THIS IS NOT ASIA REDUX
[Latest Global Dollar Liquidity Measure: +15.7% annual growth rate; latest Endogenous Liquidity Index: -23.0%]

As a keen watcher of credit spreads, I don't pretend to downplay the seriousness of the crisis in creditland. Estimations for corporate profits and global economic growth will most certainly have to be revised downwards. But this is not 1998 redux, as some are suggesting (sorry, no link). Back in September 1998, our Global Dollar Liquidity measure was all but collapsing: -4.7%. It is +15.7% now.

WEEKLY FED BALANCE SHEET REVIEW. FUNDING LIQUIDITY IS UP (BUT WHO CARES?)
. Federal Reserve: "Factors Affecting Reserve Balances", July 25

- Fed's Treasuries holdings: $778.1bn (-$3.6bn)
- Other central banks' Treasuries holdings: $1,253.3bn (+$1.8bn) (*)
- Other central banks' agency securities: $749.7bn (+$5.2bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,781.0bn (+$3.4n)

(*) Off-balance-sheet items.
agustin_mackinlay@yahoo.com
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Foreign central banks continue to buy Treasury and agency securities: they added a further $7bn to their accounts. Meanwhile, the renewed inversion of the yield curve means that the 5.25% Fed funds rate is likely to take its toll on domestic liquidity conditions (-$3.6bn). All in all, "funding" liquidity remains strong, with the annual rate of growth of our preferred measure at a 30-month high (+15.7%). But who cares about funding liquidity anyway? All the action is in "market" liquidity.

Here, the meltdown is taking epic proportions. Our still preliminary Endogenous Liquidity Index is down 21%! All major components are weak: CDS and other credit spreads, volatility measures, and measures of financial innovation. Still, the Moody's Baa spread (the key spread in my long-term models) is unchanged vs. July 2006. Am I missing something here?

TRADING RANGE SCENARIO STILL IN THE CARDS ...
[Latest Global Dollar Liquidity Measure: +15.6% annual growth rate; latest Endogenous Liquidity Index: -15.0%]

Sorry for the lack of posting ... Not always easy from a distance ... Trading range scenario still in the cards ... A further 35 basis points to go on the Baa spread before Liquidity Combo Model (funding + market liquidity) turns officially bearish ... Looks very unlikely to me ... Yield curve's renewed inversion signals lower inflationary pressures ahead ... Markets doing the Fed's job ...

TRAVELLING! BACK ON TUESDAY OR WEDNESDAY!

WEEKLY FED BALANCE SHEET REVIEW. 24 UP, 5 DOWN
. Federal Reserve: "Factors Affecting Reserve Balances", July 18

- Fed's Treasuries holdings: $781.6bn (-$0.2bn)
- Other central banks' Treasuries holdings: $1,251.5bn (+$6.5bn) (*)
- Other central banks' agency securities: $744.5bn (+$0.6bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,777.6bn (+$6.9bn)

(*) Off-balance-sheet items.
agustin_mackinlay@yahoo.com
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Twenty-nine weekly Fed balance sheets have been published so far this year. In as much as 24 of them, our Global Dollar Liquidity measure has shown gains. In fact, we're growing at a 15.6% annual rate, the fastest pace since January 2005. Liquidity bears do not seem to pay attention to these facts. Rather, they tend to concentrate on market liquidity. Admittedly, things do not look pretty in parts of credit-land. Richard Bernstein, chief investment strategist at Merril Lynch, mentions the L-word no less than 13 times in his very bearish comments on market liquidity [HT: Robert].

Now, as a keen watcher of credit spreads myself, I will concede that expectations of corporate earnings will have to be downgraded sooner or later if spreads continue to surge. But let's not forget one thing: while we are witnessing the greatest episode of wealth creation in the history of civilization, long-term interest rates are toying with ... what? 5%? Analyze that!

KEN FISHER & CREDIT SPREADS
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: -5.5%]

Very interesting piece by Ken Fisher. I am in a hurry right now, so no time to analyze in detail. The message is: watch credit spreads! Yes, they have been rising over the last couple of weeks. But year-on-year measures tell a more bullish story. I agree — but I'll keep an eye on those pesky spreads.

RISING CREDIT SPREADS ...
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: -3.0%]

Increasing funding liquidity and decreasing credit spreads: the ideal scenario to run with the bulls. But now credit spreads are rising: should we worry about risky assets? My (very simple) long-term models tell me not to worry — yet.

