LIQUIDITY WATCH. HALF EMPTY OR HALF FULL?
. Federal Reserve: "Factors Affecting Reserve Balances", November 28
- Fed's Treasuries holdings: $793.8bn (+$0.9bn)
- Other central banks' Treasuries holdings: $1,225.3bn (+$2.0bn) (*)
- Other central banks' agency securities: $806.2 (+$3.7bn) (*)
- Global Dollar Liquidity Measure: $2,825.3bn (+$6.6bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
[1] Weekly Fed balance sheet watch: half empty or half full? In terms of the Global Dollar Liquidity measure, the month of November is now officially the second weakest of the year. As Peter Garnham puts it in today's FT, "the monthly increase [in Chineses foreign exchange reserves] represented the smallest rise since September 2006". Is the glass half empty, as I suggested last week? Or is it half full, as the Citigroup-ADIA and Fortis-Ping An deals indicate? In other words, is the slowing pace of foreign CBs reserve accumulation indicating growing interest in stocks and acquisitions? Or is it —rather onimously— a sign of flight-to-quality dollar-buying within emerging economies? To look for clues, quantity indicators (such as monetary aggregates) will be pretty useless here. Market-based indicators should provide the answers. See below...
[2] Market-based indicators: encouraging news — but still in a range. Our Endogenous Liquidity Index surged 8.5% over the last three trading sessions, spurred mostly by the shyness of the VIX and by improving junk bond spreads. Even more encouraging, ten year-inflation breakevens have once again fallen sharply (232 bps), suggesting the likelihood of further rate cuts from the Fed. Meanwhile, the platinum-gold ratio is holding well in the midst of the precious metals sell-off. When valued against this market-based "Goldilocks-Stagflation" indicator, a 1525 target for the S&P500 looks possible. Beyond that, caution should prevail: surging Moody's Baa spreads are telling us in no uncertain terms that corporate earnings are increasingly at risk.
Friday, November 30, 2007
Thursday, November 29, 2007
LIQUIDITY WATCH. THE EURO, CHECKS & BALANCES, AND ... THE VIX
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -31.3%]
The euro, checks & balances, and the VIX; nimble; Fortis-China deal.
[1] The euro, checks & balances and ... the VIX. Über-bears and 'stagflationists' are on record with their bleak 1970s-2000s comparisons. Having written my MA thesis on the subject of Bretton Woods, what strikes me is this key difference: the euro. In a remarkable speech on 'Globalization', Alan Greenspan said: "Should globalization be allowed to proceed and thereby create an ever more flexible international financial system, history suggests that current imbalances will be defused with little disruption. And if other currencies, such as the euro, emerge to share the dollar's role as a global reserve currency, that process, too, is likely to be benign". In today's Financial Times, Richard Laming makes a similar point: "... the reality is that no currency and no national economy are strong enough to play that role any more. Welcome to the multi-polar world". Bingo! Checks and balances, ladies and gentlemen, are always to be welcomed. That may indeed be the message of the not-so-hot VIX. [Alan Greenspan: "Globalization", Bundesbank Lecture, 2004] [Richard Laming: "Europe has already learnt the lesson of a multi-polar world", Financial Times]
[2] Nimble. In his speech at the Council on Foreign Relations, Fed governor Donald Kohn uttered the L-word eleven times. (The all-time record-holder is his colleague Frederic Mishkin, who mentioned 'liquidity' no less than thirty times in an October 2007 speech). To be honest, I feel underwhelmed. Mr. Kohn lacks the technical brilliance of Randy Kroszner, or the rhetorical skills of Kevin Warsh. People were mesmerized by one sentence at the end of the speech: "... these uncertainties require flexible and pragmatic policymaking--nimble is the adjective I used a few weeks ago". [Donald L. Kohn: "Financial Markets and Central Banking", Federal Reserve Board]
[3] Another day, another deal. It looks like Gillian Tett, the Financial Times editor, was on to something when she wrote that "Gulf investors (could) be about to ride to the rescue of the US credit markets". Exhibit A: the Citigroup-ADIA deal, with terms that "are eerly similar to those Prince Alaweed bin Talal secured when he helped Citi out in 1991" (Lex Column). Ms. Tett should have been even more inclusive. The trend also involves Chinese investors and European banks: "Shares of Ping An Insurance (Group) Co (2318.HK: Quote, Profile, Research) jumped 5.13 percent after China's No.2 life insurer said it had paid 1.81 billion euros ($2.7 billion) for a stake in Europe's Fortis (FOR.AS: Quote, Profile, Research) (FOR.BR: Quote, Profile, Research)". [Reuters: "China's Ping An Insurance jumps amid Fortis deal"]
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -31.3%]
The euro, checks & balances, and the VIX; nimble; Fortis-China deal.
[1] The euro, checks & balances and ... the VIX. Über-bears and 'stagflationists' are on record with their bleak 1970s-2000s comparisons. Having written my MA thesis on the subject of Bretton Woods, what strikes me is this key difference: the euro. In a remarkable speech on 'Globalization', Alan Greenspan said: "Should globalization be allowed to proceed and thereby create an ever more flexible international financial system, history suggests that current imbalances will be defused with little disruption. And if other currencies, such as the euro, emerge to share the dollar's role as a global reserve currency, that process, too, is likely to be benign". In today's Financial Times, Richard Laming makes a similar point: "... the reality is that no currency and no national economy are strong enough to play that role any more. Welcome to the multi-polar world". Bingo! Checks and balances, ladies and gentlemen, are always to be welcomed. That may indeed be the message of the not-so-hot VIX. [Alan Greenspan: "Globalization", Bundesbank Lecture, 2004] [Richard Laming: "Europe has already learnt the lesson of a multi-polar world", Financial Times]
[2] Nimble. In his speech at the Council on Foreign Relations, Fed governor Donald Kohn uttered the L-word eleven times. (The all-time record-holder is his colleague Frederic Mishkin, who mentioned 'liquidity' no less than thirty times in an October 2007 speech). To be honest, I feel underwhelmed. Mr. Kohn lacks the technical brilliance of Randy Kroszner, or the rhetorical skills of Kevin Warsh. People were mesmerized by one sentence at the end of the speech: "... these uncertainties require flexible and pragmatic policymaking--nimble is the adjective I used a few weeks ago". [Donald L. Kohn: "Financial Markets and Central Banking", Federal Reserve Board]
[3] Another day, another deal. It looks like Gillian Tett, the Financial Times editor, was on to something when she wrote that "Gulf investors (could) be about to ride to the rescue of the US credit markets". Exhibit A: the Citigroup-ADIA deal, with terms that "are eerly similar to those Prince Alaweed bin Talal secured when he helped Citi out in 1991" (Lex Column). Ms. Tett should have been even more inclusive. The trend also involves Chinese investors and European banks: "Shares of Ping An Insurance (Group) Co (2318.HK: Quote, Profile, Research) jumped 5.13 percent after China's No.2 life insurer said it had paid 1.81 billion euros ($2.7 billion) for a stake in Europe's Fortis (FOR.AS: Quote, Profile, Research) (FOR.BR: Quote, Profile, Research)". [Reuters: "China's Ping An Insurance jumps amid Fortis deal"]
Wednesday, November 28, 2007
LIQUIDITY WATCH. "PRICE DISCOVERY", THE NEW BUZZWORD
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -34.8%]
"Price Discovery", the new buzzword; the wisdom of Charles Plosser; Liquidity @ Financial Times.
[1] The new buzzword. "Price discovery" is the new buzzword at the Federal Reserve. This Hayekian notion is being relentlessly put forward —among others— by governor Randall Kroszner, who recently devoted an entire speech to this "process by which buyers and sellers' preferences, as well as any other available market information, results in the 'discovery' of a price that will balance supply and demand and provide signals to market participants about how most efficiently to allocate resources". The lack of price discovery is the price participants are paying for the new, securitization-driven financial system with highly dispersed credit risk. [Randall Kroszner: "Risk Management and the Economic Outlook"; "Recent Events in Financial Markets", Federal Reserve Board]
[2] The wisdom of Charles Plosser (I). Unsurprisingly, the Philly Fed president and CEO takes up the issue of ... price discovery. Plosser is even more explicit: "This price discovery process is still underway, and it is likely to be some time before it is completely sorted out. It is important to recognize that the Federal Reserve cannot resolve this price discovery problem. The markets will have to figure this out. Arbitrarily lowering interest rates or providing liquidity to the market does not provide the answers the market seeks. Indeed, in some circumstances, lowering interest rates may prolong the painful process of price discovery" (italics mine). There you have it. Markets will have to figure it out!
[3] The wisdom of Charles Plosser (II). Mr. Plosser's speech has been characterized as highly "hawkish". I beg to disagree. While he repeatedly stated that the Fed "must resist the temptation to respond to short-term, transitory disturbances" by "arbitrarily lowering interest rates" (on inflation expectations/moral hazard grounds), he also outlined his criteria for setting the Fed funds target. An exceedingly high target would result in the creation of "too little liquidity, leading to ... too little inflation or perhaps even deflation". Further, Mr. Plosser states that "is important to appreciate the fact that slow-growing economies exhibit real, or inflation-adjusted, interest rates that are somewhat lower than those of fast-growing economies". In other words, he appears to have the yield curve in mind. With the ten-year note yield 50 bps below the Fed funds rate target, there is clearly a case for more rate cuts from the central bank. [Charles I. Plosser: "Economic Outlook and Central Bank Policy", Federal Reserve Bank of Philadelphia]
[4] Liquidity @ Financial Times: Martin Wolf, monday morning quarterback? Martin Wolf describes modern banking as "an accident waiting to happen". The banking system, in his view, is dangeroulsy subsidized, prone to excessive risk-taking, etc. Bad, very bad! A strong whiff of monday-morning-quarterbacking lingers over this piece. If I remember correctly, Mr. Wolf used to describe the recent period of world economic growth as a "New Golden Age". Time to recall Schumpeter's words: "Stabilized capitalism is a contradiction in terms ... The history of capitalism is studded with violent bursts and catastrophes. It is no gentle process of adjustment but something more like a series of explosions". [Martin Wolf: "Why banking remains an accident waiting to happen", Financial Times] [Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007; web page; prologue; interview; podcast]
[5] Liquidity @ Financial Times: Illiquidity or insolvency? Max Keiser, founder of Karma Banque, says that banks engaged in a "global Ponzi scheme backed by what we now know to be largely counterfeit mortgage paper". He concludes: "Therefore it is insolvency along with its corollaries – opacity, misleading statements, dishonesty and larceny – that constitute the problem and illiquidity that is its symptom". [Max Keiser: "Problem with banks was insolvency", Financial Times]
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -34.8%]
"Price Discovery", the new buzzword; the wisdom of Charles Plosser; Liquidity @ Financial Times.
[1] The new buzzword. "Price discovery" is the new buzzword at the Federal Reserve. This Hayekian notion is being relentlessly put forward —among others— by governor Randall Kroszner, who recently devoted an entire speech to this "process by which buyers and sellers' preferences, as well as any other available market information, results in the 'discovery' of a price that will balance supply and demand and provide signals to market participants about how most efficiently to allocate resources". The lack of price discovery is the price participants are paying for the new, securitization-driven financial system with highly dispersed credit risk. [Randall Kroszner: "Risk Management and the Economic Outlook"; "Recent Events in Financial Markets", Federal Reserve Board]
[2] The wisdom of Charles Plosser (I). Unsurprisingly, the Philly Fed president and CEO takes up the issue of ... price discovery. Plosser is even more explicit: "This price discovery process is still underway, and it is likely to be some time before it is completely sorted out. It is important to recognize that the Federal Reserve cannot resolve this price discovery problem. The markets will have to figure this out. Arbitrarily lowering interest rates or providing liquidity to the market does not provide the answers the market seeks. Indeed, in some circumstances, lowering interest rates may prolong the painful process of price discovery" (italics mine). There you have it. Markets will have to figure it out!
