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A world of difference
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tiandi
Senior |
06-Sep-2007 22:37
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also a lot of luck |
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Pension
Elite |
06-Sep-2007 10:45
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Pinancle, play share dun need theory and acedamic, what you need is money and gut. |
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Pinnacle
Master |
06-Sep-2007 10:39
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Standard CharteredIn the middle of last month the financial markets suffered a significant deterioration in sentiment, caused by heightened awareness and concern about risk, especially credit risk, and an accompanying fall in liquidity and rise in volatility in most markets. With the start of the new month and with various central banks acting to provide liquidity, the situation seems to have stabilised, but to contrasting degrees across markets and products. The key questions are whether the worst of the turbulence is over, or, are we just in a lull before the next phase, and what will be the impact? Our view is that the turmoil will continue. We are at the end of the beginning, not the beginning of the end, and there will be significant differentiation in the impact of that turmoil. Firstly, let's contrast the performance of markets in the East and the West. In the East, the financial market turmoil does not seem to be an issue. China has stood out as a beacon of stability throughout the recent turmoil, with equity prices continuing to rise. The vast amount of liquidity rapped inside the country, constrained by restrictions on outflows, has provided some immunity against external events, hence the new stock market peaks that are hit virtually every day. Officials and commentators locally have been focusing on the domestic risks of overheating, inflation, and the need to raise interest rates, which is in sharp contrast to the West. Indeed, economic growth continues to be strong across Asia. India's GDP growth accelerated again this week, while equity markets have bounced back strongly since mid-August, with the likes of the Hang Seng and other 'emerging' market indices up over 20%. For a while on Tuesday, Shanghai was up over 100% for the year. It appears that, if there are problems with liquidity in the East, it is because there is too much! Looking to the West, by contrast, we see a different view. On the positive side, central banks have taken action and markets have recovered some poise: equity markets are up 5-10% from their lows. The Fed in particular has reacted quickly to the credit market turmoil. Market consensus now is for a 25bps cut at the next FOMC meeting (18 Sep) to restore confidence and address the clear risk that 'Wall Street's' financial turmoil spills over into 'Main Street'. Fed Chairman Bernanke, however, has left his options open by tying that decision to the performance of the underlying economy and stressing that it is not the Fed's role to bail out speculators. The current market distress is as much about psychology as anything, and it is unclear if cuts in the target funds rate will solve the worries about transparency and counterparty risk. Nevertheless, the probability of the Fed waiting until Dec to begin its cutting cycle - our official call - is looking less likely. We would like to wait for more evidence of the economy weakening, especially employment, before changing that view to a Sep rate cut. In fact, another cut in the discount rate is likely before any cut to the funds rate. Outside the US, both the Bank of England (BoE) and the European Central Bank (ECB) look to be on hold for the next couple of quarters in response to the turbulence. Credit spreads and swap spreads have come off their highs but show a contrast as well. Credit spreads for financial institutions remain close to their highs, especially for shorter-dated protection, whereas non-financials have come off. The 'real' economy, especially that part linked to Asian growth, is doing well and this is reflected in such indicators as freight rates which are at all time highs. The biggest problem that western central banks face is the lack of inter-bank liquidity (beyond overnight lending), and despite all their efforts, that does not seem to have loosened at all. Though the longer-dated swap spreads have narrowed substantially, the two-year swap spread is at its highest since early 2000 and the difference between 10-year and 2-year swap spreads is negative - the first occurrence in at least 12 years. Both this and the credit spreads for financial institutions could be telling us the same thing: the market is worried that some financial institutions are vulnerable in the short-term. The starkest indication of all though is in the money markets. Partially because the BoE has probably been the least accommodating of major central banks, and there is little distorting effect of likely hikes or cuts, the GBP money markets show some of the clearest signs of the inter-bank liquidity problems. The spread between 'risk-free' government bills and GBP 3-month LIBOR is at unprecedented highs of about 100bps. (As an aside, one additional problem for UK mortgage lenders is 'tracker' mortgages which are priced against the Base rate whereas funding is through the, now much higher, inter-bank market.) The market is getting tighter, not easier, which is a far from comforting sign. In contrast, Japan has shown no signs of tension in its money markets. This is echoed in the EUR money markets and in USD as well, though this is partially obscured by market perceptions of rate cuts. The USD market is interesting as the Fed has been the most active at providing liquidity, for instance increasing the maturity of repos and accepting a wider spectrum of assets, including Asset-Backed Securities (ABS) but the market is potentially just as stressed as others, with inter-bank rates well above 'normal' levels. Liquidity is vital. Remember, the end of the credit bubble in the late 80's resulted in Drexel Burnham Lambert going out of business, through lack of liquidity more than anything else. This leads to another contrast: complexity and simplicity. Whilst industrial companies can get funding at reasonable levels, the ABS market is closed to new issues and funding for existing portfolios is very difficult. It will be surprising if, whatever happens, some of these complex structured markets return to normal any time soon. With the expected huge amounts of refinancing for ABS portfolios likely towards the end of September, look for this issue to remain in the spotlight. Differentiation is back in fashion: East vs. West, Non-Financial vs. Financial, Simple vs. Complex, Good credits vs. Weak. And most important of all?. Liquid vs. Illiquid. Expect the next few weeks to highlight these differences. |
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