six months, because severe losses and investor withdrawals threatened their survival. The past two months had seen the sale of loans by these and other funds that were hurt by banks making higher margin calls, traders said. They added that lists of assets being sold would be circulated after funds missed margin calls… ‘The amount of paper for sale is far outstripping the buying power of the market the moment,” said one hedge fund manager. ‘Every time one of those lists [of assets for sale] circulates, the market drops another point.’”
February 6 – Financial Times (Aline van Duyn, Michael Mackenzie and Paul J Davies): “Standard & Poor’s… is warning that the move could be damaging for banks with direct exposure to the insurers. S&P said the potential losses for banks triggered in the event of downgrades for the bond insurers would mainly be through the hedging arrangements that the bond insurers have provided on the least risky tranches of collateralised debt obligations. Bond insurers have hedged $125bn of subprime-related CDOs, S&P said. Although S&P did not specify which banks were most exposed, it noted that Citibank, Merrill Lynch and CIBC had all reported hedges on the so-called supersenior tranches of high-grade CDOs and had recently taken reserves for counterparty risk. ‘The value of those hedges has increased as the value of the underlying CDOs has fallen and can be presumed to be 40% to 60% of the notional amounts,’ said Tanya Azarchs, analyst at S&P. ‘More reserving may be necessary to reflect the increase in counterparty risk, if the ratings on guarantors are lowered.’”
February 7 – Financial Times (Paul J Davies): “Fitch Ratings is poised to downgrade some of the safest AAA-rated slices of complex pools of corporate credit derivatives by up to five notches after a review of its rating criteria for collateralised debt obligations… Yesterday it published a draft of its new methodology for market feedback. Fitch expects to implement the changes on March 31 and begin issuing ratings to new and existing deals.”
February 8 – Financial Times (Gillian Tett): “Earlier this week I chatted with a jet-lagged US financier. Like many of his ilk, he is flitting around the Middle East and Asia trying to extract finance from sovereign wealth funds and other investment groups. His latest travels have delivered a surprise: some funds are quietly getting cold feet about the idea of putting more capital directly into western banks, he says. ‘There is a backlash building,’ he muttered… This is striking stuff. In recent months, many equity investors have taken comfort from the idea that sovereign wealth funds could ride to the rescue of Wall Street… Thus far $40bn-60bn-odd worth of injections have been promised to groups such as Merrill Lynch and Citi, depending on how you measure the promises. But having stepped into the breach so visibly late last year, some funds are now getting jitters. In China, for example, there are rising complaints that funds are foolish to shovel cash directly into risk-laden US banks when they could be using it in better ways, such as purchasing western commodity or manufacturing groups. ‘The Chinese are worried they are turning into [the source of] dumb money,’ says one well-placed Asian financier, who partly blames the trend on the Blackstone saga, which produced significant paper losses for the Chinese investors. Meanwhile, in the Middle East, the latest round of Federal Reserve interest rate cuts has created unease.”
February 5 – Bloomberg (Jody Shenn): “Buying and selling of collateralized debt obligations based on mortgage bonds, high-yield loans or preferred shares has ground to a near-halt, traders said at the securitization industry's largest conference. ‘We’re definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks,’ Ross Heller, an executive director at JPMorgan Securities Inc., said…”
February 5 – Bloomberg (Pierre Paulden and Bryan Keogh): “Less than a year after Apollo Management LP paid $6.6 billion for real estate broker Realogy Corp., bond prices show the deal may be worthless. Debt used to finance the April purchase trades at 61 cents on the dollar, and derivatives tied to the securities indicate an 80% chance that…Realogy will default. Apollo, the private-equity firm run by Leon Black, put up about $2 billion of cash to buy the owner of Coldwell Banker and Century 21, borrowing the rest... Falling bond prices are jeopardizing private-equity returns after easy access to cheap debt fueled a record $1.4 trillion of leveraged buyouts in 2006 and 2007.”
February 4 – Financial Times (David Oakley): “Heavily indebted European and US companies face growing financial difficulties because they cannot refinance their borrowings owing to the continuing closure of the credit markets. Companies’ inability to borrow is raising the spectre of defaults, particularly among the most highly leveraged companies in sectors, such as property, that have been hardest hit by economic uncertainty. A big source for refinancing in Europe was the high-yield bond market, which has been closed since July, the longest closure since 2003. The European leveraged loan market is also at a standstill, with only a handful of deals priced in the past month and $64bn in loans still awaiting syndication, according to Dealogic…” Willem Sels, head of credit strategy at Dresdner Kleinwort, said: ‘The closure of the high-yield bond market is approaching a point where it will become a problem for some companies. There does come a time when a company can no longer postpone the need for refunding.’”
February 6 – Financial Times (Daniel Pimlott): “CB Richard Ellis, the world’s biggest real estate adviser, has cautioned that forced sales of property around the world would jump in the last six months of this year if the credit market turmoil did not improve. Brett White, chief executive of CBRE, told the FT that distressed sales of commercial property would rise if borrowers could not refinance loans after borrowing had become more expensive in the wake of the credit squeeze. ‘The issue is that loans come due. A lot of people have shorter-term loans and its going to be hard to replace them,’ said Mr White. ‘The longer it goes on, the worse it gets.’ Sales of commercial property have slowed dramatically since August, as the market for commercial mortgage-backed securities (CMBS) has dried up. CMBS made up 25-30% of all commercial real estate lending in the US at the height of the market last year… But December issuance of CMBS was down nearly 75% from its peak in March… Volumes of US office properties sold dropped 42% in the final quarter of 2007…”
February 6 – Bloomberg (Pierre Paulden): “The default rate for high-yield, high-risk bonds will rise ninefold this year from 2006, said Edward Altman, the New York University professor who created the Z-score mathematical formula that measures a company’s bankruptcy risk. Altman predicts 4.64% of the $1.1 trillion in junk bonds outstanding will default this year, up from 0.51% at the end of 2006, Altman said…”
February 5 – Bloomberg (John Glover): “Fitch Ratings may downgrade collateralized debt obligations by as many as five levels under new criteria the company plans to introduce by the end of March. The biggest cuts are likely to be made to CDOs based on credit-default swaps that aren’t actively managed. So-called static synthetic CDOs that currently have the top AAA ranking are likely face downgrades of an average five grades… CDOs holding high-yield assets will be cut as much as three levels for the portions first in line for losses, said the ratings firm.”