[3] The wisdom of Charles Plosser (II). Mr. Plosser's speech has been characterized as highly "hawkish". I beg to disagree. While he repeatedly stated that the Fed "must resist the temptation to respond to short-term, transitory disturbances" by "arbitrarily lowering interest rates" (on inflation expectations/moral hazard grounds), he also outlined his criteria for setting the Fed funds target. An exceedingly high target would result in the creation of "too little liquidity, leading to ... too little inflation or perhaps even deflation". Further, Mr. Plosser states that "is important to appreciate the fact that slow-growing economies exhibit real, or inflation-adjusted, interest rates that are somewhat lower than those of fast-growing economies". In other words, he appears to have the yield curve in mind. With the ten-year note yield 50 bps below the Fed funds rate target, there is clearly a case for more rate cuts from the central bank. [Charles I. Plosser: "Economic Outlook and Central Bank Policy", Federal Reserve Bank of Philadelphia]
[4] Liquidity @ Financial Times: Martin Wolf, monday morning quarterback? Martin Wolf describes modern banking as "an accident waiting to happen". The banking system, in his view, is dangeroulsy subsidized, prone to excessive risk-taking, etc. Bad, very bad! A strong whiff of monday-morning-quarterbacking lingers over this piece. If I remember correctly, Mr. Wolf used to describe the recent period of world economic growth as a "New Golden Age". Time to recall Schumpeter's words: "Stabilized capitalism is a contradiction in terms ... The history of capitalism is studded with violent bursts and catastrophes. It is no gentle process of adjustment but something more like a series of explosions". [Martin Wolf: "Why banking remains an accident waiting to happen", Financial Times] [Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007; web page; prologue; interview; podcast]
[5] Liquidity @ Financial Times: Illiquidity or insolvency? Max Keiser, founder of Karma Banque, says that banks engaged in a "global Ponzi scheme backed by what we now know to be largely counterfeit mortgage paper". He concludes: "Therefore it is insolvency along with its corollaries – opacity, misleading statements, dishonesty and larceny – that constitute the problem and illiquidity that is its symptom". [Max Keiser: "Problem with banks was insolvency", Financial Times]
Tuesday, November 27, 2007
LIQUIDITY WATCH. IT'S AUGUST DÉJÀ VU!
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -36.5%]
It's August déjà vu; New York Fed statement; Liquidity @ Financial Times; Smart money & the VIX.
[1] It's August déjà vu. So says Morgan Stanley's Richard Berner in an insightful piece: "Fed officials again confront deteriorating credit markets, dwindling money-market liquidity and consequent downside risks to US economic growth, possibly requiring them to ease by more than the 25 bp we currently expect. The pressures are also evident in offshore markets, and represent a challenge for other central banks". From the perspective of our Endogenous Liquidity Index, I coudn't agree more: it has now reached a new low, just below that of August 16. While CDS spreads and cash bond spreads best reflect the panic, the VIX appears to have woken from its slumber. As Mr. Berner puts it: "Unlike the past, when financial markets could cushion the banks or vice-versa, this time they are deleveraging and shrinking together, representing a constraint on the supply of credit". Now, keep in mind that the August sell-off led to a spectacular recovery. Will the news of the Citigroup-Abu Dhabi link-up be the catalyst for the rebound? That's certainly the bet in the futures markets this morning. [Richard Berner: "Testing Time for the Fed", Morgan Stanley GEF] [Dan Wilchins: "Citi to sell $7.5 bln stake to Abu Dhabi group", Reuters]
[2] New York Fed statement on pressures in money markets. The New York Fed issued a statement regarding the turmoil in the money markets, where rates trade slightly above the Fed funds target: "In response to heightened pressures in money markets for funding through the year-end, the Federal Reserve Bank of New York’s Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year. The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion ... In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC’s target rate around year-end". [Michael Mackenzie & Saskia Scholtes: "Banks quiver as Fed shoots wide of target", Financial Times]
[3] Liquidity @ Financial Times: the euro as an international reserve currency? Simon Tilford, chief economist at the Center for European Reform, disects the pros and cons of the euro as an international reserve currency. The chief benefit, undoubtedly, comes from the opportunities afforded by seigniorage: "As is the case at present in the US, the eurozone would benefit from what are in effect very low interest loans in the form of large central bank holdings of euros. Also, the growth of international trade would boost demand for euros, with the result that the eurozone could cheaply finance an external deficit, much as the US has been doing for decades". But the downsides, writes Mr. Tilford, are even greater. Read the whole thing. (By the way, this precisely what I told students at the University of Leiden, when I helped Prof. Hosli teach a course on European Monetary Union). [Simon Tilford: "Could the euro rule supreme? It’s not worth it", Financial Times]
[4] Smart Money & the VIX. Bill Luby writes an interesting post on the topic of "smart money and the VIX". Quoting Bernie Schaeffer's “Monday Morning Outlook”, which he describes as "generally an excellent perspective for any trader to contemplate going into the trading week", Bill concludes that "the VIX is the footprints of the smart money". Hey, that's precisely why it features so prominently in our Endogenous Liquidity Index! [Bill Luby: "Smart Money and the VIX", VIX and More]
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -36.5%]
It's August déjà vu; New York Fed statement; Liquidity @ Financial Times; Smart money & the VIX.
[1] It's August déjà vu. So says Morgan Stanley's Richard Berner in an insightful piece: "Fed officials again confront deteriorating credit markets, dwindling money-market liquidity and consequent downside risks to US economic growth, possibly requiring them to ease by more than the 25 bp we currently expect. The pressures are also evident in offshore markets, and represent a challenge for other central banks". From the perspective of our Endogenous Liquidity Index, I coudn't agree more: it has now reached a new low, just below that of August 16. While CDS spreads and cash bond spreads best reflect the panic, the VIX appears to have woken from its slumber. As Mr. Berner puts it: "Unlike the past, when financial markets could cushion the banks or vice-versa, this time they are deleveraging and shrinking together, representing a constraint on the supply of credit". Now, keep in mind that the August sell-off led to a spectacular recovery. Will the news of the Citigroup-Abu Dhabi link-up be the catalyst for the rebound? That's certainly the bet in the futures markets this morning. [Richard Berner: "Testing Time for the Fed", Morgan Stanley GEF] [Dan Wilchins: "Citi to sell $7.5 bln stake to Abu Dhabi group", Reuters]
[2] New York Fed statement on pressures in money markets. The New York Fed issued a statement regarding the turmoil in the money markets, where rates trade slightly above the Fed funds target: "In response to heightened pressures in money markets for funding through the year-end, the Federal Reserve Bank of New York’s Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year. The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion ... In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC’s target rate around year-end". [Michael Mackenzie & Saskia Scholtes: "Banks quiver as Fed shoots wide of target", Financial Times]
[3] Liquidity @ Financial Times: the euro as an international reserve currency? Simon Tilford, chief economist at the Center for European Reform, disects the pros and cons of the euro as an international reserve currency. The chief benefit, undoubtedly, comes from the opportunities afforded by seigniorage: "As is the case at present in the US, the eurozone would benefit from what are in effect very low interest loans in the form of large central bank holdings of euros. Also, the growth of international trade would boost demand for euros, with the result that the eurozone could cheaply finance an external deficit, much as the US has been doing for decades". But the downsides, writes Mr. Tilford, are even greater. Read the whole thing. (By the way, this precisely what I told students at the University of Leiden, when I helped Prof. Hosli teach a course on European Monetary Union). [Simon Tilford: "Could the euro rule supreme? It’s not worth it", Financial Times]
[4] Smart Money & the VIX. Bill Luby writes an interesting post on the topic of "smart money and the VIX". Quoting Bernie Schaeffer's “Monday Morning Outlook”, which he describes as "generally an excellent perspective for any trader to contemplate going into the trading week", Bill concludes that "the VIX is the footprints of the smart money". Hey, that's precisely why it features so prominently in our Endogenous Liquidity Index! [Bill Luby: "Smart Money and the VIX", VIX and More]
Monday, November 26, 2007
LIQUIDITY WATCH. LATE FOR THE RENDEZ-VOUS?
. Federal Reserve: "Factors Affecting Reserve Balances", November 21
- Fed's Treasuries holdings: $792.6bn (+$5.2bn)
- Other central banks' Treasuries holdings: $1,223.3bn (-$11.2bn) (*)
- Other central banks' agency securities: $802.5 (+$8.2bn) (*)
- Global Dollar Liquidity Measure: $2,818.6bn (+$2.2bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
Will funding liquidity come to the rescue of market liquidity? Our Endogenous Liquidity Index managed to post a solid 2.4% gain on Friday thanks to both falling CDS spreads and to the rather lame VIX. Yet, the index is still perilously close to its August 16 low. Bulls hope that funding or macroeconomic liquidity will come to its rescue. But November has failed to deliver on that front. The weekly Fed balance sheet shows a meagre $2.2bn gain in our Global Dollar Liquidity measure, as Treasuries sales by foreign CBs are partly compensated by agency securities purchases. All in all, the increase leaves much to be desired, because the volume of repos continues to surge — which only serves to highlight the sense of fragility in money markets. The bottom line is: funding liquidity is failing to rescue its wounded cousin, a.k.a. market liquidity.
. Federal Reserve: "Factors Affecting Reserve Balances", November 21
- Fed's Treasuries holdings: $792.6bn (+$5.2bn)
- Other central banks' Treasuries holdings: $1,223.3bn (-$11.2bn) (*)
- Other central banks' agency securities: $802.5 (+$8.2bn) (*)
- Global Dollar Liquidity Measure: $2,818.6bn (+$2.2bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
Will funding liquidity come to the rescue of market liquidity? Our Endogenous Liquidity Index managed to post a solid 2.4% gain on Friday thanks to both falling CDS spreads and to the rather lame VIX. Yet, the index is still perilously close to its August 16 low. Bulls hope that funding or macroeconomic liquidity will come to its rescue. But November has failed to deliver on that front. The weekly Fed balance sheet shows a meagre $2.2bn gain in our Global Dollar Liquidity measure, as Treasuries sales by foreign CBs are partly compensated by agency securities purchases. All in all, the increase leaves much to be desired, because the volume of repos continues to surge — which only serves to highlight the sense of fragility in money markets. The bottom line is: funding liquidity is failing to rescue its wounded cousin, a.k.a. market liquidity.
Friday, November 23, 2007
LIQUIDITY WATCH. THE DOLLAR GRABS THE HEADLINES
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -35.2%]
Liquidity @ Financial Times; good point by Brad Setser.
[1] Liquidity @ Financial Times. (a) The US dollar, according to economist David Hale, has both a flow and a stock problem: the US would like to keep its reserve currency status intact, yet it calls for a "significant revaluation of the Chinese currency in spite of its role in funding the US budget deficit"; (b) Ralph Atkins quotes former German finance minister Hans Eichel: "The euro could become a reserve currency with equal status to the dollar". But the now the chickens have come home to roost, and many in Europe appear to entertain second thoughts about their ambitions for the euro. This is certainly not the case of former Bundesbank economist Ottmar Issing: "As a central bank, the currency is your baby. And if it is so widely appreciated, it is an expression of credibility and trust in the future stability of the currency". Between early 2002 and the second quarter of 2007, the euro's share of foreign exchange reserves rose from 19.7% to 25.6%, according to IMF data. [David Hale: "Where the dollar’s decline is taking the world", Financial Times][Ralph Atkins: "Dollar safe from challenge of the euro", Financial Times]
[2] Liquidity @ Financial Times. (c) The dollar is killing us! The FT's leading headline, another dollar-related story, features this comment by Tom Enders, CEO of Airbus: "The dollar has passed the pain barrier. This is life-threatening. We need to question our business model. This is no longer sustainable"; (d) Gillian Tett revisits a well-known dichotomy: while liquidity is booming in parts of the world (read: petrodollars), it is all but collapsing in Western financial markets. (Funding v. market liquidity, anyone?). Her conclusion: "... it is one thing to expect Gulf investors to grab the odd chunk of a bank; it is quite another to hope they will bail out, say, the corporate leveraged market or subprime world. And that second scenario, I suspect, is still a dream too far. So, for the moment, we are doomed to remain in a schizophrenic financial world - where cash gluts co-exist with liquidity droughts".
