Monday, March 17, 2008


Just when the most impressive liquidity crisis in recent memory makes headlines everywhere, the editor of the Global Liquidity Blog finds himself incredibly busy with a number of different projects. Plus, I'll be in Paris for the Easter week-end. In other words, no blog until next Tuesday. Liberté, egalité, liquidité!



Thursday, March 13, 2008

[Latest Global Dollar Liquidity measure: +11.3% annual growth rate; latest Endogenous Liquidity Index: -50.6%]

There are all sorts of rumors out there about hedge funds, and even about some big financial institution going under. The liquidity crisis, apparently, is fast becoming a ... solvency crisis! Here's my two cents on the rumors: I don't believe them. I trully think that the new market-based, securitization-driven financial market has succeeded in diversifying credit risk. Of course, we are only now becoming aware of the phenomenal downside: a spectacular information crunch, whereby nodody really knows the extent of the damage sustained by one's credit counterparties.

Overall, the Fed's liquidity operations are well designed. But perhaps Mr. Bernanke should be more explicit about his goal: to solve the liquidity puzzle while not giving the impression that he stamps his signature on mere American ... pesos.

Monday, March 10, 2008

[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]

Friday, March 7, 2008

. Federal Reserve: "Factors Affecting Reserve Balances", March 5

- Fed's Treasuries holdings: $789.6bn (+$12.9bn)
- Other central banks' Treasuries holdings: $1,280.6bn (+$10.3bn) (*)
- Other central banks' agency securities: $869.4 (-$1.8bn) (*)
- Global Dollar Liquidity Measure: $2,939.6bn (+$21.5bn)

(*) Off-balance-sheet items

Who cares about funding (or macroeconomic) liquidity when market liquidity is all but collapsing? The answer: FX and commodity markets traders. They like what they see: foreign central banks desperately trying to avoid the unavoidable — namely, sharp interest rate increases in places like China, Russia and Argentina, to name but a few. We may be witnessing the last phase of extravagant moves in some of these markets. Meanwhile, our Endogenous Liquidity Index saw one of its worst days ever, as all components —including all CDS indices— fell sharply (a very rare occurrence).The ELI is now down more than 50% from a year ago! The hedge fund community, in particular, is feeling the heat. Peloton Partners, trying to pick the bottom in credit markets, is now out of the game. Carlyle Capital, which had geared up 32 times to buy a $22bn book a triple-A mortgages, is making headlines (for the wrong reasons, presumably).

To put it in perspective, here are a few quotes from analysts interviewed by the Financial Times: "The repricing of liquidity and credit lines to hedge funds will squeeze more credit funds out of business" (Huw van Steenis, Morgan Stanley); "... The most chaotic times in the credit markets since the Great Depression" (William O'Donnell, UBS); "There is an extreme lack of liquidity and markets are being moved by liquidation fears and margin calls" (Tom Di Galoma, Jefferies). There you have it. [Michael Mackenzie: "Hedge funds spark fixed income stress", Financial Times] [James Mackintosh: "Gloom set to worsen as threat of spiral grows", Financial Times].

Thursday, March 6, 2008

[Latest Global Dollar Liquidity measure: +11.9% annual growth rate; latest Endogenous Liquidity Index: -47.3%]

In his discussion of the dynamics of inflation expectations, Federal Reserve Governor Frederic Mishkin discounts the current uptick in the spread between "nominal Treasuries" and TIPS as a reflection (in part) of "changes in ... the relative liquidity of TIPS and similar maturity nominal Treasuries". Hmmm ... Now let's not forget that Mr. Mishkin is referring to a market-based indicator here. He should, perhaps, show more respect for other market-based indicators. Long ago, Manuel Johnson and Robert Keleher taught us the following golden rule, partly based on the teachings of British economist David Ricardo (1772-1823): whenever a currency falls in terms of other currencies, AND in terms of gold, AND its yield curve gets steeper, AND commodity prices soar, there's no way to hide the ugly truth — there is indeed an inflation problem.