February 4 – Financial Times (Henny Sender and Aline van Duyn): “Leading private equity firms are unlikely to participate in any recapitalisation of Ambac and MBIA, increasing the pressure on banks to come up with a rescue package for the bond insurers. A number of firms, including Bain Capital, Carlyle Group, Kohlberg Kravis Roberts and TPG, have looked at investing in the cash-strapped groups… These investors have all concluded that the risks are far too great, according to people familiar with their thinking. The decision puts more pressure on the banks to provide rescue financing for Ambac and MBIA.”
February 5 – Bloomberg (John Glover): “Fitch Ratings may downgrade all of the $220 billion of collateralized debt obligations it assesses that are based on corporate securities because of rising losses. The…company may lower the notes by as much as five levels after failing to accurately assess the risk of debt that packages other assets, according to guidelines proposed by Fitch today. CDOs with AAA grades that are based on credit-default swaps and aren’t actively managed may face the steepest reductions.”'
February 4 – Bloomberg (Abigail Moses): “Banks in Europe may cut sales of collateralized debt obligations as much as 50% this year as mounting subprime mortgage losses prompt investors to shun the securities, Moody’s… said. Sales of CDOs, securities that pool bonds and loans, rose 11% to a record 112.8 billion euros ($167 billion) in 2007, analysts led by Florence Tadjeddine…wrote…”
February 4 – Bloomberg (Laura Cochrane): “Moody’s… may cut the ratings on A$83 billion ($75 billion) of Australian mortgage-backed bonds linked to PMI Group Inc. on concern the U.S. home-loan insurer will find it harder to pay claims. Moody’s is reviewing the ratings on bonds tied to loans insured by the local unit of PMI… They account for about 45% of the A$180 billion mortgage-backed bonds issued in Australia…”
February 5 – Bloomberg (Shannon D. Harrington): “Primus Guaranty Ltd., a manager of $23 billion in credit-default swaps, posted its biggest loss after writing down the value of guarantees it has on mortgage-backed securities… The fourth-quarter loss was $403.8 million…”
The dollar index rallied 1.6% this week to 76.67. For the week on the upside, the Mexican peso gained 0.3%, and the Taiwanese dollar 0.1%. On the downside, the South African rand declined 4.1%, the Norwegian krone 2.4%, the Swedish krona 2.4%, the Danish krone 2.2%, the Euro 2.2%, the British pound 1.4%, the Australian dollar 1.4%, and the Swiss franc 1.4%.
February 8 - Bloomberg (Tony C. Dreibus): “Wheat rose to a record for a third day on the Chicago Board of Trade as the U.S. forecast its lowest inventories in 60 years. U.S. stockpiles will drop to 272 million bushels at the end of May, 6.8% less than expected a month ago and down 40% from the prior year, the Department of Agriculture said… Inventories will be the lowest since 1948 when farmers grew less and shipped more wheat overseas to help rebuilding countries after World War II…”
February 4 – Bloomberg (Angela Macdonald-Smith): “Coal jumped to records at Australia’s Newcastle port and South Africa’s Richards Bay as snowstorms in China, power cuts in the southern African nation and floods in Queensland reduced output. Power-plant coal prices at the New South Wales port climbed $23.09, or 25%, to $116.44 a metric ton… Coal at Richards Bay rose $12.20, or 12%, to $111.30 a ton…”
It was a huge week for commodities. Gold jumped 1.9% to $923 and Silver 2.1% to $17.33. March Copper surged 7.5%. March Crude jumped $2.78 to $91.74. March Gasoline rose 3.1%, and March Natural Gas jumped 6.8%. March Wheat surged 16% to a record high. The CRB index gained 3.1% to a new all-time record high (up 4.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 4.1% (up 1.6% y-t-d and 42% y-o-y).
February 5 – The Wall Street Journal (Gordon Fairclough and Loretta Chao): “Transport and power disruptions caused by unusual winter storms across much of China’s heartland are beginning to ease, but the scale of the dislocation shows how close the country’s racing economy is to hitting physical-growth limits… ‘Electricity consumption has been growing rapidly,’ Tan Rongyao, a spokesman for the State Electricity Regulatory Commission, said… ‘The shortage of power-generating coal has become enormously acute.’ Gu Junyuan, chief engineer of the electricity commission, said total demand for electricity in China increased 20.2% annually between 2001 and 2007. Installed generating capacity, on the other hand, grew by about 18.5% a year over the period.”
February 7 – Market News International: “Japan’s foreign reserves hit a record $996.04 billion at the end of January, rising for the eighth consecutive month and surpassing the previous record high of $973.37 billion marked at end of December, the Ministry of Finance said Thursday. The country’s forex reserves remain the second largest in the world, next to China's, which is estimated at $1.43 trillion at the end of the third quarter 2007.”