[Peggy Hollinger: "Low dollar ‘threatens the life’ of Airbus", Financial Times] [Gillian Tett: "Gulf liquidity offers glimmer of hope", Financial Times]
[3] Brad Setser: Good point! Brad Setser analyzes the rencent statement on the dollar by Chinese premier Wen Jiabao: "I have a feeling that the current (unrealized) mark-to-market losses on China's investment in Blackstone drew attention to the broader financial risks that China is taking by holding so many foreign assets". Excellent point! [Brad Setser: "A little too late", RGE]
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -35.2%]
Liquidity @ Financial Times; good point by Brad Setser.
[1] Liquidity @ Financial Times. (a) The US dollar, according to economist David Hale, has both a flow and a stock problem: the US would like to keep its reserve currency status intact, yet it calls for a "significant revaluation of the Chinese currency in spite of its role in funding the US budget deficit"; (b) Ralph Atkins quotes former German finance minister Hans Eichel: "The euro could become a reserve currency with equal status to the dollar". But the now the chickens have come home to roost, and many in Europe appear to entertain second thoughts about their ambitions for the euro. This is certainly not the case of former Bundesbank economist Ottmar Issing: "As a central bank, the currency is your baby. And if it is so widely appreciated, it is an expression of credibility and trust in the future stability of the currency". Between early 2002 and the second quarter of 2007, the euro's share of foreign exchange reserves rose from 19.7% to 25.6%, according to IMF data. [David Hale: "Where the dollar’s decline is taking the world", Financial Times][Ralph Atkins: "Dollar safe from challenge of the euro", Financial Times]
[2] Liquidity @ Financial Times. (c) The dollar is killing us! The FT's leading headline, another dollar-related story, features this comment by Tom Enders, CEO of Airbus: "The dollar has passed the pain barrier. This is life-threatening. We need to question our business model. This is no longer sustainable"; (d) Gillian Tett revisits a well-known dichotomy: while liquidity is booming in parts of the world (read: petrodollars), it is all but collapsing in Western financial markets. (Funding v. market liquidity, anyone?). Her conclusion: "... it is one thing to expect Gulf investors to grab the odd chunk of a bank; it is quite another to hope they will bail out, say, the corporate leveraged market or subprime world. And that second scenario, I suspect, is still a dream too far. So, for the moment, we are doomed to remain in a schizophrenic financial world - where cash gluts co-exist with liquidity droughts".
[Peggy Hollinger: "Low dollar ‘threatens the life’ of Airbus", Financial Times] [Gillian Tett: "Gulf liquidity offers glimmer of hope", Financial Times]
[3] Brad Setser: Good point! Brad Setser analyzes the rencent statement on the dollar by Chinese premier Wen Jiabao: "I have a feeling that the current (unrealized) mark-to-market losses on China's investment in Blackstone drew attention to the broader financial risks that China is taking by holding so many foreign assets". Excellent point! [Brad Setser: "A little too late", RGE]
Wednesday, November 21, 2007
LIQUIDITY WATCH. Mr. HOENIG & THE CHALLENGE OF LIQUIDITY
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.7%]
Mr. Hoenig & the challenge of liquidity; the People's Bank of China & the ECB; booming Islamic finance.
[1] Mr. Hoenig & liquidity. Thomas M. Hoenig, the President and CEO of the Federal Reserve of Bank of Kansas City, was the lone dissenter at the October 30-31 meeting, when the FOMC voted to lower the target for the Fed funds rate by 25 bps to 4.5%. Yet, an interesting and overlooked piece of information emerges from the minutes: "He also recognized that liquidity remains a near-term challenge and that the Federal Reserve would be prepared to act if needed". This is where things get interesting. In a recent speech delivered in Sydney, Mr. Hoenig reveals himselft as a keen watcher of liquidity trends. To understand what is going on, he suggests, one needs to think within the framework of the (relatively) new "market-centered" financial system. In this context, it is not clear that the mere provision of liquidity to banks will solve all the problems, as was the case in the older "bank-centered" financial system.
"As a case in point", he adds, "the Federal Reserve's Discount window facility was not used as much as we might have liked in the recent crisis". In other words: policy-makers lack the appropiate knowledge about liquidity crisis in the new financial system — they will need to "focus more attention on research into the microstructure of financial markets to understand why liquidity crisis develop and why markets seize up in times of crisis". Very interesting, but where does that leave us in terms of Mr. Hoenig's vote at the next FOMC meeting? The following sentence says it all: "Until we have this understanding, we will be forced to deal with these pressures indirectly via the banking system" (italics mine). In other words: as market liquidity deteriorates even further, look for an unanimous vote at the next formal or informal FOMC meeting. [FOMC Minutes] [Thomas M. Hoenig: "Maintaining Stability in a Challenging Financial System: Some Lessons Relearned Again?", Kansas City Fed]
[2] The People's Bank of China & the ECB: diverging paths? According to Bank Credit Analyst, Chinese authorities will soon focus on the need to raise short term interest rates, rather than tightening reserve requirements: "Bank lending does not appear to be excessive and the root cause of China’s liquidity overflow is the massive accumulation of foreign reserves. In fact, the country’s low interest rates and ultra-weak currency are serious economic distortions. The risk of economic overheating will continue to build if China’s hyper-stimulative monetary environment is not reversed in a more timely manner". In a separate note, the Canadian consultants warn about excessively tight financial conditions in the eurozone: "the ECB might formally cut rates". [BCA Research: "China: More Tightening Needed"] [BCA Research: "The ECB Can’t Get Any Tighter"]
[3] Booming Islamic liquidity [Liquidity @ Financial Times]. Another day, another sukuk issuance. See the advertisement on page 17 of yesterday's Financial Times. JP Morgan is the sole bookrunner of a Sukuk structure with a forward setting exchange price. The amount: $1bn. The issuer: Dana Gas. The meaning: more diversity into the financial world — a bullish sign.
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.7%]
Mr. Hoenig & the challenge of liquidity; the People's Bank of China & the ECB; booming Islamic finance.
[1] Mr. Hoenig & liquidity. Thomas M. Hoenig, the President and CEO of the Federal Reserve of Bank of Kansas City, was the lone dissenter at the October 30-31 meeting, when the FOMC voted to lower the target for the Fed funds rate by 25 bps to 4.5%. Yet, an interesting and overlooked piece of information emerges from the minutes: "He also recognized that liquidity remains a near-term challenge and that the Federal Reserve would be prepared to act if needed". This is where things get interesting. In a recent speech delivered in Sydney, Mr. Hoenig reveals himselft as a keen watcher of liquidity trends. To understand what is going on, he suggests, one needs to think within the framework of the (relatively) new "market-centered" financial system. In this context, it is not clear that the mere provision of liquidity to banks will solve all the problems, as was the case in the older "bank-centered" financial system.
"As a case in point", he adds, "the Federal Reserve's Discount window facility was not used as much as we might have liked in the recent crisis". In other words: policy-makers lack the appropiate knowledge about liquidity crisis in the new financial system — they will need to "focus more attention on research into the microstructure of financial markets to understand why liquidity crisis develop and why markets seize up in times of crisis". Very interesting, but where does that leave us in terms of Mr. Hoenig's vote at the next FOMC meeting? The following sentence says it all: "Until we have this understanding, we will be forced to deal with these pressures indirectly via the banking system" (italics mine). In other words: as market liquidity deteriorates even further, look for an unanimous vote at the next formal or informal FOMC meeting. [FOMC Minutes] [Thomas M. Hoenig: "Maintaining Stability in a Challenging Financial System: Some Lessons Relearned Again?", Kansas City Fed]
[2] The People's Bank of China & the ECB: diverging paths? According to Bank Credit Analyst, Chinese authorities will soon focus on the need to raise short term interest rates, rather than tightening reserve requirements: "Bank lending does not appear to be excessive and the root cause of China’s liquidity overflow is the massive accumulation of foreign reserves. In fact, the country’s low interest rates and ultra-weak currency are serious economic distortions. The risk of economic overheating will continue to build if China’s hyper-stimulative monetary environment is not reversed in a more timely manner". In a separate note, the Canadian consultants warn about excessively tight financial conditions in the eurozone: "the ECB might formally cut rates". [BCA Research: "China: More Tightening Needed"] [BCA Research: "The ECB Can’t Get Any Tighter"]
[3] Booming Islamic liquidity [Liquidity @ Financial Times]. Another day, another sukuk issuance. See the advertisement on page 17 of yesterday's Financial Times. JP Morgan is the sole bookrunner of a Sukuk structure with a forward setting exchange price. The amount: $1bn. The issuer: Dana Gas. The meaning: more diversity into the financial world — a bullish sign.
Tuesday, November 20, 2007
LIQUIDITY WATCH. THE DOLLAR & ... THE VIX
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.2%]
The dollar and ... the VIX; more stagflation talk.
[1] The dollar & the VIX. The euro is, in all likelihood, headed towards its $1.50/1.52 target. Talk shows and newspapers are full of stories about an impending US recession, a global financial crash, a major financial institution going under, and so on. Yet the VIX, which only managed to register a 2% gain, will likely come under pressure today. Am I missing something here? Ladies & gentlemen: I am now officially embracing the Benign Global Adjustment Theory (BGAT). This is how Morgan Stanley's Stephen Jen puts it: "What is happening to the global economy is quite healthy. The US household savings rate is likely to recover sharply over the near year, as housing wealth is eroded. We are witnessing the necessary and sufficient ingredients for global rebalancing, which should not elicit confusion or fear".
Earlier this month, in a Financial Times piece on the "silver lining in America's subprime cloud", George Schultz and John Taylor summarized the "three-pronged" strategy underlying the adjustment process: "reducing the US budget deficit to decrease government dissaving, raising economic growth abroad relative to the US in order to stimulate US exports and increasing the flexibility of exchange rates, especially in China, to facilitate the adjustment". An earlier version of the benign adjustment theory had been expressed by Alan Greenspan: "Should globalization be allowed to proceed and thereby create an ever more flexible international financial system, history suggests that current imbalances will be defused with little disruption. And if other currencies, such as the euro, emerge to share the dollar's role as a global reserve currency, that process, too, is likely to be benign".
This is not the 1970s redux. There's Chindia. There are alternatives to the dollar. And the world is embracing capitalism: Africa is rapidly becoming the new frontier — and even North Korea is developping a "fledging merchant class". [Stephen Jen: "The Undervalued Dollar To Keep Weakening", GEM] George Shultz & John Taylor: "The silver lining in America’s subprime cloud", Financial Times] [Alan Greenspan: "Bundesbank Lecture 2004"]
[2] More stagflation talk [Liquidity @ Financial Times]. More ruminations on the stagflation scenario. Here's Paul Ashworth of Capital Economics: "... the price of petrol at the pumps has already risen past $3 a gallon; if crude prices remain near $100 a barrel, it could reach $3.60 before too long ... The resulting squeeze on real incomes couldn't have come at a worse time, with the credit crunch, the downturn in housing and a softening labour market all pointing to slowing consumption growth". This is something we monitor on a daily basis at the Global Liquidity Blog. Our market-based "Goldilocks-Stagflation" indicator improved further yesterday, led by a higher platinum-gold ratio. ["View of the Day - Paul Ashworth, Capital Economics", Financial Times]
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.2%]
The dollar and ... the VIX; more stagflation talk.
