Monday, March 10, 2008

LIQUIDITY NEWS. THE "TAF" INCREASE IS A SMART MOVE
[Latest Global Dollar Liquidity measure: +11.3% annual growth rate; latest Endogenous Liquidity Index: -50.6%]

[1] The TAF increase: a smart move! On Friday, the Federal Reserve announced that the amounts outstanding in the Term Auction Facility (TAF) would be increased to $100 billion. In a separate move, the Fed will initiate "a series of term repurchase transactions that are expected to cumulate to $100 billion". These are smart moves, reminiscent of the European Central Bank's recent liquidity policies. The aim is to provide liquidity without altering the target rate of the fed funds. For most of 2007, Fed policy has been rather restrictive: fed funds traded above Treasury market rates, and monetary base growth was very weak. Now, the triple combination of a steeper yield curve, rising commodity prices and a faltering dollar is signalling that the fed funds rate is fast approaching an appropiatley accomodative level. The Fed needs to be more creative. The TAF increase is a smart move. [Press release]

[2] Panic in credit-land! The Moody's Baa spread has reached 335bp, a level not seen since January 2003. And the Credit Default Swap market is in turmoil. On Friday, the iTraxx Japan 80 index traded at 155bp, a 30bp increase in just one session! According to the Financial Times, "Institutions that lapped up credit risk products in recent years – many financing their purchases through borrowing – are scrambling to reduce their exposure following heavy losses ... The spread widening is so severe, you’re seeing a rise in borrowing rates across the board for everybody except top-quality governments. It’s affecting both the price and availability of credit". We'll be closely watching the U.S. investment grade CDS market, now trading at 178bp over Libor. A move above 200bp, according to Bank of America, "could trigger a jump towards 220bp". Meanwhile, Cumberland Advisors's David Kotok sees the current panic as an opportunity: "My negative and disagreeable email is approaching the peak levels I last saw in 2000. Then we were buying 6% tax-free bonds while investors were selling them to buy Cisco and Microsoft at 100 times earnings". [Robert Cookson: "Credit derivatives turmoil strikes", Financial Times] [David Kotok: "J'ai Peur", Cumberland Advisors]

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