February 8 – Nikkei: “After announcing price increases on some items, Kirin Brewery Co., Nissin Food Products and other food and beverage companies saw demand surge before the hikes took effect… Kirin Brewery in October announced it would lift prices on Feb. 1. January shipments of beer and beer-like beverages shot up more than 50% on the year, ‘for probably the first time ever,’ said a company official… Instant noodle makers uniformly bumped up prices by 10% or so last month, preceded by announcements in the fall. Since there was a three- to four-month lead up to the hikes, demand ballooned over that period….”
Asian Bubble Watch:
February 5 – Bloomberg (Francisco Alcuaz Jr.): “Philippine inflation accelerated to the fastest pace in 15 months in January as prices of food, water and services rose, reducing the central bank's scope to cut interest rates. Consumer prices climbed 4.9% from a year earlier…”
February 8 – Bloomberg (Anoop Agrawal): “India’s foreign-exchange reserves rose $4.36 billion to a record $292.7 billion in the week ended Feb. 1…”
February 8 – Bloomberg (Pratik Parija): “Imports of wheat into India, the world’s second-largest consumer of the grain, may climb 68% this year, supporting prices that are at a record.”
Unbalanced Global Economy Watch:
February 8 – Bloomberg (Greg Quinn): “Canada added 46,400 jobs in January, more than four times as many as anticipated… The unemployment rate fell to 5.8% from 6% the previous month, returning to a 33-year low set in October…”
February 5 – Bloomberg (Fergal O’Brien): “European retail sales fell the most in at least 13 years in December as higher food and energy costs prompted consumers to rein in their Christmas spending. Retail sales in the euro area declined 2% in December from a year earlier, the biggest drop since at least January 1995…”
February 4 – Bloomberg (Ben Sills): “European producer-price inflation accelerated in December to the fastest pace in a year, boosted by surging energy costs. Factory-gate prices increased 4.3% from a year earlier…”
February 5 – Bloomberg (Steve Scherer): “Italy’s inflation rate in January surged to the highest in at least 11 years, driven by rising energy, transportation and food costs. Consumer prices calculated by European Union standards rose 3.1% from a year earlier…”
February 5 – Bloomberg (Ben Sills): “Industrial production in Spain, which accounts for a seventh of the economy, posted the biggest contraction in more than five years in December as slower European growth curbed demand for Spanish goods. Production at factories, farms and mines fell 2.4% from a year earlier after adjusting for the number of days worked…”
February 8 – The Wall Street Journal (Christopher Emsden and Edith Balazs): “Accelerating inflation is driving interest rates higher in Eastern Europe, even as borrowing costs on the western side of the continent are coming down. The Czech National Bank on Thursday raised its core interest rate by a quarter of a percentage point to 3.75% in an effort to fight inflation, which hovers near six-year highs. The move followed similar rate increases in Poland, Romania and Serbia in recent days, and the dashing of hopes for a rate cut in Hungary, as inflation gallops across the continent. The main drivers of inflation in the east are the same as in the west: rising food and energy prices. Inflation rates are also above central-bank targets in the euro zone and in the United Kingdom… But along with higher food and energy prices, the economies of the east are also seeing spill-over into so-called second-round effects, such as wage increases to compensate for higher prices. Those second-round effects threaten to keep inflation rates at higher levels in Eastern Europe for a longer period of time…”
February 8 – Bloomberg (Marketa Fiserova and Andrea Dudikova): “Czech inflation accelerated faster than expected in January to the quickest pace in more than nine years because of government increases in taxes, rent and healthcare fees. The inflation rate rose to 7.5% from 5.4% in December…”
February 7 – Bloomberg (Ott Ummelas): “Estonia’s inflation rate rose to a near 10-year high in January, led by an increase in taxes on fuel, alcohol and tobacco, boosting concerns that high consumer prices may help undermine economic growth. The inflation rate increased to 11%, the most since April 1998, from 9.6% in December…”
February 5 – Bloomberg (Alex Nicholson): “Russian inflation accelerated in January to its fastest pace in 30 months as oil and gas prices surged, fueling consumer demand. Consumer prices rose an annual 12.6% in January from 11.9% in the previous month…”
February 7 – Bloomberg (Alex Nicholson): “Central Bank Deputy Chairman Alexei Ulyukayev said the Russian economy is showing signs of ‘overheating,’ the Interfax agency reported… High consumer demand and an ‘imbalance’ between wage growth and productivity are ‘symptoms of overheating…’”
February 4 – Bloomberg (Tracy Withers): “An index measuring Australian consumer prices rose at the fastest annual pace in 20 months in January, reinforcing speculation the central bank will increase interest rates tomorrow. Prices climbed 3.9% from a year earlier, breaching the 3% limit of the central bank's target, according to a monthly gauge released by TD Securities Ltd. and the Melbourne Institute...”
February 5 – Financial Times (Raphael Minder): “Canberra on Monday warned that Australia was facing a ‘very substantial’ inflation problem as data from China, Singapore and Indonesia pointed to inflationary pressure from rising food, energy and housing costs. ‘The inflation genie is out of the bottle,’ said Wayne Swan, Australia’s treasurer… ‘We’ve got an inflation problem to deal with, and deal with it we will.’ His comments followed news that Australian house prices rose by 3.2% in the fourth quarter of last year, bringing the increase for the year to 12.3%... In Singapore, which has also seen a property boom, Lee Hsien Loong, the prime minister, forecast the inflation rate could exceed 5% this year, compared with a previous government forecast of between 3.5% and 4.5%. In Indonesia, the central bank forecast that inflation this year would be between 6% and 6.5%... In China, most economists expect inflation to breach 7% this quarter… China has also been hit by a sharp rise in coal prices, which in Asia reached a high of $124 a tonne, up more than 30% in the past week.”