[1] The dollar & the VIX. The euro is, in all likelihood, headed towards its $1.50/1.52 target. Talk shows and newspapers are full of stories about an impending US recession, a global financial crash, a major financial institution going under, and so on. Yet the VIX, which only managed to register a 2% gain, will likely come under pressure today. Am I missing something here? Ladies & gentlemen: I am now officially embracing the Benign Global Adjustment Theory (BGAT). This is how Morgan Stanley's Stephen Jen puts it: "What is happening to the global economy is quite healthy. The US household savings rate is likely to recover sharply over the near year, as housing wealth is eroded. We are witnessing the necessary and sufficient ingredients for global rebalancing, which should not elicit confusion or fear".
Earlier this month, in a Financial Times piece on the "silver lining in America's subprime cloud", George Schultz and John Taylor summarized the "three-pronged" strategy underlying the adjustment process: "reducing the US budget deficit to decrease government dissaving, raising economic growth abroad relative to the US in order to stimulate US exports and increasing the flexibility of exchange rates, especially in China, to facilitate the adjustment". An earlier version of the benign adjustment theory had been expressed by Alan Greenspan: "Should globalization be allowed to proceed and thereby create an ever more flexible international financial system, history suggests that current imbalances will be defused with little disruption. And if other currencies, such as the euro, emerge to share the dollar's role as a global reserve currency, that process, too, is likely to be benign".
This is not the 1970s redux. There's Chindia. There are alternatives to the dollar. And the world is embracing capitalism: Africa is rapidly becoming the new frontier — and even North Korea is developping a "fledging merchant class". [Stephen Jen: "The Undervalued Dollar To Keep Weakening", GEM] George Shultz & John Taylor: "The silver lining in America’s subprime cloud", Financial Times] [Alan Greenspan: "Bundesbank Lecture 2004"]
[2] More stagflation talk [Liquidity @ Financial Times]. More ruminations on the stagflation scenario. Here's Paul Ashworth of Capital Economics: "... the price of petrol at the pumps has already risen past $3 a gallon; if crude prices remain near $100 a barrel, it could reach $3.60 before too long ... The resulting squeeze on real incomes couldn't have come at a worse time, with the credit crunch, the downturn in housing and a softening labour market all pointing to slowing consumption growth". This is something we monitor on a daily basis at the Global Liquidity Blog. Our market-based "Goldilocks-Stagflation" indicator improved further yesterday, led by a higher platinum-gold ratio. ["View of the Day - Paul Ashworth, Capital Economics", Financial Times]
Monday, November 19, 2007
LIQUIDITY WATCH. LOOKING BETTER
. Federal Reserve: "Factors Affecting Reserve Balances", November 14
- Fed's Treasuries holdings: $787.7bn (+$2.6bn)
- Other central banks' Treasuries holdings: $1,234.5bn (-$2.7bn) (*)
- Other central banks' agency securities: $794.3 (-$1.1bn) (*)
- Global Dollar Liquidity Measure: $2,8164n (-$1.3bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
[1] Looking better. Is Goldilocks fighting back? That's certainly the message from our market-based Goldilocks-Stagflation indicator (which seems to yield interesting signals in times of financial stress). The recent sell-off in the gold and oil markets has created a better tone for risky assets. The platinum-gold ratio is back at 1.85, a two-week high, and ten-year inflation breakevens also trade at around two-week lows (236 bps). All in all, and provided that the dollar keeps its composure, a 1525 print for the S&P500 now looks like a distinct possibility.
[2] Weekly Fed balance sheet watch. The second weekly Fed balance sheet for the month of November is out — with very little in the way of news. Our Global Dollar Liquidity measure sheds $1.3bn as foreign CBs sales narrowly outweight the Fed's own repo operations. The annual rate of growth stands unchanged at 14.1%, thus portraying a solid, if not booming, state of affairs in the global economy.
[3] Liquidity puts? Peter Cohan defines liquidity puts as "the right of Collateralized Debt Obligation (CDO) holders to sell back the CDO to its issuer at the original price". And he adds: "The liquidity put is responsible for the $25 billion worth of CDOs on Citi's balance sheet" [HT: Portfolio.com].
[4] Liquidity & Business turnrounds [Liquidity @ Financial Times]. Fascinating article on the interplay between global liquidity conditions and the market for corporate restructuring. On the one hand, easy access to liquidity and innovative debt instruments have encouraged greater flexibility in restructuring. On the other hand, balance sheets have become much more complicated. Credit Default Swaps holders have introduced a set of new players to the game. Overall, restructuring experts are cautiously optimistic here: the lack of "big international failures" appears to support the view that credit risk is indeed widely dispersed. [John Willman: "Challenges ahead as funding dries up", Financial Times]
[5] U.S. Deflation ahead? Don't rule out the possibility, says Canadian consultants Bank Credit Analyst. Not surprisingly, they expect more rate cuts from the Federal Reserve. [BCA Research: "U.S. Inflation …. Or Deflation?"]
[6] Synthetic CDO market alive & well. Newspapers are awash with news on the liquidity crisis and the credit crunch. Now take a look at this: "ING Investment Management is marketing a synthetic collateralized debt obligation with UBS. ING will manage the USD1.3 billion dollar corporate-backed CDO, which is a big step up from the manager’s previous synthetic offerings issued this year that were USD140 million and USD280 million respectively ... The latest deal, called ING Managed Synthetic 2007-3, is a plan vanilla structure, according to an investor who has seen the deal. The investor added that the structured credit group at UBS has made strides in the past year in winning mandates from strong managers making early forays into synthetic". [Daily Institutional Investor: "ING Markets Big Managed Synthetic"]
. Federal Reserve: "Factors Affecting Reserve Balances", November 14
- Fed's Treasuries holdings: $787.7bn (+$2.6bn)
- Other central banks' Treasuries holdings: $1,234.5bn (-$2.7bn) (*)
- Other central banks' agency securities: $794.3 (-$1.1bn) (*)
- Global Dollar Liquidity Measure: $2,8164n (-$1.3bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
[1] Looking better. Is Goldilocks fighting back? That's certainly the message from our market-based Goldilocks-Stagflation indicator (which seems to yield interesting signals in times of financial stress). The recent sell-off in the gold and oil markets has created a better tone for risky assets. The platinum-gold ratio is back at 1.85, a two-week high, and ten-year inflation breakevens also trade at around two-week lows (236 bps). All in all, and provided that the dollar keeps its composure, a 1525 print for the S&P500 now looks like a distinct possibility.
[2] Weekly Fed balance sheet watch. The second weekly Fed balance sheet for the month of November is out — with very little in the way of news. Our Global Dollar Liquidity measure sheds $1.3bn as foreign CBs sales narrowly outweight the Fed's own repo operations. The annual rate of growth stands unchanged at 14.1%, thus portraying a solid, if not booming, state of affairs in the global economy.
[3] Liquidity puts? Peter Cohan defines liquidity puts as "the right of Collateralized Debt Obligation (CDO) holders to sell back the CDO to its issuer at the original price". And he adds: "The liquidity put is responsible for the $25 billion worth of CDOs on Citi's balance sheet" [HT: Portfolio.com].
[4] Liquidity & Business turnrounds [Liquidity @ Financial Times]. Fascinating article on the interplay between global liquidity conditions and the market for corporate restructuring. On the one hand, easy access to liquidity and innovative debt instruments have encouraged greater flexibility in restructuring. On the other hand, balance sheets have become much more complicated. Credit Default Swaps holders have introduced a set of new players to the game. Overall, restructuring experts are cautiously optimistic here: the lack of "big international failures" appears to support the view that credit risk is indeed widely dispersed. [John Willman: "Challenges ahead as funding dries up", Financial Times]
[5] U.S. Deflation ahead? Don't rule out the possibility, says Canadian consultants Bank Credit Analyst. Not surprisingly, they expect more rate cuts from the Federal Reserve. [BCA Research: "U.S. Inflation …. Or Deflation?"]
[6] Synthetic CDO market alive & well. Newspapers are awash with news on the liquidity crisis and the credit crunch. Now take a look at this: "ING Investment Management is marketing a synthetic collateralized debt obligation with UBS. ING will manage the USD1.3 billion dollar corporate-backed CDO, which is a big step up from the manager’s previous synthetic offerings issued this year that were USD140 million and USD280 million respectively ... The latest deal, called ING Managed Synthetic 2007-3, is a plan vanilla structure, according to an investor who has seen the deal. The investor added that the structured credit group at UBS has made strides in the past year in winning mandates from strong managers making early forays into synthetic". [Daily Institutional Investor: "ING Markets Big Managed Synthetic"]
Friday, November 16, 2007
GLOBAL LIQUIDITY WATCH
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -30.6%]
- Endogenous Liquidity Watch. Another punishing session yesterday, as volatility measures, bond spreads and CDS spreads again closed sharply up. The Moody's Baa spread, in particular, trades at a new record for the year (218 bps). In all likelyhood, my trusted long-term model for risky assets will flash a sell signal for the fourth month in a row. On a slightly more encouraging note, the platinum-gold ratio is again trading above 1.80, while 10-year inflation breakevens are stabilizing around 240 bps. On the basis of that "Goldilocks-Stagflation" indicator, the S&P500 appears to be fairly valued at 1450.
- Liquidity @ Financial Times. [1] Renewed stress on interbank lending: Two-month sterling at a two-month high; overnight dollar libor up; Barclays unveils a £1.3bn writedown (Dave Shellock: "Mixed data and tight liquidity"). [2] Mark-to-market & subprime losses: the current crisis compared with other episodes (Gillian Tett: "Fog and fear obscure the reality behind subprime losses"). [3] The United Arab Emirates & the dollar peg: increased speculation that the UAE favor a move to drop the dollar peg and track a basket of currencies instead. Bring it on! (Peter Garnham: "Gulf states’ dollar peg comes under threat"). [4] Citigroups' funding woes: "In a further sign of falling confidence in the bank, it now costs more to insure its bonds against default in credit derivatives than it does for emerging market countries such as Mexico and Malaysia" (David Oakley: "Citigroup’s lending charges shoot up"). [5] China & US: China warns exporters could be 'devastated' by US slowdown. "China's central bank estimates that every 1 per cent drop in US economic growth translates into a 6 per cent fall in Chinese exports" (Jamil Anderlini: "China warns exporters 'could be devastated' by US slowdown").
- ECB Monthly Bulletin: not a pretty picture. [1] Growth v. inflation dynamics: "On balance, risks to the outlook for growth are judged to lie on the downside ... Risks to the medium-term outlook for price developments are fully confirmed to lie on the upside". Not good! [2] Financial volatility: "... in view of the potential impact of prolonged financial market volatility and the re-pricing of risk on the real economy, the level of uncertainty remains high"; [3] Monetary growth: influenced by "temporary or special factors" (read: flight-to-quality buying of euro-denominated money market funds, mostly from the eurozone's periphery), but still too strong for comfort. [Editorial] [full text pdf] [Ralph Atkins: "Rapid food price rises fuel inflation fears, ECB warns", Financial Times].
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -30.6%]
- Endogenous Liquidity Watch. Another punishing session yesterday, as volatility measures, bond spreads and CDS spreads again closed sharply up. The Moody's Baa spread, in particular, trades at a new record for the year (218 bps). In all likelyhood, my trusted long-term model for risky assets will flash a sell signal for the fourth month in a row. On a slightly more encouraging note, the platinum-gold ratio is again trading above 1.80, while 10-year inflation breakevens are stabilizing around 240 bps. On the basis of that "Goldilocks-Stagflation" indicator, the S&P500 appears to be fairly valued at 1450.
