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Rate Cut Gives Little Relief to Commercial Paper Market

Listen to this article Despite the lift the Fed's rate cut gave to the stock and corporate bond markets, the commercial paper market remains in distress.

While CP outstandings are still falling, which is not good, particularly given this month's maturing CP is much greater than last month's, the level of decline is not as severe as during the last three weeks in August, when outstandings fell a total of $244 billion over that period. Nevertheless, one would have expected the rate cut to reverse the shrinkage in the commercial paper market.

Given that failure to roll maturing CP often results in issuers drawing on backup lines of credit, the tsuris in the money markets puts pressure on banks and competes with other uses of bank lending capacity. However, analysts speculate that some issuers, expecting a slowing economy, may be selling less CP.

From Bloomberg:

The U.S. commercial paper market shrank for a sixth week, extending the biggest slump in at least seven years and signaling Federal Reserve interest-rate cuts haven't yet drawn investors back to short-term debt.

Short-term debt maturing in 270 days or less fell $48.1 billion in the week ended yesterday to a seasonally adjusted $1.87 trillion, including a $32.1 billion decline in financial firms' commercial paper. Asset-backed debt dropped $15.6 billion, according to the Fed in Washington.

Commercial paper investments have declined $354.5 billion, or almost 16 percent, since the week ended Aug. 8, according to the Fed. The slump began in asset-backed paper and spilled into financial companies' short-term debt. Banks and other financial institutions have sold almost $14 billion of bonds and notes since Aug. 24, allowing them to pay off commercial paper.....

The prospect of a slowing economy, which prompted the Fed to act this week, may have caused firms to reduce sales, said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

``The economy is not very strong,'' Crescenzi said. That reduces the need for banks and brokerage firms to sell new debt to fund their day-to-day activities, he said. ``The demand for money weakens when the economy weakens.'',,,,

Financial issuers are selling longer-term debt and avoiding the risk that commercial paper won't roll over when it matures, said James Cusser, who manages about $1.5 billion in fixed-income securities at Waddell & Reed Inc. in Shawnee Mission, Kansas.

``Financial companies may be willing to forgo all the advantages of commercial paper as long as the market is stable because they haven't seen a liquidity event like this before,'' Cusser said. The banks and brokerage may keep paying off commercial paper ``until the clouds pass.''

The buyers' freeze shut out borrowers including mortgage lenders Countrywide Financial Corp. and Thornburg Mortgage Inc. as well as GMAC LLC and investment company Cheyne Finance Plc.

GMAC, the lender owned by Cerberus Capital Management LP and General Motors Corp., last week accepted $21.4 billion in financing from Citigroup Inc. after being unable to sell commercial paper. Calabasas, California-based Countrywide borrowed its entire $11.5 billion in available bank credit lines last month to fund its operations after being unable to roll over its short-term debt.

``It's more of a supply issue than demand,'' said Peter Crane, founder of Crane Data LLC, the Westborough, Massachusetts- based publisher of the Money Fund Intelligence Newsletter. ``People would buy it, but issuers don't want to issue at the price.''

Asset-backed commercial paper sellers use the cash to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Because some of the programs are backed by subprime loans, where defaults had reached a five-year high, investors refused to buy the debt.

The view that purchasers of asset-backed commercial paper have driven the drop by boycotting the paper completely is a ``myth that needs to be dispelled,'' Maureen Coen, global head of asset-backed commercial paper origination at Credit Suisse Group, said at conference in New York yesterday.

``We all could have predicted exactly the dollar amount of decline frankly,'' she said, because it was driven by exits by issuers that were forced due to program rules such as declines in the values of holdings, or that were voluntary because borrowing costs were higher in the market versus other sources of short- term debt.

Outstanding asset-backed commercial paper has slumped $253.4 billion. The declines slowed each week from a peak of $77.1 billion in the week ended Aug. 22. Sales have declined as investors balked at buying some commercial paper, shutting out some issuers.

``This means there are still players being escorted from the market,'' Crane said.

By Steve Hargreaves, CNNMoney.com staff writer
September 20 2007: 5:32 PM EDT

NEW YORK (CNNMoney.com) -- Oil prices jumped over $1 Thursday, setting a new record high as the dollar continued to reel in the wake of a half-point interest rate cut by the Federal Reserve.

U.S. crude for October delivery rose $1.39 to settle at $83.32 a barrel on the New York mercantile exchange. Crude also hit a new intraday high of $83.90 a barrel.

Trading was exceptionally volatile and light Thursday as the October contract for crude expired, which helped add to the gains.

The dollar plummeted to a new low against the euro Thursday and hit a 1-to-1 parity with the Canadian dollar for the first time in 30 years.

The debate behind $80 oil
That helped attract a flood of speculative money into oil contracts, said Ray Carbone, a broker and trader on the Nymex floor with Paramount Options.

A declining dollar raises oil prices as oil is priced in dollars worldwide, so producer nations, such as OPEC, are less likely to increase production if the value of oil is declining. Also, a falling dollar makes oil less expensive for consumers outside the U.S., encouraging more consumption.

"As long as you have a weak dollar, you're going to have higher oil prices," said Carbone. "There's lots of speculation going on in commodities prices in general."