February 5 – Bloomberg (Tracy Withers): “New Zealand’s wages unexpectedly grew at a record pace in the fourth quarter as a labor shortage prompted companies to pay more to retain employees. Wages for non-government workers, excluding overtime, increased 1.1% from the third quarter…”
February 4 – Bloomberg (Jeremy R. Cooke): “California will borrow $3.2 billion this week to help close a deficit that led Governor Arnold Schwarzenegger to declare a state fiscal emergency. California is seeking to attract buyers by selling bonds with shorter maturities and some of the highest credit ratings, the type of debt favored by investors concerned the value of insured and lower-rated debt might weaken further. The sale, California’s first offering of deficit bonds since a fiscal crisis in 2004, follows a week when long-term municipal bonds fell and two of the largest planned offerings were canceled.”
Central Banker Watch:
February 5 – Bloomberg (Jacob Greber): “Australia’s central bank raised its benchmark interest rate by a quarter point to an 11-year high, saying a ‘significant slowing in demand’ is needed to cool the fastest inflation since 1991. Governor Glenn Stevens and his board increased the overnight cash rate target to 7%...”
February 4 – Bloomberg (Gabi Thesing): “European Central Bank Governing Council member Klaus Liebscher said the ECB will do what is needed to prevent a price-wage spiral from accelerating inflation. Liebscher said that at 3.5% inflation in Austria is ‘clearly too high,’ according to a statement published by the Austrian Central Bank… Compensating workers for the increased cost of living with higher pay increases and one-off payments would lead to a ‘price-wage spiral, higher budget deficits, higher taxes and in the end lower competitiveness.’”
Bursting Bubble Economy Watch:
February 4 – Bloomberg (Scott Lanman): “The Federal Reserve said it became tougher for U.S. companies and consumers to get loans in the past three months, particularly to buy real estate. Most lenders anticipate more delinquencies and losses this year, assuming ‘economic activity progresses in line with consensus forecasts,’ according to the central bank’s quarterly survey of senior loan officers… About 80% of banks raised standards on commercial-property loans, a record since the Fed began seeking information on the subject in 1990… ‘It’s definitely a broader-based tightening than we’ve seen before,’ said Edward McKelvey, senior U.S. economist at Goldman Sachs… ‘The economy is weakening and weakening in a pretty substantial way.’”
February 8 – The Wall Street Journal (Robin Sidel, Sudeep Reddy and Jane J. Kim): “America’s love affair with credit cards may be headed for the rocks. Credit-card delinquencies are rising across the nation, a sign that some Americans are at the end of their rope financially. And these mounting delinquencies, in turn, have prompted banks to tighten lending standards, keeping people who have maxed out their cards from finding new sources of credit. The result could be a sharp pullback in consumer spending that would further weaken the slowing U.S. economy. Such a pullback may already be taking shape… Sinking home prices have made it much harder to convert home equity into cash for living expenses. At the same time, plastic has pushed into every corner of American life, making new inroads that worry some economists and card issuers.”
February 4 – Market News International (Kevin Kastner): “Banks tightened lending standards across the board on all types of mortgage and commercial loans as concerns about credit quality in the near term made banks more cautious as demand for these loans declined… The outlook for loan quality in 2008 was bleak, with 70%-80% of U.S. banks expecting a deterioration of mortgage loan quality this year, including prime mortgages. In addition, 75%-80% of banks anticipated a deterioration in C&I loan quality. About 55% of U.S. banks reported tighter lending standards for prime mortgages, compared with 40% in…October. This percentage pales in comparison to the nearly 85% of banks that reported tightening lending standards on nontraditional mortgages and the 71% of banks that reported tightening standards on subprime mortgages."
February 6 – Bloomberg (Carlos Torres): “The increase in U.S. unemployment that’s jeopardizing economic growth is being driven by a drop in the number of people working for themselves, government figures indicate. Hours worked by the self-employed dropped at a 15.5% annual pace in the last three months of 2007, the biggest decrease in 15 years, according…the Labor Department. The decline ‘is probably related to the housing downturn, since one in six workers in construction is self-employed, twice the average for all industries,’ said Patrick Newport, an economist at Global Insight… The number of people running their own businesses dropped by 365,000 last quarter, compared with the same period in 2006…”
February 7 - Dow Jones (Michael R. Crittenden): “The downturn in the housing market and the increasing reliance on Fannie Mae and Freddie Mac to provide liquidity to the mortgage market is taking its toll on the two firms, their regulator said… ‘Public disclosures indicate that Freddie Mac will report annual losses for the first time in its history and Fannie Mae for the first time in 22 years,’ James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said…”
February 7 - Dow Jones (Michael R. Crittenden): “The increases in mortgage loan limits included in the U.S. economic stimulus package have been hailed as a major step in dealing with a stubborn housing crisis. But even Fannie Mae and Freddie Mac… have said the measure carries some challenges. As a result, it remains to be seen what effect the change will have. ‘(The higher mortgage limits) only are relevant if investors accept them,’ Stanford Group analyst Jaret Seiberg said… ‘If investors balk, the new powers will not help the market.’ …The legislation would increase the conforming loan limit to a maximum of $729,750… The size of loans the Federal Housing Administration can insure would also be increased to $729,750 for high-cost areas, in the hopes of replacing some of the subprime and adjustable-rate mortgages at the root of the current housing crisis… Once again, instead of thinking of ways to further protect the American taxpayer, we are actually considering ways to further expose them for the benefit of those making healthy six-figure salaries,’ Sen. Richard Shelby… said… James B. Lockhart III, director of the Office of Federal Housing Enterprise Oversight, told the Senate Banking Committee… that increasing the conforming loan limit presents ‘new challenges’ for Fannie Mae and Freddie Mac. ‘Jumbo loans would present new risks to the already challenged GSEs. Underwriting them successfully will require new models, systems and tough capital allocation decisions,’ he said.”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
February 8 – The Wall Street Journal (Nicole Gelinas): “Fitch Ratings, while telling investors last Friday to expect additional 'widespread and significant downgrades' on $139 billion worth of subprime loans, has cited a new factor in their ‘worsening performance.’ ‘The apparent willingness of borrowers to ‘walk away’ from mortgage debt,’ the analysts noted, ‘has contributed to extraordinary high levels of early default’ on loans issued during the 18 months before the mortgage bubble burst. It expects losses to reach 21% of initial loan balances for subprime mortgages issued in 2006 and 26% for those issued in early 2007. Such behavior, where not precipitated by willful fraud, shows that American homebuyers supposedly duped by their lenders aren't so dumb. They’re perfectly capable of acting rationally without political interference.”