- Liquidity @ Financial Times. [1] Renewed stress on interbank lending: Two-month sterling at a two-month high; overnight dollar libor up; Barclays unveils a £1.3bn writedown (Dave Shellock: "Mixed data and tight liquidity"). [2] Mark-to-market & subprime losses: the current crisis compared with other episodes (Gillian Tett: "Fog and fear obscure the reality behind subprime losses"). [3] The United Arab Emirates & the dollar peg: increased speculation that the UAE favor a move to drop the dollar peg and track a basket of currencies instead. Bring it on! (Peter Garnham: "Gulf states’ dollar peg comes under threat"). [4] Citigroups' funding woes: "In a further sign of falling confidence in the bank, it now costs more to insure its bonds against default in credit derivatives than it does for emerging market countries such as Mexico and Malaysia" (David Oakley: "Citigroup’s lending charges shoot up"). [5] China & US: China warns exporters could be 'devastated' by US slowdown. "China's central bank estimates that every 1 per cent drop in US economic growth translates into a 6 per cent fall in Chinese exports" (Jamil Anderlini: "China warns exporters 'could be devastated' by US slowdown").
- ECB Monthly Bulletin: not a pretty picture. [1] Growth v. inflation dynamics: "On balance, risks to the outlook for growth are judged to lie on the downside ... Risks to the medium-term outlook for price developments are fully confirmed to lie on the upside". Not good! [2] Financial volatility: "... in view of the potential impact of prolonged financial market volatility and the re-pricing of risk on the real economy, the level of uncertainty remains high"; [3] Monetary growth: influenced by "temporary or special factors" (read: flight-to-quality buying of euro-denominated money market funds, mostly from the eurozone's periphery), but still too strong for comfort. [Editorial] [full text pdf] [Ralph Atkins: "Rapid food price rises fuel inflation fears, ECB warns", Financial Times].
Thursday, November 15, 2007
LIQUIDITY WATCH. TWO CRISIS, ONE KEY DIFFERENCE
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -28.4%]
Two crisis, one sharp difference; Bank Credit Analyst & the Fed; Advance, overshoot and correct; strong economic growth in the Netherlands.
[1] Two crisis, one key difference. There is a crucial difference between the current turmoil in credit markets and the late-summer crisis: inflation breakevens. Back then, inflation expectations had all but collapsed on the back of rising credit spreads. Ten-year inflation breakevens reached a high of 246 bps on June 14, only to fall back sharply to 219 bps in eary September. [While on vacation, I wrote a quick post on August 8: MOST IMPORTANT PIECE OF NEWS: THE COLLAPSE IN INFLATION EXPECTATIONS, COURTESY OF THE INVERTED YIELD CURVE]. That's what the Fed had been expecting — and it duly acted on September 18. By the time "Helicotper Ben" eased again on October 31, inflation breakevens were back at 234 bps. Right now, rising inflation breakevens (at 240 bps), coupled with a much steeper yield curve, seem to preclude any further aggressive move by the central bank.
[2] Bank Credit Analyst & the Fed. The highly rated (and rightly so) Canadian consultants see things from a very different perspective indeed. They argue that the Fed may have fallen behind the curve in terms of policy easing: "The shift to a neutral bias by the FOMC was misplaced given the renewed rioting in the financial markets ... Rather than panic and bet on Armageddon, investors should stay focused on the rapidly rising odds of a major reflationary program, i.e. much lower rates and yields than most have envisioned. The Fed may already be easing by stealth". [Bank Credit Analyst: "Has the Fed Fallen Behind the Curve?"].
[3] Governor Warsh: "Advance, overshoot, and correct". I've always liked Governor Warsh's "watchful optimism". Credit markets may be in turmoil, but that is, perhaps, the price to pay for the ... "democratization of credit and growing access to capital"! In very Schumpeterian terms, he draws this poignant conclusion: "As in the political realm, the path to the end of history may well prove to be prone to advance, overshoot, and correct". [Kevin Warsh: "The End of History?", Federal Reserve Board].
[4] Great Moderation Watch: Dutch economic growth. Things look pretty good from Amsterdam. Yesterday, the leading local business newspaper carried a headline about the robust growth of the Dutch economy (+4.1% in Q3). Even as the euro gets stronger and the credit market turmoil deepens, exports grew at the astonishing rate of 7.5%. [Het Financieele Dagblad: "Export voert Nederlandse groei naar record hoogte"].
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -28.4%]
Two crisis, one sharp difference; Bank Credit Analyst & the Fed; Advance, overshoot and correct; strong economic growth in the Netherlands.
[1] Two crisis, one key difference. There is a crucial difference between the current turmoil in credit markets and the late-summer crisis: inflation breakevens. Back then, inflation expectations had all but collapsed on the back of rising credit spreads. Ten-year inflation breakevens reached a high of 246 bps on June 14, only to fall back sharply to 219 bps in eary September. [While on vacation, I wrote a quick post on August 8: MOST IMPORTANT PIECE OF NEWS: THE COLLAPSE IN INFLATION EXPECTATIONS, COURTESY OF THE INVERTED YIELD CURVE]. That's what the Fed had been expecting — and it duly acted on September 18. By the time "Helicotper Ben" eased again on October 31, inflation breakevens were back at 234 bps. Right now, rising inflation breakevens (at 240 bps), coupled with a much steeper yield curve, seem to preclude any further aggressive move by the central bank.
[2] Bank Credit Analyst & the Fed. The highly rated (and rightly so) Canadian consultants see things from a very different perspective indeed. They argue that the Fed may have fallen behind the curve in terms of policy easing: "The shift to a neutral bias by the FOMC was misplaced given the renewed rioting in the financial markets ... Rather than panic and bet on Armageddon, investors should stay focused on the rapidly rising odds of a major reflationary program, i.e. much lower rates and yields than most have envisioned. The Fed may already be easing by stealth". [Bank Credit Analyst: "Has the Fed Fallen Behind the Curve?"].
[3] Governor Warsh: "Advance, overshoot, and correct". I've always liked Governor Warsh's "watchful optimism". Credit markets may be in turmoil, but that is, perhaps, the price to pay for the ... "democratization of credit and growing access to capital"! In very Schumpeterian terms, he draws this poignant conclusion: "As in the political realm, the path to the end of history may well prove to be prone to advance, overshoot, and correct". [Kevin Warsh: "The End of History?", Federal Reserve Board].
[4] Great Moderation Watch: Dutch economic growth. Things look pretty good from Amsterdam. Yesterday, the leading local business newspaper carried a headline about the robust growth of the Dutch economy (+4.1% in Q3). Even as the euro gets stronger and the credit market turmoil deepens, exports grew at the astonishing rate of 7.5%. [Het Financieele Dagblad: "Export voert Nederlandse groei naar record hoogte"].
Tuesday, November 13, 2007
LIQUIDITY ANALYSIS. LIBERTÉ, ÉGALITÉ, LIQUIDITÉ
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.4%]
Banque de France, the French central bank, has just published a Focus paper on "Ten key words to make sense of the crisis". First on the list: the L-Word — liquidité. The paper notes the paradox of "co-habitation": abundant macroeconomic liquidity coupled with a liquidity squeeze in certain segments of the global capital markets. The key thing to keep in mind is that "various types of liquidity exist":
Macroeconomic liquidity differs from market liquidity: the former is defined as the quantity of monetary assets available in the economy, while the latter constitutes the market's ability to absorb the sale of assets rapidly without a significant fall in prices. While the former is permanent and results from medium-term economic developments, the latter is more fragile; its existence is contingent on the confidence on the quality of the assets traded or in that of the counterparties involved and may, without this confidence, dry up suddenly.
Market liquidity, however, appears to be an increasingly important determinant of bank liquidity, i.e the ability of banks to meet their liabilities or unwind or settle their positions. Banks' growing use of market financing and the size of their off-balance sheet exposures have indeed increased the volatility of bank liquidity, making banks more reliant on the provision of liquidity by the central bank during periods of market stress.
The recent turmoil has showed that a system based on market financing is more vulnerable to a sudden drying up of liquidity than a system of bank intermediation is to traditional bank runs, even though the latter may still occur in the absence of ayhsyan adequate system of guarantees.
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.4%]
Banque de France, the French central bank, has just published a Focus paper on "Ten key words to make sense of the crisis". First on the list: the L-Word — liquidité. The paper notes the paradox of "co-habitation": abundant macroeconomic liquidity coupled with a liquidity squeeze in certain segments of the global capital markets. The key thing to keep in mind is that "various types of liquidity exist":
Macroeconomic liquidity differs from market liquidity: the former is defined as the quantity of monetary assets available in the economy, while the latter constitutes the market's ability to absorb the sale of assets rapidly without a significant fall in prices. While the former is permanent and results from medium-term economic developments, the latter is more fragile; its existence is contingent on the confidence on the quality of the assets traded or in that of the counterparties involved and may, without this confidence, dry up suddenly.
Market liquidity, however, appears to be an increasingly important determinant of bank liquidity, i.e the ability of banks to meet their liabilities or unwind or settle their positions. Banks' growing use of market financing and the size of their off-balance sheet exposures have indeed increased the volatility of bank liquidity, making banks more reliant on the provision of liquidity by the central bank during periods of market stress.
The recent turmoil has showed that a system based on market financing is more vulnerable to a sudden drying up of liquidity than a system of bank intermediation is to traditional bank runs, even though the latter may still occur in the absence of ayhsyan adequate system of guarantees.
Monday, November 12, 2007
LIQUIDITY WATCH. LIQUIDITY, VOLATILITY, BILL LUBY!
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -31.8%]
Bill Luby's on fire (again); a look at endogenous liquidity; over-hyped geo-political risk?
[1] Liquidity, volatility, Bill Luby! "Liquidity is the inverse of volatility", says Minyanville's Todd Harrison. And that's, IMHO, largely true. That's why I have incorporated the inverse of the VIX (and other financial volatility measures) into the Endogenous Liquidity Index. And that's also, by the way, a view held at the Bank of Canada. Now, Bill Luby follows trends in financial volatility very, very closely indeed. Lately, he has been bearish on the S&P500 and bullish on the VIX. Well done! Bill told me yesterday on his blog: "I'm still bearish and will be looking closely to see if the bulls are able to make any headway in the coming week".
[2] Toying with all-time lows: a look at the Endogenous Liquidity Index. The carnage continues, as volatility creeps up and credit spreads widen even more. The Endogenous Liquidity Index is now down 32%. From the perspective of our market-based "Goldilocks-Stagflation" indicator, things still look pretty bad. Platinum prices fell sharply on Friday, sending the platinum-gold ratio down to 1.73, a three-year low. While inflation breakevens appear to have stabilized somewhat, the S&P500 continues to look rather expensive. In order for the 1450 support to hold, bulls desperately need to see a sharp fall both in the euro and in gold prices.
[3] Over-hyped geo-political risk? Looking for a silver lining somewhere, the overall geo-political picture is showing signs of improvement — which bodes ill for both oil and gold prices in the short to medium term. While I don't claim any particular expertise in that field, I am an avid reader of Thomas Barnett's blog. Dr. Barnett's key insight: connectivity is reshaping the world faster than you think. Gee, he's even calling for a Sino-American strategic alliance! This would be the key to connect the "Gap": Africa, parts the Caribbean, most of the Middle East, North Korea, etc. While that may sound like pipe dreams, consider the following news: (a) The US military is diffusing Washington rhetoric on Iran; (b) Trade and investment flows between Turkey and Iraqi Kurdistan are sharply up; (c) Former Sunni insurgents are collaborating with the U.S. like never before; (d) Iraqi citizens are guiding U.S. troops to arms caches like never before (again); (e) "Talk to Iran", says the former head of the Israeli intelligence agency Mossad. Etc, etc.
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -31.8%]
Bill Luby's on fire (again); a look at endogenous liquidity; over-hyped geo-political risk?
[1] Liquidity, volatility, Bill Luby! "Liquidity is the inverse of volatility", says Minyanville's Todd Harrison. And that's, IMHO, largely true. That's why I have incorporated the inverse of the VIX (and other financial volatility measures) into the Endogenous Liquidity Index. And that's also, by the way, a view held at the Bank of Canada. Now, Bill Luby follows trends in financial volatility very, very closely indeed. Lately, he has been bearish on the S&P500 and bullish on the VIX. Well done! Bill told me yesterday on his blog: "I'm still bearish and will be looking closely to see if the bulls are able to make any headway in the coming week".