LIQUIDITY TALK
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: -1.2%]

- Liquidity & CNBC's Trillion Dollar Survey. According to CNBC's survey, "Liquidity is the strongest factor influencing the stock market right now". More than 26% of those surveyed see "market liquidity" as the key factor. That's pretty interesting: our own measures of market liquidity aren't quite as bullish.
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- Boeing, Caterpillar & Volatility. Fascinating piece by John Gapper. Here's the key part: "The 787 is remarkable for the degree to which Boeing has outsourced production around the world. Boeing itself is responsible for about 10 per cent by value –– tail fin and final assembly. The rest is done by 40 partners, with the wings built in Japan, the carbon composite fuselage in Italy and the US and the landing gear in France".

Boeing has ceased to call itself a manufacturing company; instead, it now sees itself as a systems aggregator, whatever that means. Now take Caterpillar. Weak U.S. demand due to the housing slump? No problem: let's open a Component Manufacturing Campus in Wuxi, China. What do Boeing's and Caterpillar's actions tell us about the expected volatility of the business cycle?
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- Cisco Systems: productivity & the business cycle. There are a number of theories pretending to explain the "Great Moderation" of the business cycle. In the late 1990s, it was all about how digital networks helped companies better manage their inventories, thus leading to a smoother cycle. (By the way, I believe it's true: look at this amazing chart).

Enter John Chambers. In this interview, the Cisco CEO tells the Financial Times that "The introduction of consumer-driven web 2.0 technologies into businesses is set to usher in a new phase of productivity growth that could surpass that achieved during the late-1990s internet boom". Again: what does that tell us about the expected volatility of the business cycle?
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- China to buy Ginnie Mae paper? What a story (Bloomberg). Just as the U.S. budget situation appears to be improving, the housing market slumps. No problem: just ask the Chinese to buy up those Ginnie Mae-guaranteed bonds.

WEEKLY FED BALANCE SHEET REVIEW. UP, BUT NO BY MUCH
. Federal Reserve: "Factors Affecting Reserve Balances", July 11

- Fed's Treasuries holdings: $781.8bn (-$3.8bn)
- Other central banks' Treasuries holdings: $1,245.0bn (+$4.4bn) (*)
- Other central banks' agency securities: $744.0bn (+$2.5bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,770.7bn (+$3.1bn)

(*) Off-balance-sheet items.
agustin_mackinlay@yahoo.com
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The weekly Fed balance sheet shows a rather modest (+$3.1bn) gain in our Global Dollar Liquidity measure. Foreign Central banks continue to show more appetite for Treasuries than for agency securities, which probably reflects the lure of higher yields. The weekly gains may be subdued, but July is nonetheless the 56th month in a row with our measure growing north of 10% in annual terms. As Barry Ritholtz would put it: un-frickin-believable.

VOLATILITY AND CREDIT SPREADS
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: -5.5%]

The Endogenous Liquidity Index was essentially flat yesterday, but its components were not. CDS spreads again went sharply up, but volatility measures sold-off quite dramatically. There's a lesson here, at least for me. The "Great Moderation" of the business cycle —for which volatility indicators act as a proxy— matters at least as much as credit spreads. More on that soon.

IMPLOSION! EXPLOSION!
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: -5.1%]

Our Endogenous Liquidity Index suffered yesterday its sharpest one-day fall since inception: -6.0%! All components registered losses: the "Great Moderation" indicator (as measured by the VIX and other volatility measures), CDS spreads and credit spreads in general, and measures of financial innovation. Implosion!

Meanwhile, foreign central banks continue to buy Treasury and agency securities at increasing rates. (See our last weekly report and this post by Brad Setser, who doesn't rule out the possibility that total emerging market reserve growth could "easily be in the $500-600b range for the first half of the year -- or $1,000 to $1,200b annualized"). Explosion!

With global liquidity both exploding and imploding, I remain true to the trading-range scenario for risky assets. Is there any money to be made? According to the Financial Times:

A $2bn fund run by New York's Paulson & Co was the single best-performing fund, rising 39.95 per cent after fees in June thanks to its dedicated bets against subprime mortgages – loans to less credit-worthy homeowners. Other hedge funds following similar strategies produced returns as high as 27.5 per cent in the month, while another manager has tripled investor money this year, according to investors.

Nice!

DANCIN' LIQUIDITY!
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: +2.0%]

This is, hands down, the liquidity story du jour. Chuck Prince, the Citigroup CEO, tells the Financial Times that he feels confident enough to dismiss fears that the music is about to stop for the cheap credit-fuelled buy-out boom, declaring that Citigroup is "still dancing". And he adds: "...the party [will] end at some point but there [is] so much liquidity at the moment it would not be disrupted by the turmoil in the US subprime mortgage market".