February 7 – Financial Times (Paul J Davies): “As the bond insurers, or monolines, have seen their seemingly rock-solid AAA ratings begin to buckle, worries have grown about what downgrades for these companies might mean for banks. Now, one particular type of trade done between banks and monolines is being seen as an extra hidden danger. These so-called negative basis trades were done in large volumes in recent years. They allowed both banks and monolines to book apparently ‘free money’ and saw monolines writing guarantees on each other. If they have to be unwound, it will be a costly business for all involved. The real problem is that almost no one has any idea how significant the profits taken on these trades might be. These trades were profitable because a bond could pay out more in interest than it cost to buy the insurance available in the derivatives market to protect the holder against default. In the world of structured finance, a bank would buy a bond, get it guaranteed, or wrapped, by a monoline to support the bond’s AAA rating, but then also pay another monoline to write a default swap on the first monoline, to guard against it defaulting on its guarantee. The difference between what the bank paid for the insurance and what it received in yield from the bond could be pocketed as ‘risk-free’ profit – and in many cases banks took the entire value of that income over the life of the bond upfront. One senior industry insider admits that billions of dollars worth of these trades were done… Bob McKee, an analyst at Independent Strategy, a London research house, believes that up to $150bn worth of CDO business done by the monolines could be negative basis trades. Standard & Poor’s…said it believed some of the CDOs hedged by bond insurers were part of a strategy of “negative basis trades” The problem is that if monolines are downgraded and their protection becomes ineffective, profits booked up-front need to be reversed. Restating earnings is a very tricky area for investment banks – not least because the traders involved will have long ago pocketed their bonuses.”
Mortgage Finance Bust Watch:
February 7 – Bloomberg (Andrew Frye and Erik Holm): “MGIC Investment Corp., the largest U.S. mortgage insurer, is scaling back coverage in California, Florida, Arizona and Nevada to reduce losses on loans. The company will offer fewer policies to homebuyers who don’t have top credit scores… The insurer will also tighten standards in parts of 14 other states… In the high-risk regions, MGIC will no longer back so-called Alt-A mortgages where borrowers don't provide full documentation. It also won't insure mortgages on condominiums for more than 90% of their value.”
February 7 – Bloomberg (Bob Ivry and Jody Shenn): “Joe Ripplinger took out a $184,000 mortgage in 2006 and makes his payments every month. Now he owes $192,000. The 66-year-old Minneapolis house painter has a payment- option adjustable-rate mortgage. It allows him to write a check for $565 a month even though he owes $1,300. The difference is added to the mortgage, and when his total debt reaches $212,000, or after five years have passed, his monthly minimum will jump to about $2,800, which he can’t afford. ‘We’re barely making it right now,’ Ripplinger said. The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke… ‘We call them neutron loans because they’re like a neutron bomb,’ said Brock Davis, a broker with U.S. Express Mortgage Corp. Three years later the house is still there and the people are gone.’”
February 6 – Financial Times (Bernard Simon): “GMAC, the financial services group owned by Cerberus Capital Management and General Motors, is considering the sale of at least part of Residential Capital, its troubled mortgage lender, ResCapafter a hefty fourth-quarter loss. GMAC posted a net loss of $724m, a sharp reversal from a profit of $1bn a year earlier. ResCap’s loss grew to $921m from $128m while earnings from motor vehicle financing slipped to $137m from $593m. Both the US automotive and mortgage businesses have been squeezed by rising funding costs and problems in the subprime sectors. However, Robert Hull, chief financial officer, said the increase in automotive delinquencies and losses remained "relatively mild" and in line with previous economic downturns. GMAC reported a 2007 loss of $2.3bn compared with a $2.1bn profit the previous year. Its results would translate into a net loss of at least $300m for General Motors, well above analysts’ forecasts.”
February 6 – Financial Times: “It is never wholly reassuring when a company commits to support one of its divisions ‘to the extent it doesn’t hurt our other businesses’. But then GMAC, the financing arm of General Motors that is 51%-owned by Cerberus Capital Management, has little choice when it comes to ResCap. Losses at the mortgage business overwhelmed small fourth quarter profits in GMAC’s other operations. ResCap has not turned a profit since the third quarter of 2006 and has lost a cumulative $4.5bn since.”
Real Estate Bubbles Watch:
February 7 – Bloomberg (Hui-yong Yu): “Construction in central Seattle rose last year, with $1.1 billion worth of projects completed, 44% more than the year before, and a further $3 billion of projects was under way, the Downtown Seattle Association said. The value of commercial and residential projects under construction was up 30% from 2006.”