[2] Toying with all-time lows: a look at the Endogenous Liquidity Index. The carnage continues, as volatility creeps up and credit spreads widen even more. The Endogenous Liquidity Index is now down 32%. From the perspective of our market-based "Goldilocks-Stagflation" indicator, things still look pretty bad. Platinum prices fell sharply on Friday, sending the platinum-gold ratio down to 1.73, a three-year low. While inflation breakevens appear to have stabilized somewhat, the S&P500 continues to look rather expensive. In order for the 1450 support to hold, bulls desperately need to see a sharp fall both in the euro and in gold prices.
[3] Over-hyped geo-political risk? Looking for a silver lining somewhere, the overall geo-political picture is showing signs of improvement — which bodes ill for both oil and gold prices in the short to medium term. While I don't claim any particular expertise in that field, I am an avid reader of Thomas Barnett's blog. Dr. Barnett's key insight: connectivity is reshaping the world faster than you think. Gee, he's even calling for a Sino-American strategic alliance! This would be the key to connect the "Gap": Africa, parts the Caribbean, most of the Middle East, North Korea, etc. While that may sound like pipe dreams, consider the following news: (a) The US military is diffusing Washington rhetoric on Iran; (b) Trade and investment flows between Turkey and Iraqi Kurdistan are sharply up; (c) Former Sunni insurgents are collaborating with the U.S. like never before; (d) Iraqi citizens are guiding U.S. troops to arms caches like never before (again); (e) "Talk to Iran", says the former head of the Israeli intelligence agency Mossad. Etc, etc.
Friday, November 9, 2007
LIQUIDITY WATCH. MIXED NEWS AT BEST
. Federal Reserve: "Factors Affecting Reserve Balances", November 7
- Fed's Treasuries holdings: $785.1bn (+$2.5bn)
- Other central banks' Treasuries holdings: $1,237.2bn (+$5.7bn) (*)
- Other central banks' agency securities: $795.4 (-$5.4bn) (*)
- Global Dollar Liquidity Measure: $2,817.7bn (+$2.8bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
[1] Weekly Fed Balance sheet review: mixed news at best. The first weekly Fed balance sheet for the month of November yields a small gain (+$2.8bn) in terms of the Global Dollar Liquidity measure. A number of foreign central banks may have swapped agency securities for Treasuries, perhaps as part of a flight-to-quality move within their overall custody holdings. The annual rate of growth of the Global Dollar Liquidity measure has fallen sharply to 14.11%. Because tough comparisons lie ahead, central banks must step up to the plate in order for our global liquidity measure to post meaningful gains.
[2] Endogenous Liquidity Watch: a horror movie ... again! So much for the credit wildfire hypothesis. Our Endogenous Liquidity Index (-29.9%) is perilously close to its August 16 all-time low. All components show weakness: CDS and corporate bond spreads, (the inverse of) volatility measures, indicators of financial innovation, etc. Most disquieting of all, the Moody's Baa spread has once again shot up to 210 bps, threatening to match is recent September 12 high of 213 bps. Meanwhile, our market-based "Goldilocks-Stagflation" indicator refuses to improve, as the platinum-gold ratio reaches new lows. (Mercifully, inflation breakeavens appear to be cooling a bit). In other words: even at 1475, the S&P500 does not look particularly cheap.
[3] Commodity prices: a looming correction? Can commodity prices rally in the face of declining measures of funding and market liquidity? While reflecting on the $100-per-barrel-oil-price-hype, I stumbled upon this intriguing post. Steve de Angelis, who travels regularly to Kurdistan, argues that booming trade and investment flows between Turkey and Iraqi Kurdistan have created a dynamic and complex situation. The Turkish government cannot just invade and destroy this economic connectivity: it would be too costly. Say that current oil prices carry a $20 "geo-political" premium. Stories like this, coupled with the overall liquidity situation, make me wonder: Is it time to short the damned thing? [Steve de Angelis: "Kurdistan's Economic Boom and Relations with Turkey", Enterprise Resilience Management Blog; Richard A. Oppel: "Turkish-Bred Prosperity Makes War Less Likely in Iraqi Kurdistan", The New York Times].
. Federal Reserve: "Factors Affecting Reserve Balances", November 7
- Fed's Treasuries holdings: $785.1bn (+$2.5bn)
- Other central banks' Treasuries holdings: $1,237.2bn (+$5.7bn) (*)
- Other central banks' agency securities: $795.4 (-$5.4bn) (*)
- Global Dollar Liquidity Measure: $2,817.7bn (+$2.8bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
_________________
[1] Weekly Fed Balance sheet review: mixed news at best. The first weekly Fed balance sheet for the month of November yields a small gain (+$2.8bn) in terms of the Global Dollar Liquidity measure. A number of foreign central banks may have swapped agency securities for Treasuries, perhaps as part of a flight-to-quality move within their overall custody holdings. The annual rate of growth of the Global Dollar Liquidity measure has fallen sharply to 14.11%. Because tough comparisons lie ahead, central banks must step up to the plate in order for our global liquidity measure to post meaningful gains.
[2] Endogenous Liquidity Watch: a horror movie ... again! So much for the credit wildfire hypothesis. Our Endogenous Liquidity Index (-29.9%) is perilously close to its August 16 all-time low. All components show weakness: CDS and corporate bond spreads, (the inverse of) volatility measures, indicators of financial innovation, etc. Most disquieting of all, the Moody's Baa spread has once again shot up to 210 bps, threatening to match is recent September 12 high of 213 bps. Meanwhile, our market-based "Goldilocks-Stagflation" indicator refuses to improve, as the platinum-gold ratio reaches new lows. (Mercifully, inflation breakeavens appear to be cooling a bit). In other words: even at 1475, the S&P500 does not look particularly cheap.
[3] Commodity prices: a looming correction? Can commodity prices rally in the face of declining measures of funding and market liquidity? While reflecting on the $100-per-barrel-oil-price-hype, I stumbled upon this intriguing post. Steve de Angelis, who travels regularly to Kurdistan, argues that booming trade and investment flows between Turkey and Iraqi Kurdistan have created a dynamic and complex situation. The Turkish government cannot just invade and destroy this economic connectivity: it would be too costly. Say that current oil prices carry a $20 "geo-political" premium. Stories like this, coupled with the overall liquidity situation, make me wonder: Is it time to short the damned thing? [Steve de Angelis: "Kurdistan's Economic Boom and Relations with Turkey", Enterprise Resilience Management Blog; Richard A. Oppel: "Turkish-Bred Prosperity Makes War Less Likely in Iraqi Kurdistan", The New York Times].
Thursday, November 8, 2007
LIQUIDITY ANALYSIS. I LIKE BUBBLES!
[Latest Global Dollar Liquidity measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -28.5%]
"Bubbles are good. I've made a lot of money on bubbles". Tom Perkins
There is a fascinating debate going on among readers of the Financial Times on the tricky subject of ... financial bubbles [1]. Are they a good or a bad thing? Do central banks have to prick them? Here's my two cents on the controversy: I like bubbles! Here's why. To begin with, there are no financial bubbles in North Korea, Cuba, or the Congo; there were no bubbles in the former Soviet Union either. To the best of my knowledge, nobody has ever heard about a financial bubble in Maoist China. See the point? As the great Canadian economist Reuven Brenner once said (in the midst of the dot.com bubble), a bubble gives young entrepreneurs a unique opportunity to experiment with cheap capital. In his recent book Pop! Why Bubbles Are Great For The Economy (New York: HarperCollins, 2007) [webpage] [review], Newsweek blogger Daniel Gross makes an interesting point.
During the mid-XIXth century telegraph mania, says Gross, "Investors lost gobs of money, but the United States soon had the world’s most extensive telegraph system: more than 23,000 miles by 1852, with an additional 10,000 under construction, compared with just 750 miles in France". But the greatest bubble fan of all was none other than Austrian economist Joseph A. Schumpeter. Quoting the great Harvard professor, biographer Thomas McCraw writes: "Financial speculation, though it gets a very bad press, is an important part of this process [of creative destruction]. Speculators often turn out to be investment bankers funding the entrepreneurs who in turn push innovations through the economy" [2]. Ladies and gentlemen: this is precisely what we are witnessing right now.
The trick, of course, is to be long risky assets when "creation" prevails, and short (or long risk-free assets) whenever "destruction" rules. Right now, "destruction" appears to be having a field day: witness the massive writeoffs, to the tune of $60 billion, and the collapse in our Endogenous Liquidity Index. But its reign will be short-lived. Innovation is rampant, and markets will find a way to finance it.
[1] See the relevant "litterature" as published by the Financial Times. Michael Savage: "Medicine may be worse than the asset bubble disease"; George Cooper: "We may have witnessed an old-fashioned monetisation"; Paul DeGraauwe: "Central banks should prick asset bubbles".
[2] Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007, p. 178. [web page] [prologue] [interview] [podcast]
[Latest Global Dollar Liquidity measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -28.5%]
"Bubbles are good. I've made a lot of money on bubbles". Tom Perkins
There is a fascinating debate going on among readers of the Financial Times on the tricky subject of ... financial bubbles [1]. Are they a good or a bad thing? Do central banks have to prick them? Here's my two cents on the controversy: I like bubbles! Here's why. To begin with, there are no financial bubbles in North Korea, Cuba, or the Congo; there were no bubbles in the former Soviet Union either. To the best of my knowledge, nobody has ever heard about a financial bubble in Maoist China. See the point? As the great Canadian economist Reuven Brenner once said (in the midst of the dot.com bubble), a bubble gives young entrepreneurs a unique opportunity to experiment with cheap capital. In his recent book Pop! Why Bubbles Are Great For The Economy (New York: HarperCollins, 2007) [webpage] [review], Newsweek blogger Daniel Gross makes an interesting point.
During the mid-XIXth century telegraph mania, says Gross, "Investors lost gobs of money, but the United States soon had the world’s most extensive telegraph system: more than 23,000 miles by 1852, with an additional 10,000 under construction, compared with just 750 miles in France". But the greatest bubble fan of all was none other than Austrian economist Joseph A. Schumpeter. Quoting the great Harvard professor, biographer Thomas McCraw writes: "Financial speculation, though it gets a very bad press, is an important part of this process [of creative destruction]. Speculators often turn out to be investment bankers funding the entrepreneurs who in turn push innovations through the economy" [2]. Ladies and gentlemen: this is precisely what we are witnessing right now.
The trick, of course, is to be long risky assets when "creation" prevails, and short (or long risk-free assets) whenever "destruction" rules. Right now, "destruction" appears to be having a field day: witness the massive writeoffs, to the tune of $60 billion, and the collapse in our Endogenous Liquidity Index. But its reign will be short-lived. Innovation is rampant, and markets will find a way to finance it.
[1] See the relevant "litterature" as published by the Financial Times. Michael Savage: "Medicine may be worse than the asset bubble disease"; George Cooper: "We may have witnessed an old-fashioned monetisation"; Paul DeGraauwe: "Central banks should prick asset bubbles".
[2] Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007, p. 178. [web page] [prologue] [interview] [podcast]
Wednesday, November 7, 2007
LIQUIDITY WATCH. THE DOLLAR & THE "GOLDILOCKS-STAGFLATION" INDICATOR
[Latest Global Dollar Liquidity measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -23.7%]
The Goldilocks-Stagflation indicator; buying 10-Year Note Puts; credit recession?