The dollar's recent fall was sparked when the Federal Reserve lowered its key funds rate - an overnight rate it charges to banks and one that affects the amount people pay on everything from mortgages to credit cards - from 5.25 percent to 4.75 percent Tuesday.

While the move may stimulate economic growth domestically - which also pushes oil prices higher - it hurts the dollar as the lower interest rate makes some dollar-denominated investments less attractive for foreign investors.

Traders were also keeping a close eye on storms brewing in the Gulf of Mexico. Oil companies have already evacuated several platforms, but so far production hasn't been cut dramatically.

Thursday is the seventh record close for crude in the past eight sessions. So far this year, crude has soared $22.27 a barrel, a gain of 36.5 percent.

Although crude is at a record high in nominal terms, it is still below the inflation-adjusted highs of around $95 a barrel set in the early 1980s following the outbreak of the Iran-Iraq war.

Traders have also cited declining crude inventories in the U.S. as another reason for oil's record run.

On Wednesday the Energy Information Administration said crude stocks fell by 3.8 million barrels last week, more than twice the drop expected.

Oil prices have more than quadrupled in the last five years, going from around $20 a barrel in 2002 to more than $80 today. Most analysts cite rising global demand coupled with limited new supplies as the underlying reason behind the jump.

The tight supply-demand scenario has exaggerated the effects of geopolitical tensions, as there is less spare capacity to make up for a potential disruption in supplies.

Carbon said Israel's recent military action in Syria is also weighing on the minds of traders, as is tougher rhetoric by France towards Iran over that country's nuclear program as well as the bombing of a pipeline in Beiji (about 150 miles outside Baghdad) on Tuesday.

"These tensions are certainly on the minds of people when they speculate on oil," he said. "If anything happens, it will get us to $100 a barrel in short order."

Fears of dollar collapse as Saudis take fright Rolling Eyes

The Telegraph

Saudi Arabia has refused to cut interest rates in lockstep with the US
Federal Reserve for the first time, signalling that the oil-rich Gulf
kingdom is preparing to break the dollar currency peg in a move that risks
setting off a stampede out of the dollar across the Middle East.

"This is a very dangerous situation for the dollar," said Hans Redeker,
currency chief at BNP Paribas.

"Saudi Arabia has $800bn (£400bn) in their future generation fund, and the
entire region has $3,500bn under management. They face an inflationary
threat and do not want to import an interest rate policy set for the
recessionary conditions in the United States," he said.

The Saudi central bank said today that it would take "appropriate measures"
to halt huge capital inflows into the country, but analysts say this policy
is unsustainable and will inevitably lead to the collapse of the dollar
peg.

As a close ally of the US, Riyadh has so far tried to stick to the peg, but
the link is now destabilising its own economy.

The Fed's dramatic half point cut to 4.75pc yesterday has already caused a
plunge in the world dollar index to a fifteen year low, touching with
weakest level ever against the mighty euro at just under $1.40.

There is now a growing danger that global investors will start to shun the
US bond markets. The latest US government data on foreign holdings released
this week show a collapse in purchases of US bonds from $97bn to just $19bn
in July, with outright net sales of US Treasuries.

The danger is that this could now accelerate as the yield gap between the
United States and the rest of the world narrows rapidly, leaving America
starved of foreign capital flows needed to cover its current account
deficit -- expected to reach $850bn this year, or 6.5pc of GDP.

Mr Redeker said foreign investors have been gradually pulling out of the
long-term US debt markets, leaving the dollar dependent on short-term
funding. Foreigners have funded 25pc to 30pc of America's credit and
short-term paper markets over the last two years.

"They were willing to provide the money when rates were paying nicely, but
why bear the risk in these dramatically changed circumstances? We think
that a fall in dollar to $1.50 against the euro is not out of the question
at all by the first quarter of 2008," he said.

"This is nothing like the situation in 1998 when the crisis was in Asia,
but the US was booming. This time the US itself is the problem," he said.

Mr Redeker said the biggest danger for the dollar is that falling US rates
will at some point trigger a reversal yen "carry trade", causing massive
flows from the US back to Japan.

Jim Rogers, the commodity king and former partner of George Soros, said the
Federal Reserve was playing with fire by cutting rates so aggressively at a
time when the dollar was already under pressure.

The risk is that flight from US bonds could push up the long-term yields
that form the base price of credit for most mortgages, the driving the
property market into even deeper crisis.

"If Ben Bernanke starts running those printing presses even faster than
he's already doing, we are going to have a serious recession. The dollar's
going to collapse, the bond market's going to collapse. There's going to be
a lot of problems," he said.

The Federal Reserve, however, clearly calculates the risk of a sudden
downturn is now so great that the it outweighs dangers of a dollar slide.

Former Fed chief Alan Greenspan said this week that house prices may fall
by "double digits" as the subprime crisis bites harder, prompting
households to cut back sharply on spending.

For Saudi Arabia, the dollar peg has clearly become a liability. Inflation
has risen to 4pc and the M3 broad money supply is surging at 22pc.

The pressures are even worse in other parts of the Gulf. The United Arab
Emirates now faces inflation of 9.3pc, a 20-year high. In Qatar it has
reached 13pc.

Kuwait became the first of the oil sheikhdoms to break its dollar peg in
May, a move that has begun to rein in rampant money supply growth.