February 8 – Bloomberg (Brian Swint): “U.K. housing repossessions reached the highest since 1999 last year and will increase further this year as banks curb lending and the economy slows, the Council for Mortgage Lenders said.”
February 5 – Bloomberg (Michael Quint): “U.S. securities regulators are examining whether municipal governments should publicly disclose when periodic auctions used to set rates on some of their debt fail to attract enough bidders, a spokesman for the SEC said. About $270 billion of municipal auction bonds have interest rates that are determined by bidding that typically occurs every seven, 28 or 35 days. When there aren’t enough buyers, as has occurred in recent months, the auction fails and bondholders who wanted to sell are left holding the securities… ‘A failed auction makes the bond an illiquid security, and that certainly affects investors,’ said Lance Pan, director of research at…Capital Advisors Group, which manages about $7.5 billion of short-term investments.”
February 5 – Financial Times (James Politi): “The US administration on Monday blamed the slowdown in the economy for a projected increase of the budget deficit to a near-record level of $410bn this year, or 2.9% of gross domestic product. The expected jump in the deficit was announced as George W. Bush sent to Congress a $3,100bn federal budget for 2009 – the last and largest of his eight-year presidency… The spending plan, which is likely to set off an intense tug-of-war with Democrats who control Congress, includes a 7.5% increase in funding for the military to $515bn and a cut of about $200bn over five years in government healthcare programmes such as Medicare… The new budget estimates that the deficit will rise from $162bn, or 1.2% of gross domestic product, in 2007, to more than double that amount, or $410bn, in 2008, and $407bn in 2009.”
February 5 – Financial Times (Demetri Sevastopulo): “US military spending continues to soar with the Pentagon yesterday asking Congress for a record $515bn to fund the armed services in fiscal 2009. The military base budget funds everything from military salaries to big-ticket weapons, but does not include money for the wars in Iraq and Afghanistan. The $515bn request represents a 7.5% increase from last year, and translates into the 11th consecutive annual increase for the defence department.”
February 6 – Dow Jones (John Godfrey): “The U.S. federal government amassed a $90bn budget deficit in the first four months of the fiscal year that began Oct. 1… That deficit is nearly double the $48 billion shortfall amassed during the same time period in the previous fiscal year… According to the CBO, federal receipts will likely grow, year-to-year, 3.3%. That’s down from roughly 7% growth in revenue the year before, and growth rates exceeding 10% the two preceding years. While payroll taxes through January grew about 6.9% over the same time period last year, individual income taxes grew just 4.4% and corporate income taxes shrank 10.1%, the CBO said. In contrast, federal spending through the first four months was 8.7% higher than during the same time period last year.”
February 7 – Bloomberg (Jenny Strasburg and Katherine Burton): “Hedge-fund managers lost an average of 1.8% in January as stock markets around the globe got off to their worst start since 1990. The biggest losers were managers who buy and bet against stocks, known as long-short funds, which fell 4.1%, according to… Hedge Fund Research Inc.”
February 6 – Bloomberg (Tom Cahill and Katherine Burton): “SRM Global, the hedge fund run by former UBS AG trader Jon Wood, fell about 30% this year as of Jan. 18… The drop followed a loss of about 30% in 2007…”
Crude Liquidity Watch:
February 5 – Bloomberg (Yon Pulkrabek and Matthew Brown): “Gulf states including Saudi Arabia and the United Arab Emirates will be forced to revalue their currency pegs this year following the dollar’s declines and the Federal Reserve’s interest-rate cuts, said Bear Stearns Cos. Five Gulf nations lowered interest rates last week in step with the U.S. to keep their links to the dollar even as inflation accelerates… ‘It’s going to be very difficult for central banks in the region to have adequate control of monetary policy, and hence inflation, when the Fed is slashing rates left, right and centre and the dollar is slumping,’ Steven Barrow…wrote…”
February 7 – Bloomberg (Will McSheehy): “Gulf states including Saudi Arabia and the United Arab Emirates, which control $1.8 trillion of wealth, may control ‘the third global currency’ by 2020, according to Dubai economist and former Lebanese minister Nasser Saidi. ‘The common Gulf Cooperation Council currency can emerge as a global currency that other countries of the region, other Arab and central Asian economies, could peg their currencies to,’ Saidi, chief economist for the Dubai International Financial Centre, said…”
At the Heart of Deepening Monetary Disorder:
It was an eventful week for indications of the real economy’s (waning) soundness. At 15.2 million annualized, January vehicle sales were the weakest since October 2005 (that followed more than a year of very strong sales). A larger-than-expected increase in weekly initial unemployment claims (356k) pushed continuing unemployment claims rose to the highest level (2.785 million) since late 2005. The ABC/Washington Post weekly Consumer Comfort index sank a notable 6 points this week to negative 33, the lowest reading since the early nineties.
Importantly, this week’s Federal Reserve survey of senior bank-loan officers provided confirmation both that bankers have become much more cautious in lending and that borrowers have lost enthusiasm for taking on more debt. Moreover, any indication of general tightening of bank Credit takes on major significance today due to the seizing up and breakdown of Wall Street finance. Inarguably, what erupted last year in subprime has now evolved into a broad-based and severe Credit tightening. Notably, 80% of banks tightened Credit for commercial real estate lending and better than a third tightened commercial and industrial (C&I) Credit. It is worthwhile excerpting directly from the Fed’s survey:
“In the January survey, significant numbers of domestic respondents reported that they had tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the past three months; the remaining respondents noted that their lending standards had remained basically unchanged. About 55% of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40% in the October survey. Of the thirty-nine banks that originated nontraditional residential mortgage loans, about 85% reported a tightening of their lending standards… compared with about 60% in October…”
“About 60% of domestic respondents…indicated that demand for prime residential mortgages had weakened over the past three months, and 70% of respondents…noted weaker demand for nontraditional and subprime mortgage loans over the same period… About 60% of domestic respondents indicated that they had tightened their lending standards for approving applications for revolving home equity lines… Regarding demand, about 35% of domestic banks…reported that demand for revolving home equity lines of credit had weakened over the past three months.”