[1] The Dollar & the "Goldilocks-Stagflation" Indicator. The sharp fall in the dollar is taking its toll on our market-based "Goldilocks-Stagflation" indicator. The numerator is the platinum-gold ratio, an indicator of global economic growth. Although platinum prices trade at- or near record highs, gold has climbed even faster. The ratio, which closed at 2.01 in mid-May, trades now at 1.79. On the other hand, the denominator (ten year inflation-breakevens) is back at 241 bps, a level not seen since early July. Again, the weak dollar is the main culprit. Valued against the "Goldilocks-Stagflation" indicator, the S&P500 now looks rather expensive. A sharp correction, both in the euro and the S&P500, would be a ... wonderful thing.
[2] Buying 10-Year Note Puts. Steen Jakobsen, the Saxo Bank fund manager, tells readers of his blog that he is buying 109-50 and 110-50 December puts on the 10-year note futures. In his view, the rapidly falling dollar threatens the inflation outlook: "The 1st reaction before final collapse of the US dollar must be the market taking the long-end of the US higher, based on inflation and weak US dollar. Hence my surprisingly negative view on 10y notes (prices)...."
[3] A confusing piece on a confusing situation. Morgan Stanley economists Richard Berner and David Greenlaw write a confusing piece on a ... very confusing situation! They worry about the global consequences of the credit market turmoil: "... the liquidity squeeze and tighter financial conditions could hobble growth in some key regions abroad, notably in the UK and some liquidity-fueled emerging market economies. ... In fact, the liquidity crunch may claim its next victim in European growth. Our colleague Eric Chaney notes that the US and Europe are both coupled financially by a tightening in lending standards. While the tightening is more severe on this side of the pond, what matters is how European lenders respond and its impact on capital spending" [Richard Berner & David Greenlaw: "The Credit Recession", Morgan Stanley GEF].
[Latest Global Dollar Liquidity measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -23.7%]
The Goldilocks-Stagflation indicator; buying 10-Year Note Puts; credit recession?
[1] The Dollar & the "Goldilocks-Stagflation" Indicator. The sharp fall in the dollar is taking its toll on our market-based "Goldilocks-Stagflation" indicator. The numerator is the platinum-gold ratio, an indicator of global economic growth. Although platinum prices trade at- or near record highs, gold has climbed even faster. The ratio, which closed at 2.01 in mid-May, trades now at 1.79. On the other hand, the denominator (ten year inflation-breakevens) is back at 241 bps, a level not seen since early July. Again, the weak dollar is the main culprit. Valued against the "Goldilocks-Stagflation" indicator, the S&P500 now looks rather expensive. A sharp correction, both in the euro and the S&P500, would be a ... wonderful thing.
[2] Buying 10-Year Note Puts. Steen Jakobsen, the Saxo Bank fund manager, tells readers of his blog that he is buying 109-50 and 110-50 December puts on the 10-year note futures. In his view, the rapidly falling dollar threatens the inflation outlook: "The 1st reaction before final collapse of the US dollar must be the market taking the long-end of the US higher, based on inflation and weak US dollar. Hence my surprisingly negative view on 10y notes (prices)...."
[3] A confusing piece on a confusing situation. Morgan Stanley economists Richard Berner and David Greenlaw write a confusing piece on a ... very confusing situation! They worry about the global consequences of the credit market turmoil: "... the liquidity squeeze and tighter financial conditions could hobble growth in some key regions abroad, notably in the UK and some liquidity-fueled emerging market economies. ... In fact, the liquidity crunch may claim its next victim in European growth. Our colleague Eric Chaney notes that the US and Europe are both coupled financially by a tightening in lending standards. While the tightening is more severe on this side of the pond, what matters is how European lenders respond and its impact on capital spending" [Richard Berner & David Greenlaw: "The Credit Recession", Morgan Stanley GEF].
Tuesday, November 6, 2007
BOOK REVIEW. JOSEPH SCHUMPETER & CREDIT CREATION
. Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007 [web page] [prologue] [interview] [podcast]
As Larry Kudlow used to say, Joseph Schumpeter is my favorite dead economist. We all know about the importance of the innovative entrepreneur. And we have all heard about "creative destruction", Schumpeter's "wonderful metaphor" (only second to Adam Smith's "invisible hand"). But somebody needed to put it all in context — a task at which Thomas McCraw excels like no other. Schumpeter led a very agitated life, constantly moving from one place to the other. He finally settled down at Harvard in the early 1930s. In sharp contrast to John Maynard Keynes' quiet life in England, Schumpeter's perpetual travels forced him to take a dynamic view of capitalism. The Keynes-Schumpeter rivalry is one of the most exciting elements of the book. From the perspective of the Global Liquidity Blog, however, I will concentrate on the parts that deal with money and credit.
Innovation & credit creation
Already in his Theory of Economic Development (1911), Schumpeter lays down the assumption that innovation implies the constant creation of ... credit. In a 1917 article, he emphasizes the role of money and credit in economic progress. As McCraw aptly puts it in the prologue:
The core ethos of capitalism looks constantly ahead and relies on credit in launching new ventures. From the Latin root credo —'I believe'— credit represents a wager on a better future. The entrepreneurs and consumers who make these bets often care little about the past and have scant patience with the present. They undertake innovative projects and make expensive purchases (houses, for example) that require far greater resources than those laying at hand. In the absence of credit, both consumers and entrepreneurs would suffer endless frustrations (p. 7).
In a 1928 essay on "The Instability of Capitalism", published in Keynes's Economic Journal, he again focuses on the crucial role of credit. "Innovation", he writes, "being discontinuous and involving considerable change and being typically embodied in new firms, requires large expenditures previous to the emergence of any revenue. 'Credit-creation', therefore, becomes an essential part both of the mechanism of the process and of the theory explaining it". These large bets on the success of a new venture, McCraw adds, "can be lost completely if the venture fails". During the 1930s, Schumpeter struggled with what he called his "money book", a long treatise on money that was never completed. Instead, he opted for a monumental analysis of business cycles. And here's where things get really interesting.
Business Cycles
In his monumental Business Cycles (1939), Schumpeter analyses the dynamics of past industrial revolutions. He emphazises three key institutional innovations crucial to the rise of capitalism: "the factory, the corporation, and the modern financial system" (p. 254). The "railroadization" of the United States, beginning in the 1840s, is characterized by huge amounts of "credit creation":
Huge amounts of money flowed into the United States from Britain and Europe, through the purchase of railroad bonds and the use of overdrafts on banks (lines of credit). Some of these British overdrafts were granted 'with almost unbelievable freedom and carelessness'. In the United States itself, credit creation was often even more reckless — but it was also extremely innovative (p. 263).
The automobile industry was one of Schumpeter's favorite examples of capitalist growth. "In the invention of new financial techniques", writes McCraw, "the automobile industry was 'amost in a class by itself'. General Motor's introduction of installment buying created an immense amount of credit by turning consumers into significant borrowers ... With some many customers borrowing and repaying money to own a car, automotive manufacturers were able to minimize their own debts" (p. 267). There you have it. Right from the horse's mouth. Financial innovation follows business innovation: that's the good part. But euphoria leads to "freedom and carelessness" on the part of investors: that's the bad part. As I reflect on the current credit market mess, I can't help thinking: "We've been through this before. Big deal".
Are there any lessons to be learned from the book? I would point to the following:
[a] The "Great Moderation" thesis. From a Schumpeterian point of view, this notion does not make much sense. In contrast to Keynes' stagnationism, Schumpeter held the view that capitalism was no gentle process of adjustment but something more "like a series of explosions" (p. 255). [b] The US current account and liquidity conditions. Some commentators worry about the impact of an eventually declining U.S. current account deficit on financial innovation and liquidity conditions. Again, what drives financial innovation is ... business innovation. Don't worry about that one. [c] Economic growth and credit demand. Innovation and growth can occur without corporations having to raise large sums of cash. General Motors did it in the 1920s, and Apple is doing it right now. [d] Shorter cycles ahead? The more I read about business innovation, the more I am convinced that the process is alive and kicking: renewable energy, medical techniques, biosynthetics, Interet 2.0, etc. To me, that spells more, and shorter, cycles of euphoria and panic. And, yes, more financial innovation down the road.
. Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007 [web page] [prologue] [interview] [podcast]
As Larry Kudlow used to say, Joseph Schumpeter is my favorite dead economist. We all know about the importance of the innovative entrepreneur. And we have all heard about "creative destruction", Schumpeter's "wonderful metaphor" (only second to Adam Smith's "invisible hand"). But somebody needed to put it all in context — a task at which Thomas McCraw excels like no other. Schumpeter led a very agitated life, constantly moving from one place to the other. He finally settled down at Harvard in the early 1930s. In sharp contrast to John Maynard Keynes' quiet life in England, Schumpeter's perpetual travels forced him to take a dynamic view of capitalism. The Keynes-Schumpeter rivalry is one of the most exciting elements of the book. From the perspective of the Global Liquidity Blog, however, I will concentrate on the parts that deal with money and credit.
Innovation & credit creation
Already in his Theory of Economic Development (1911), Schumpeter lays down the assumption that innovation implies the constant creation of ... credit. In a 1917 article, he emphasizes the role of money and credit in economic progress. As McCraw aptly puts it in the prologue:
The core ethos of capitalism looks constantly ahead and relies on credit in launching new ventures. From the Latin root credo —'I believe'— credit represents a wager on a better future. The entrepreneurs and consumers who make these bets often care little about the past and have scant patience with the present. They undertake innovative projects and make expensive purchases (houses, for example) that require far greater resources than those laying at hand. In the absence of credit, both consumers and entrepreneurs would suffer endless frustrations (p. 7).
In a 1928 essay on "The Instability of Capitalism", published in Keynes's Economic Journal, he again focuses on the crucial role of credit. "Innovation", he writes, "being discontinuous and involving considerable change and being typically embodied in new firms, requires large expenditures previous to the emergence of any revenue. 'Credit-creation', therefore, becomes an essential part both of the mechanism of the process and of the theory explaining it". These large bets on the success of a new venture, McCraw adds, "can be lost completely if the venture fails". During the 1930s, Schumpeter struggled with what he called his "money book", a long treatise on money that was never completed. Instead, he opted for a monumental analysis of business cycles. And here's where things get really interesting.
Business Cycles
In his monumental Business Cycles (1939), Schumpeter analyses the dynamics of past industrial revolutions. He emphazises three key institutional innovations crucial to the rise of capitalism: "the factory, the corporation, and the modern financial system" (p. 254). The "railroadization" of the United States, beginning in the 1840s, is characterized by huge amounts of "credit creation":
Huge amounts of money flowed into the United States from Britain and Europe, through the purchase of railroad bonds and the use of overdrafts on banks (lines of credit). Some of these British overdrafts were granted 'with almost unbelievable freedom and carelessness'. In the United States itself, credit creation was often even more reckless — but it was also extremely innovative (p. 263).
The automobile industry was one of Schumpeter's favorite examples of capitalist growth. "In the invention of new financial techniques", writes McCraw, "the automobile industry was 'amost in a class by itself'. General Motor's introduction of installment buying created an immense amount of credit by turning consumers into significant borrowers ... With some many customers borrowing and repaying money to own a car, automotive manufacturers were able to minimize their own debts" (p. 267). There you have it. Right from the horse's mouth. Financial innovation follows business innovation: that's the good part. But euphoria leads to "freedom and carelessness" on the part of investors: that's the bad part. As I reflect on the current credit market mess, I can't help thinking: "We've been through this before. Big deal".
Are there any lessons to be learned from the book? I would point to the following:
[a] The "Great Moderation" thesis. From a Schumpeterian point of view, this notion does not make much sense. In contrast to Keynes' stagnationism, Schumpeter held the view that capitalism was no gentle process of adjustment but something more "like a series of explosions" (p. 255). [b] The US current account and liquidity conditions. Some commentators worry about the impact of an eventually declining U.S. current account deficit on financial innovation and liquidity conditions. Again, what drives financial innovation is ... business innovation. Don't worry about that one. [c] Economic growth and credit demand. Innovation and growth can occur without corporations having to raise large sums of cash. General Motors did it in the 1920s, and Apple is doing it right now. [d] Shorter cycles ahead? The more I read about business innovation, the more I am convinced that the process is alive and kicking: renewable energy, medical techniques, biosynthetics, Interet 2.0, etc. To me, that spells more, and shorter, cycles of euphoria and panic. And, yes, more financial innovation down the road.
