Monday, October 15, 2007

[Latest Global Dollar Liquidity measure: +14.2% annual growth rate; latest Endogenous Liquidity Index: -11.9%]

Risk management & the Great Moderation; liquidity @ Financial Times; Brad Setser on missing Chinese reserves.

[1] Liquidity @ Financial Times: Risk management & the Great Moderation. In early 2006, the Chicago Mercantile Exchange launched Snowfall Futures and Options contracts. The exchange also offers the Hurricane Event futures and options and its sister contracts: the Hurricane Seasonal futures and options and the Hurricane Seasonal Maximum futures and options [CME]. In early June, just as our Endogenous Liquidity Index was reaching new highs, Goldman Sachs even launched a CDO based on CAT bonds! Today's FT carries a front page-story on freight derivatives, which is on course to become a ... $150bn market! Ladies & gentlemen, my point is that the growing panoply of financial instruments created to price and trade risk is itself a key element of the "Great Moderation" of the business cycle — which bodes well for liquidity conditions. Sell volatility on rallies! [Jennifer Hughes: "Weather derivatives: Bonds help cushion a catastrophe", Financial Times; David Oakley: "China factor helps drive freight derivatives", Financial Times].

[2] Liquidity @ Financial Times: liquidity regulation. Karel Lannoo, CEO of the Centre for European Policy Studies (CEPS), argues against "another EU directive to regulate bank liquidity". According to Mr. Lannoo, "Liquidity is very much a relative concept, which lends itself to standards, not to tight rules. It is a function of the risk profile of a bank, which will be difficult to put down in a directive, unless it becomes an unworkable piece of regulation". [Karel Lannoo: "Tight rules not suited to liquidity", Financial Times].

[3] Liquidity @ Financial Times: a $75bn super-fund? The Master Liquidity Enhancement Conduit (MLEC), announced on Monday by Citigroup, Bank of America and JPMorgan, could be up and running within 3 months. According to FT reporters, "The plan is an attempt to address concerns about SIVs and conduits, vehicles that are often off-balance sheet but closely affiliated to banks. They typically fund themselves in the short-term asset-backed commercial paper market but purchase long-term securities". [Gillian Tett, Krishna Guha & David Wighton: "Banks agree $75bn mortgage debt fund", Financial Times].

[4] Brad Setser on Chinese reserve growth. Brad Setser detects a $45-$50bn shortfall in valuation-adjusted Chinese reserves. His hypothesis: the Chinese are beefing up their Sovereign Wealth Fund: "I would estimate that $50b was shifted to the CIC". Brad's hypothesis raises an important question for liquidity watchers: can we rely solely on quantity indicators? My own answer would be: watch market-based indicators such as credit spreads and volatility readings. Or, in this blog's terminology: pay slightly more attention to "endogenous" liquidity indicators, and slightly less attention to monetary aggregates. [Brad Setser: "Why did China only add $100b to its fx reserves in the third quarter?", RGE Monitor].

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