“About 10% of respondents -- up from about 5% in…October -- reported that they had tightened their lending standards on credit card loans… About 30% of respondents noted that they had reduced the extent to which such loans were granted to customers who did not meet credit-scoring thresholds… About 15% of domestic banks -- up from about 5% in…October -- indicated a diminished willingness to make consumer installment loans… About one-third of domestic banks -- up from about one fourth… -- reported that they had tightened their lending standards on consumer loans other than credit card loans… Regarding loan demand, about 35% of domestic institutions, on net, indicated that they had experienced weaker demand for consumer loans of all types…”
“About 80% of domestic banks reported tightening their lending standards on commercial real estate loans over the past three months, a notable increase from the October survey. The net fraction of domestic banks reporting tighter lending standards on these loans was the highest since this question was introduced in 1990…”
“In the January survey, one-third of domestic institutions…reported having tightened their lending standards on C&I loans to small as well as to large and middle-market firms over the past three months. Significant net fractions of respondents also noted that they had tightened price terms on C&I loans to all types of firms… Compared with domestic institutions, larger net fractions of U.S. branches and agencies of foreign banks reported having tightened lending standards and terms on C&I loans…”
With Wall Street’s securitization markets basically closed for business and even bank Credit Availability now tightening meaningfully, January’s collapse in the ISM Non-Manufacturing index should have been less of shock to the markets. After all, the services-based U.S. economy is primarily finance-driven, and our financial system is floundering.
The ISM Non-Manufacturing index unexpectedly sank 12.5 points to 41.9 (below 50 indicates contraction), the lowest level since October 2001. Expectations had the index slipping only a point or so to a still expansionary 53. Instead, New Orders dropped more than 10 points to 43.5, while the Prices component dipped ever so slightly to a disconcerting 70.7. Alarmingly, the Non-Manufacturing Employment index sank to 43.9, the lowest reading since the 43.9 registered in the month subsequent to the 9/11 terrorist attacks. This report corroborates the recent dismal jobs report, where “Service-Producing” job growth collapsed from December’s 143,000 (5-month average growth of 138,000) to January’s 34,000.
It is worth noting that, despite the bursting of the technology Bubble, the Non-Manufacturing index remained above 50 (at 50.7) through February 2001. But as Credit problems engulfed the corporate debt market, the Employment component proceeded to drop 6.4 points in 11 months to fall to 44.3 by early 2002. Remarkably – and indicative of breadth and severity of the unfolding Credit Crises – the Non-Manufacturing Employment index sank 7.9 points just last month. Meanwhile, the ISM Manufacturing Employment index declined 4.7 points in two months to its lowest level since September 2003. The Bubble Economy is now clearly suffocating from insufficient Credit. In particular, the unfolding Corporate Credit Crisis has begun to impact jobs, incomes and the overall economy.
It was, as well, an eventful week for indications of the soundness of the U.S. and global financial systems. On the inflation front, major commodities indices (including the CRB and the UBS/Bloomberg Constant Maturity) surged to record highs. Platinum jumped 7% this week to a record on tight supplies and power shortages in South Africa. Lead gained 5%. Copper jumped 7.5% (biggest gain in almost a year), increasing y-t-d gains to almost 16%. Palladium rose to the highest price since 2002. Sugar rose 5% on Friday, and I’d be remiss not to note crude’s 4% one-day surge.
But when it comes to spectacular moves, wheat takes the cake. Prices surged to yet another record high (up 30% y-t-d), as forecasts have U.S. stockpiles falling to the lowest level since 1948. Global supplies are said to be the lowest since 1978. Alarmingly, wheat increased the 30 cent daily limit in Chicago trading for five straight sessions, with Bloomberg reporting this week’s 16% gain as the “biggest in history.” Prices are now up 140% y-o-y. Along for the ride, soybeans rose 4% this week to a near-record ( U.S. inventories at 4-yr low), increasing one-year gains to 80%. Corn prices gained 2% (having doubled in the past two years), also trading at record highs. Production and inventory concerns saw coffee prices rise 5.8% this week to the highest level since 1999. Cocoa gained 3.8% this week (37% 1-yr gain).
The question remains: How much will the Chinese, Indians, Russians, American consumers and others be willing to pay for wheat and other vital commodities? For energy? For stores of value such as gold, silver and the other (increasingly) precious metals in an age of unregulated, unrestrained, unanchored, electronic-based, securities-based, and market-driven global “money” and Credit. With trillions of dollar liquidity sloshing vagariously around the global financial “system”, there is clearly more than ample high-octane inflationary fuel to destabilize markets for myriad essential things of limited supply. And, increasingly, there is talk of problematic margin calls and derivative-related issues impacting commodities trading conditions. The talk is of trading dislocations and nervous “bankers” pulling away from the financing of hedging activities in various markets. Or, in short, we are witnessing a precarious ratcheting up of Monetary Disorder – in a multitude of key markets and on a global basis.
