Thursday, September 27, 2007

[Latest Global Dollar Liquidity Measure: +13.4% annual growth rate; latest Endogenous Liquidity Index: -15.9%]

Endogenous Liquidity at a two-month high; the dollar & bond yields; Russian liquidity squeeze.

[1] Surging Endogenous Liquidity! Our index, designed to capture trends in market liquidity through market-based indicators, surged 2% yesterday, closing at a two-month high. Lower CDS and cash bond spreads, declining volatility and rising share prices of financial innovators indicate increasing risk appetite and leverage. So far, the index has acted mostly as a coincident indicator for risky assets. Still, it remains a valuable tool when monitoring divergence/convergence trends with respect to funding liquidity.

[2] Marc Chandler on the dollar & bond yields. Brown Brothers Harriman's Mark Chandler disputes the notion that aggressive Fed easing (on September 18) actually aggravated the U.S. inflation picture. His key argument: European yields increased too. In other words, falling bond prices on the heels of the FOMC anouncement may simply reflect "the loss of the safe-haven bid for bonds". Interesting!

[3] Mansoor Modi-huddin on the dollar & bond yields. Buried in page 34 of today's Financial Times, there is a strinkingly similar explanation by Mansoor Modi-huddin of UBS: "Paradoxically, [last weeks's aggressive 50 basis points interest rate cut from the Federal Reserve, by reinvigorating markets around the globe] may have made it easier for other central banks to continue with their tightening cycle, putting downward pressure on the dollar via yield differentials".

[4] More Russian liquidity troubles. In Moscow, FT reporter Catherine Belton reports that "A senior Russian banker warned on Wednesday of debt defaults as the liquidity squeeze in Russia tightened following the global credit crunch and interbank lending rates climbing to a two-year high" ("Russian liquidity trouble starts to boil"). Read the whole story. Events in Eastern Europe make it more urgent to create a ... Euro Global Liquidity Measure!

[5] Credit derivatives volume at $45 trillion. From the Wall Street Journal's Market Beat site: The credit derivatives sector "expanded by almost a third in the same period to a notional outstanding volume of $45.46 trillion, from $34.42 trillion at the end of 2006. This nevertheless takes a little off the pace the industry has seen so far. Last year, according to ISDA, the notional volume of credit derivative contracts outstanding more than doubled ... The derivatives market’s continued expansion is testimony to what has become its central role in capital markets, particularly during the liquidity crisis of the past couple of months, according to ISDA Chief Executive Officer Robert Pickel. "We expect this strong volume to continue over the 2007 second half, as privately negotiated derivatives have provided liquidity and functioned efficiently through the recent market volatility," he said.

[6] Jim O'Neill, the trade deficit and ... global liquidity. Jim O'Neill, the Goldman Sachs economist, reckons that the U.S. trade position may be on the verge of a spectacular improvement, a fact that would have many consequences for investors. Already, writes O'Neill, "Chinese retail sales are contributing as much to the world as the US". Michael Pettis worries about the impact of the vanishing US surplus in terms of global liquidity conditions: "As I said in an earlier post I believe that the recycling of the US trade deficit has been the main factor underpinning the recent globalization cycle. If so, and when the current cycle ends, if history is any indication the adjustment from the insanely happy days of too much liquidity (with its attendant surge in risk appetite) to a more “normal” level of liquidity will be a very difficult one ..." Maybe. But then again, volatility indicators would probably recede, and liquidity would assume a different shape.

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