Monday, November 5, 2007
. Monetary Policy. A not-so-dovish dove. Frederic Mishkin, one the FOMC doves, sounds considerably less dovish in his speech today at the Risk USA 2007 Conference. Key excerpts: "Because monetary policy makers can never be certain of the amount of policy easing that is needed to forestall the adverse effects of disruptions in financial markets, decisive policy actions may, from time to time, go too far and thus produce unwelcome inflationary pressures ... The combined 75 basis points of policy easing put in place at the past two meetings should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and should help promote moderate growth over time".
- Frederic S. Mishkin: "Financial Instability and Monetary Policy", Federal Reserve Board of Governors.
- Frederic S. Mishkin: "Financial Instability and Monetary Policy", Federal Reserve Board of Governors.
. Liquidity & Markets. Gold prices. Philip Manduca, the sharp Titanium Capital strategist, says it's time to take profits in the gold market. (Though the long term trend is still up, he added this morning on Bloomberg TV). Speaking of gold, Manuel Hinds and Benn Steil warn about the dollar running out of luck: "The dollar sustained its role as the international standard of value because of good fortune on two fronts. First, the Fed under Paul Volcker hammered out inflationary expectations with a painful but necessary period of high interest rates. Second, there was no viable alternative. It may not be so lucky this time. Today, not only does the euro wait in the wings as understudy, but gold banks have risen in tandem with the dollar’s decline and offer the world a viable private alternative that has permanent intrinsic value".
- Manuel Hinds & Benn Steil: "History's warning about the price of money", Council on Foreign Relations.
- Manuel Hinds & Benn Steil: "History's warning about the price of money", Council on Foreign Relations.
. Endogenous Liquidity Watch. Tumbling! Needless to say, our Endogenous Liquidity Index tumbled last week (-6.1%). The fall was led by rising financial volatility measures — a clear message to complacent "Global Decoupling" bulls. CDS and junk bond spreads were sharlpy up; our market-based measure of financial innovation suffered less devastating losses. The index now trades at levels not seen since September 17, when markets for risky assets began to recover from the mid-August collapse.
. Financial Innovation. A new revolution coming our way? Writing for the Financial Times's weekly review of the fund management industry, Steve Johnson highlights the coming mass-marketization of the hedge fund industry, chiefly as a consequence of the European Union's Ucits III legislation. Says Guy Monson, chief investment officer at Sarasin Chiswell: "It's a big bang and we have only just scratched the surface of what we are going to see in the next two or three years. It's hard to underestimate what a revolution this is. You ain't seen nothing yet". Read the whole thing.
- Steve Johnson: "Sophistication goes mass market", Financial Times.
- Steve Johnson: "Sophistication goes mass market", Financial Times.
Friday, November 2, 2007
LIQUIDITY WATCH. WEEKLY FED BALANCE SHEET, NEW YORK FED & SYSTEMIC RISK
. Federal Reserve: "Factors Affecting Reserve Balances", October 31
- Fed's Treasuries holdings: $782.7bn (+$2.1bn)
- Other central banks' Treasuries holdings: $1,231.5bn (-$2.6bn) (*)
- Other central banks' agency securities: $800.8 (+$4.3bn) (*)
- Global Dollar Liquidity Measure: $2,815.0bn (+$3.8bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
__________________
[1] Not a bad month, liquidity-wise. The last weekly Fed balance sheet for the month of October yields little in the way of surprises. A modest increase in our Global Dollar Liquidity measure is enough to propel the annual rate of growth to 14.7%, a four-month high. Foreign central banks, as usual, are leading the charge: custody holdings are back at +20.1%. This could change, of course, if the effective Fed funds rate were to persistently trade above the new 4.5% target over the next couple of weeks.
[2] New York Fed conference on systemic risk. The Federal Reserve Bank of New York has just published an overview of its recent conference on "New Directions for Understanding Systemic Risk". If I had to summarize the findings in just a couple of words, I'd say two things. First, the new financial system —with "disintermediation" as its core feature— is less prone to systemic risk, as credit risk is spread more widely. Second, as more assets are subject to mark-to-market discipline, liquidity crisis are bound to create ... new sets of risks! ["New Directions for Understanding Systemic Risk", Economic Policy Review, Volume 13, Number 2, November 2007].
[3] "Great Moderation" Watch: liquidity & "global decoupling" [Liquidity @ Financial Times]. Manisha Girotra, chairman of UBS India, dismisses the notion of "global decoupling" as just another case of ... excess liquidity! "With growth in the US slowing down, funds are getting redirected to Asia". In other words, it's all down to ... funding liquidity (which, at least according to the numbers I follow, is still in pretty good shape) [Sundeep Tucker, Joe Leahy and Geoff Dyer: "Defying gravity? Asia’s continued rise spurs ‘decoupling’ debate", Financial Times].
. Federal Reserve: "Factors Affecting Reserve Balances", October 31
- Fed's Treasuries holdings: $782.7bn (+$2.1bn)
- Other central banks' Treasuries holdings: $1,231.5bn (-$2.6bn) (*)
- Other central banks' agency securities: $800.8 (+$4.3bn) (*)
- Global Dollar Liquidity Measure: $2,815.0bn (+$3.8bn)
(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
__________________
[1] Not a bad month, liquidity-wise. The last weekly Fed balance sheet for the month of October yields little in the way of surprises. A modest increase in our Global Dollar Liquidity measure is enough to propel the annual rate of growth to 14.7%, a four-month high. Foreign central banks, as usual, are leading the charge: custody holdings are back at +20.1%. This could change, of course, if the effective Fed funds rate were to persistently trade above the new 4.5% target over the next couple of weeks.
[2] New York Fed conference on systemic risk. The Federal Reserve Bank of New York has just published an overview of its recent conference on "New Directions for Understanding Systemic Risk". If I had to summarize the findings in just a couple of words, I'd say two things. First, the new financial system —with "disintermediation" as its core feature— is less prone to systemic risk, as credit risk is spread more widely. Second, as more assets are subject to mark-to-market discipline, liquidity crisis are bound to create ... new sets of risks! ["New Directions for Understanding Systemic Risk", Economic Policy Review, Volume 13, Number 2, November 2007].
[3] "Great Moderation" Watch: liquidity & "global decoupling" [Liquidity @ Financial Times]. Manisha Girotra, chairman of UBS India, dismisses the notion of "global decoupling" as just another case of ... excess liquidity! "With growth in the US slowing down, funds are getting redirected to Asia". In other words, it's all down to ... funding liquidity (which, at least according to the numbers I follow, is still in pretty good shape) [Sundeep Tucker, Joe Leahy and Geoff Dyer: "Defying gravity? Asia’s continued rise spurs ‘decoupling’ debate", Financial Times].
Thursday, November 1, 2007
WIKINOMICS & THE CRAZIEST CREDIT MARKET HYPOTHESIS EVER (AGAIN)
[Latest Global Dollar Liquidity measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -16.8%]
Economist Edward Yardeni recently wrote: "The global economy is in the midst of the greatest boom of all times". The IMF's World Economic Outlook estimates global growth at "a solid 4.75%". Commodity prices tend to confirm that bullish view. Yet one fact remains hard to explain: interest rates are generally low, both in real and nominal terms. Whatever happened to credit demand? Why are interest rates so low in the midst of "the greatest boom of all times"? While walking by the Olympic Stadium in the south district of Amsterdam, I had an eureka moment as I saw this IKEA advertisement: "Design your own life". It reminded me of one of the craziest posts I ever wrote for this blog, back in March: Wikinomics & the Credit Demand Conundrum.
The post dealt with an article by economist-investor Thomas Nugent, which provided a clue to the low interest rate environment. This is the key quote:
What is interesting is that, with a booming economy, business-loan demand is falling, not rising. This is not your father’s traditional economic expansion. Productivity is mitigating the need for bank borrowing. To see this, think about the notion of infinite operating leverage whereby business technology is, in effect, “taking over.” Higher sales-GDP from applications can be considered “pure productivity” that doesn’t tax resources or drive up prices.
If Apple Computer sells more songs over the Internet, people are simply downloading more songs at a buck a song. This transaction has neither fixed nor variable expenses and therefore adds to GDP as pure productivity gains. This type of activity increases GDP without price pressure. It’s pure productivity, and it brings into question the entire rationale for expectations that the Fed will be raising interest rates just because GDP is growing (at least until more evidence accumulates of potential labor-market tightness).
Now back to IKEA. The furniture giant is in effect "crowdsourcing" its design process. Scandinavians are, apparently, very good at that. Back in March, I listened a Monocle interview on the amazing turnaround at Danish toy maker Lego. According to CEO Jørgen Vig Knudstorp:
We completely changed the way we run the business. We really involve users to an extreme degree ... They even decide their own products ... We are not involved in the design process ... We have become more virtual ... We have open-sourced the company and it does not take a lot of investment to generate a lot of cash.
Bingo! By "open-sourcing" the company, Lego needs to invest ... less. That is also, apparently, IKEA's bet. Demand for credit slows down, even as the economy continues to march forward. Wikinomics, anyone?
[UPDATE: take a look at the Lego Factory, Lego's crowdsourcing device].
[Latest Global Dollar Liquidity measure: +14.6% annual growth rate; latest Endogenous Liquidity Index: -16.8%]
Economist Edward Yardeni recently wrote: "The global economy is in the midst of the greatest boom of all times". The IMF's World Economic Outlook estimates global growth at "a solid 4.75%". Commodity prices tend to confirm that bullish view. Yet one fact remains hard to explain: interest rates are generally low, both in real and nominal terms. Whatever happened to credit demand? Why are interest rates so low in the midst of "the greatest boom of all times"? While walking by the Olympic Stadium in the south district of Amsterdam, I had an eureka moment as I saw this IKEA advertisement: "Design your own life". It reminded me of one of the craziest posts I ever wrote for this blog, back in March: Wikinomics & the Credit Demand Conundrum.
The post dealt with an article by economist-investor Thomas Nugent, which provided a clue to the low interest rate environment. This is the key quote:
What is interesting is that, with a booming economy, business-loan demand is falling, not rising. This is not your father’s traditional economic expansion. Productivity is mitigating the need for bank borrowing. To see this, think about the notion of infinite operating leverage whereby business technology is, in effect, “taking over.” Higher sales-GDP from applications can be considered “pure productivity” that doesn’t tax resources or drive up prices.
If Apple Computer sells more songs over the Internet, people are simply downloading more songs at a buck a song. This transaction has neither fixed nor variable expenses and therefore adds to GDP as pure productivity gains. This type of activity increases GDP without price pressure. It’s pure productivity, and it brings into question the entire rationale for expectations that the Fed will be raising interest rates just because GDP is growing (at least until more evidence accumulates of potential labor-market tightness).
Now back to IKEA. The furniture giant is in effect "crowdsourcing" its design process. Scandinavians are, apparently, very good at that. Back in March, I listened a Monocle interview on the amazing turnaround at Danish toy maker Lego. According to CEO Jørgen Vig Knudstorp:
We completely changed the way we run the business. We really involve users to an extreme degree ... They even decide their own products ... We are not involved in the design process ... We have become more virtual ... We have open-sourced the company and it does not take a lot of investment to generate a lot of cash.
Bingo! By "open-sourcing" the company, Lego needs to invest ... less. That is also, apparently, IKEA's bet. Demand for credit slows down, even as the economy continues to march forward. Wikinomics, anyone?
[UPDATE: take a look at the Lego Factory, Lego's crowdsourcing device].
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