At the Heart of Monetary Disorder, we have a leveraged speculating community increasingly on the ropes. January was a tough month for the hedge fund community. In particular, it appears the (over-hyped) “long/short” (holding both long and short positions) and (over-hyped) “quant” funds had an especially tough go of it. To begin the New Year, last year’s favorite stocks (i.e. technology, emerging markets, energy, and utilities) were hammered, while the heavily shorted sectors have significantly outperformed (i.e. homebuilders, banks, retailers, “consumer discretionary,” and transports). The yen and Swiss franc (currencies traders had shorted to finance higher yielding “carry trades”) have rallied. Even the dollar has rallied somewhat. Many speculators have been (caught) short commodities, having expected negative ramifications from the bursting of the U.S. Credit Bubble. Others have been caught over-exposed to emerging equities and debt markets. And, increasingly, it appears various trades throughout the complex corporate Credit arena have run amuck.
Friday, various indices of corporate credit risk moved to record highs, including the previously stalwart “investment grade” sector. Leveraged loan prices fell to record lows late in the week, as talk of further bank and hedge fund liquidations captivated the marketplace. While the status of the (“monoline”) Credit insurers is now a central focus, behind the scenes there is increasing angst at the prospect for a disorderly unwind of various leveraged trading strategies in corporate Credits and Credit derivatives. “Synthetic” CDOs (collateralized debt obligations) – pools of Credit default swaps and other derivatives – are especially vulnerable and problematic for the system. In short, the Corporate Credit Crisis took a decided turn for the worse this week. There is, with the economy sinking rapidly and the leveraged speculating community faltering abruptly, little prospect at this point for stabilization. The downside of the Credit Cycle is attaining overwhelming momentum.
The Wall Street punditry seems to go out of its way to get things wrong. The latest talk is that the market will simply look over the “valley” and begin focusing on a recovery from what will be, at worst, a brief and mild recession. The relative strong performance of the banks, retailers, homebuilders, and transports is accepted as confirmation of the bullish view. I’ll instead take the view that the recent major squeeze in the heavily shorted stocks and sectors is only further destabilizing and indicative of dynamics troubling to the leveraged speculating community and the Credit system more generally. “Hedges” have stopped working, creating a backdrop of angst and forced liquidations.
Despite last year’s subprime collapse and mortgage turmoil, the leveraged speculating community overall chalked up another stellar year of performance. Actually, the “community” in total likely boosted returns with bets against subprime and mortgage Credit more generally. Certainly, the hedge funds profited nicely from shorts on the financial and consumer sectors. Ironically, the initial stage of the bursting of the Credit Bubble proved a favorable backdrop for many of the major players and the community in general. The deluge of industry inflows ran unabated through much of the year, a crucial dynamic that masked rapidly developing fragilities and vulnerabilities. These flows were surely critical in supporting speculative trading positions away from the mortgage bust.
In particular, I believe the general backdrop delayed a problematic unwind of leveraged and highly speculative positions in corporate Credits (securities, derivatives and other “structured products”). Shorting mortgage-related Credit last year provided a convenient mechanism for hedging corporate Credit and equity market risk. Meanwhile, the combination of profitable (mortgage bust-related) shorts and hedges – in concert with industry fund inflows – emboldened the speculators to press their (huge) bets on technology, energy, the emerging markets, global equities, and other speculative Bubbles. The relative resiliency of the U.S. corporate Credit market and global markets through 2007 played a critical role in delaying impending economic and stock market adjustment.
Well, I believe the dam broke in January. The leveraged players were hit with losses from all directions. Their long positions were immediately slammed with simultaneous bursting Bubbles round the globe. Meanwhile, a rush to unwind positions led to upward pressure on the heavily shorted sectors, only compounding the leverage speculating community’s predicament. Last year fostered an extraordinary dynamic of ballooning “crowded trades,” and January saw the bursting of this multifaceted Bubble.
The leveraged speculating community has suffered the occasional tough month – last August providing a recent case in point. Each time, however, performance quickly bounced back. In true Bubble fashion, each quick recovery from a setback emboldened all involved; industry fund inflows not only never missed a beat – they accelerated. Yet a strong case can be made today that this (historic) Bubble has now burst – that last year was the “last gasp” before succumbing to New Post-Credit Bubble Realities. I don’t expect performance to bounce back, while I do foresee a flight away from the leveraged speculating now beginning in earnest. With “crowded trades” unraveling virtually across the board, marketplace risk is now escalating significantly for leveraged strategies in general. Systemic liquidity issues and dislocated market conditions have created an environment where there is seemingly no place to hide.
Importantly, a leveraged speculating community “unraveling” would prove a death blow for myriad sophisticated trading strategies and risk models, with enormous ramifications for systemic stability. There are unmistakable “Ponzi Dynamics” involved here worthy of a few Bulletins.
Going forward, I expect a foundering leveraged speculating community to be At The Heart of Deepening Monetary Disorder. The initial victims appear the fragile global equities market Bubbles and the U.S. Corporate Credit market. Forced deleveraging of hedge fund corporate debt and derivatives is in the process of creating a massive overhang of securities to sell, in the process profoundly curtailing Credit Availability and Marketplace Liquidity throughout. The ramifications for our finance-based Bubble Economy are momentous. As an economic and financial analyst (as opposed to “fear-monger”), I feel it is imperative to highlight that it is more “technically” accurate to categorize the unfolding scenario in the historical context of an economic “depression” rather than “recession.” This is certainly not shaping up as a short-term inventory-led economic adjustment or “mid-cycle” slowdown. Instead, we have now entered the very initial stages of what will likely prove a deep, prolonged and arduous adjustment to the underlying structure of our Credit and economic systems.