Monday, December 3, 2007

LIQUIDITY WATCH. MOODY'S BAA SPREADS AT 4 YEAR-HIGHS
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -30.6%]

Spreads are hurting; Malpass on liquidity conditions; liquidity @ Financial Times.

[1] Spreads are hurting. At 246 bps, the Moody's Baa spread relative to Treasuries trades at levels not seen since September 2003. At 135 bps (a 3 year-high), its Aaa cousing is faring a little better. Bear Stearns economist David Malpass discounts the negative implications of rising spreads: "Despite wider credit spreads relative to Treasuries, we note the relatively low interest rates in most credit markets". Does the evidence support that view? Not really — unless you factor in a slightly higher inflation rate. The fact is, quality spreads are rising across the board. Despite its horrendous track-record in terms of short-term market moves, my trusted long-term "Combo Model" for risky assets —which adds the rate of growth of the Global Dollar Liquidity measure to the inverse of the Moody's Baa spread— has entered its fourth consecutive month in bearish territory. The August and September signals were so weak that I suggested a trading-range scenario rather than an outright bear market (which turned out to be OK big picture-wise, especially in euro or gold terms). Now, spreads have become more stubborn; they refuse to back down; signals are becoming louder. Stay tuned.

[2] David Malpass on liquidity. Rich Karlgaard quotes Bear Stearns economist David Malpass on liquidity conditions: "Extra cash in the global financial system remains massive. The feeling of a credit crunch is coming more from the slowdown in velocity or turnover of money than from a scarcity of liquidity". In other words, Mr. Malpass is describing the five-month old dichotomy between strong funding liquidtity and weak market liquidity. [Rich Karlgaard: "Malpass: Slowdown, not Recession", Forbes Digital Rules]

[3] Brad Setser on China & the yen. Brad Setser on China's latest rumoured FX moves: "Put the latest from Stratfor and Yves Smith (Naked Capitalism) together, and it seems like China may be scaling back on its holdings of US treasuries in order to buy yen. Stratfor hints that China may have a policy of reducing its holdings of Treasuries; Smith argues that China is buying yen: My Asia sources tell me that China is willing to let the yuan appreciate only if the yen rises first, and they are actively buying yen to make sure that comes to pass". Interesting stuff. [Brad Setser: "China: selling Treasuries and buying yen?"]

[4] Liquidity @ Financial Times: the Stagflation debate. The stagflation debate has been going on for a while now. If I remember correctly, PIMCO's Paul McCulley embraced that scary notion back in 2005 (he has now moved to the deflation camp). In this solid FT piece, Krishna Guha reviews the main issues involved. The key question, well emphasized by Guha, is this: if inflation risks are are so high, why are long-term nonimal interest rates so low? To track 'stagflation', we have devised a market-based indicator: the "Goldilocks-Stagflation" indicator. The numerator is the platinum-gold spread (a gauge of goblal economic growth), and the denominator is the ten-year inflation breakeven (a proxy for inflation expectations). At 0.79, the "Goldilocks-Stagflation" indicator looks neither too hot nor too cold. [Krishna Guha: "Cooler yet the pressure rises", Financial Times]

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