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing ... The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be. At some point, the disruptive event will be so significant that instead of liquidity filling in, the liquidity will go the other way. I don't think we're at that point ... The way big Wall Street banks and large hedge funds [have] been picking up troubled subprime mortgage lenders [is] an example of how "liquidity rushes in" to fill the gap as others spot a buying opportunity.

LIQUIDITY TALK
[Latest Global Dollar Liquidity Measure: +15.5% annual growth rate; latest Endogenous Liquidity Index: -0.8%]

- The CDO Put at work, again. According to the Daily Institutional Investor, HSBC is in the early stages of marketing "a managed synthetic corporate collateralized debt obligation to Asian investors called Maple Hill II. The deal was structured in New York, contains largely European and U.S. investment-grade underlying and is getting global distribution. Seven-and-a-half-year and 10-year notes are available and the deal is managed by U.S.-based Babson Capital".

"The portfolio references 136 high quality global corporate credits with a 10% cap in high-yield credits". Interestingly enough, Asia appears to be the source of demand: "... there has been consistent demand for this type of deal, particularly from Japan and Korea. She added that HSBC also has a lot of new Asian accounts from places such as China, Philippines, Thailand and Malaysia looking to get into structured credit, and who look to this sort of product for its diversity and relatively high yield".
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- PIMCO's Tomoya Masanao on global liquidity. From a global liquidity point of view, this piece contains three interesting elements. [1] The changing face of the New Bretton Woods: "Currency reserves in China and other Asian countries have been a very important factor in containing risk premiums in the financial markets. These countries have been using their reserves to buy U.S. Treasuries and other high quality bonds in an effort to maintain currency pegs versus the U.S. dollar ... This evolution [i.e. investing in riskier assets via "sovereign wealth funds"] is already occurring and will accelerate over our secular horizon".

"This evolution, coupled with our global growth outlook, suggests a positive environment for riskier assets, notably stocks, real estate and commodities. That environment is unfortunately not very positive for high quality bond markets like U.S. Treasuries". [2] Towards a more balanced global business cycle? "One important change in our outlook is simply that we recognize global aggregate demand is becoming less U.S.-centric and that domestic demand in emerging markets is continuing and accelerating, which in turn is feeding growth, particularly in Europe and Japan".

"We now believe that global aggregate demand will be less dependent on U.S. consumption because of the growth in emerging markets. As the emerging markets become an increasingly important driver of global aggregate demand, the rest of the world will benefit from emerging market growth, particularly Japan and European countries". [3] The recognition of endogenous liquidity. "A second factor that led us to a different conclusion this year is the recognition that the higher asset prices, tighter credit spreads and lower bond yields we have experienced in the last three to five years have eased financial conditions globally. This global liquidity has largely offset central bank tightening in developed countries like the U.S".
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- Bennet Sedacca on global liquidity & M3. Bennet Sedacca and a confession: "I couldn't have said better myself ... the market has been driven by excess global liquidity". After this promising start, Mr. Sedacca surprises with a mention of the now-defunct M3 monetary measure. I have written about this a couple of times already, but let me take the opportunity to repeat one of the key "commandments" of liquidity watchers: M2 and M3 are not liquidity measures. Moreover: they sometines act as indicators of il-liquidity — remember 1998 in the U.S.

WEEKLY FED BALANCE SHEET REVIEW. THE LIQUIDITY CONUNDRUM
. Federal Reserve: "Factors Affecting Reserve Balances", July 4

- Fed's Treasuries holdings: $785.5bn (+$8.1bn)
- Other central banks' Treasuries holdings: $1,240.7bn (+$9.0bn) (*)
- Other central banks' agency securities: $741.5bn (-$2.1bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,767.7bn (+$15.1bn)

(*) Off-balance-sheet items.
agustin_mackinlay@yahoo.com
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Another week, another sharp increase in our Global Dollar Liquidity measure. Central banks added more than $15bn to their collective balance sheets, thus contributing to the 15.5% annual rate of growth of funding liquidity — the highest since January 2005. To be sure, the quality of the increase leaves a lot to be desired: the Fed is the biggest contributor (reflecting, perhaps, a seasonal pattern). Note too, foreign CBs' unusual choice of Treasury securities over agency bonds — probably a consequence of higher yields.

