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]

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