Meanwhile, the "liquidity conundrum" is only intensifying, as market liquidity refuses to improve. Our Endogenous Liquidity Index is down 2.5%, reflecting higher credit spreads. In my view, a bullish solution to the conundrum is more likely than not. Inflation expectations continue to moderate, and global economic growth is as strong as ever (*). In the meantime, a trading range scenario should not come as a huge surprise to liquidity watchers.

(*) According to Geraud Charpin, head of European credit strategy at UBS quoted by the Financial Times's Alphaville blog, the sell-off in the CDS market is not being driven by fundamentals: "The sell-off in the market right now is purely technical: macroeconomic numbers have been pretty good and investors expect Q2 corporate earnings to be strong. Essentially, it's all about financial market deleveraging and adjustment rather than macroeconomic fears".

TRADING RANGE AHEAD?
[Latest Global Dollar Liquidity Measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -1.6%]

Strong funding liquidity tells me not to short risky assets; weak market liquidity tells me not to buy aggressively. Trading range ahead?

LIQUIDITY TALK. THE CDO PUT AT WORK?
[Latest Global Dollar Liquidity Measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -1.6%]

According to the Daily Institutional Investor, Wachovia has structured a synthetic collateralized debt obligation for PIMCO, the first deal the firm has led for the manager. "The $750 million CDO, called Bayshore Synthetic CDO 2007-01, is made up of 115 corporate credit-default swaps. Bayshore is being rated by Moody's Investors Service and Standard & Poor's ... The deal is being marketed globally, with the bulk of synthetic CDO liabilities generally now being placed in Asia".

According to Daily Institutional Investor, the deal is a remarkable one because PIMCO "does not issue into the CDO market as frequently as other large managers". I'd bet that Accrued Interest will reflect upon this piece and all the irony it contains. More to the point, could this be the start of the CDO Put? CDS spreads, after all, are rising.

LIQUIDITY TALK. THE GLOBALIZATION OF MICRO-FINANCE!
[Latest Global Dollar Liquidity Measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -4.0%]

A few months ago I read about Kiva's website, which enables pretty much anybody to lend to an entrepreneur in the developing world. It turns out that microfinance, according to this excellent Financial Times article by Joanna Chung (*), is "quickly becoming a popular corner of the capital markets as more investment banks and investors see the business of providing small loans to low-income individuals in poor countries as potentially profitable as well as a powerful tool for development".

To my great surprise, Morgan Stanley (together with Swiss company Blue Orchard) has just issued the first microfinance Collateralized Debt Obligation in a deal worth more than $100 million. According to Ms. Chung, Standard & Poor's "expects to rate an additional two to three microfinance CDO transactions and around 25 MFIs in the coming months, with CDO issuance levels potentially reaching $500m by the end of 2007".

Absolutely fantastic!

(*) Joanna Chung. "Calls for ratings framework amid surge in microfinance", Financial Times.

LIQUIDITY TALK. BOND RALLY?
[Latest Global Dollar Liquidity Measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -4.6%]

James Cramer asks investors to "recognize the bond rally" as a bullish sign. I'm not persuaded. Treasuries may be rallying, but corporates are not: spreads are rising.

LIQUIDITY TALK. CDOs DOMINATE THE LIQUIDITY DEBATE
[Latest Global Dollar Liquidity Measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -4.6%]

Another day, another drop in our Endogenous Liquidity Index. Once again, all components showed weakness: CDS spreads, cash bond spreads, volatility measures, financial innovation measures. While most of the talk is about CDOs containing asset-backed securities, one has to wonder about the fate of the so-called synthetic CDOs, as CDS spreads continue to climb.

- The FT's Tony Jackson on CDS, CDOs & derivatives. Rightly focuses on synthetic CDOs. "[Credit derivatives] will still be in demand for their original function of hedging risk. They may be less so as a means of blindly assuming risk in the hunt for yield".

- Bloomberg's Mark Pittman on the CDO debâcle. Contains lots of quotes from angry- and bearish fund managers. "We remain nervous about the end of the week, when many leveraged investors in the CDO markets will have to mark down their positions, debt strategists at Barclays Capital in New York said in a June 28 report".

- Morgan Stanley's Richard Berner on the turn in the credit cycle. "The turn in the credit cycle has begun", writes Mr. Berber in this interesting piece. He then asks, rhetorically: "Could this so-far orderly renormalization now morph into an ugly credit crunch that would slam the brakes on the economy and corporate leverage?"

- Bank Credit Analyst feeling less pessimistic. Canada-based BCA acknowledges the increase in quality spreads, but concludes that "the shakeout in sub-prime debt is not over, but may now be contained to lower quality securities, with less risk of a contagion into credit spreads and the banking sector".