Wednesday, March 5, 2008

[Latest Global Dollar Liquidity measure: +11.9% annual growth rate; latest Endogenous Liquidity Index: -48.6%]

As I wrote yesterday, credit spreads are surging on a global basis. The Moody's Baa spread trades at a new five-year high of 322 basis points. Federal Reserve Governor Frederic Mishkin mentioned credit spreads on at least three occasions in his latest speech. First, he notes that corporate bond spreads are rising because investors are becoming "less willing to bear risk, more concerned about the valuations of a wide range of complex financial instruments, and more concerned about counterparty credit risk". He then notes that rising credit spreads point to a deterioration in "business sentiment" (translation: corporate profits will fall).

Finally, Mr. Mishkin notes, in the context of the housing market, that "a decline in house prices can increase the wedge between the default-free interest rate and the effective interest rate facing the homeowner. That is, in the eyes of the lenders, declining house prices diminish the quality of the borrowers' collateral, which effectively reduces the availability of credit to households that can be used to finance consumer purchases". Credit spreads, my friends, are taking center stage. Not a minute too soon! In today's Financial Times "Markets & Investing column", PIMCO's Bill Gross makes an important point about rising credit spreads:

Despite the rapid decline in Treasury yields, mortgage and corporate credit markets are not co-operating, producing aggregate price declines in total. Historically high levels of consumption as a percentage of gross domestic product are not being supported any more by leverageable assets that appreciate perpetually in price ... The American economy, so dependent on asset inflation of one sort or another, is now experiencing price deflation in all three major categories – real estate, stocks, and yes, bonds.

Even with the recent bout of price inflation in the Treasury market, rising credit spreads mean that the bond market as a whole is "deflating". While one could argue with the remark that the U.S. economy is "so dependent on asset inflation" —Bill Gross has a perma-bear-like tendency to sistematically discount the positive impact of business innovation on the economy— the point about price deflation in all three major categories is an important one.

[1] Frederic S. Mishkin: "Outlook and Risks for the U.S. Economy", Federal Reserve Board

[2] Bill Gross: "Urgent action needed to stave off rise of Bushville", Financial Times

Tuesday, March 4, 2008

[Latest Global Dollar Liquidity measure: +11.9% annual growth rate; latest Endogenous Liquidity Index: -48.5%]

[1] Credit spreads are surging globally. Most of the international CDS indices that I track are posting new highs in terms of spreads. Emerging markets appear to fare a touch better as of this writing. But take a look at Markit's iTraxx series. All of them, without exception, are trading at new highs in terms of spreads: Europe, Europe Crossover, Japan, Asia ex-Japan, Australia, and Japan 80. There is a whiff of panic in the air, as some spreads have surged more than 30% in just one session. Ladies and gentlemen: the credit spread explosion has gone global, no doubt about it.

[2] A Petrodollar tsunami? (Liquidity @ Financial Times). Morgan Stanley's Stephen Jen warns about the upcoming "petrodollar tsunami" that is likely to occur as oil trades at $100/barrel. Here's the key excerpt: "At $100 a barrel, the total proven reserves of the oil exporting countries is about $104,000bn – equivalent to the combined total value of publicly-traded equities and bonds in the world". Jen thinks that the tsunami has two broad implications in terms of financial markets: (a) equities will outperform bonds; (2) emerging market currencies are likely to gain both in terms of the dollar and the euro [Stephen Jen: "Petrodollar tsunami to hit euro and dollar", Financial Times]

Monday, March 3, 2008

[Latest Global Dollar Liquidity measure: +11.9% annual growth rate; latest Endogenous Liquidity Index: -48.1%]

[1] Endogenous liquidity: a new low! Surging credit spreads on both CDS and cash bonds, the higher VIX, and plunging stock prices of financial innovators: all these factors are conspiring to send our Endogenous Liquidity Index to yet a new low (-48.1% year-on-year). The most worrying factor, in my mind, continues to be the path of the Moody's Baa spread. At 317 bps, it trades at highs not seen since February 2003. This provides a clear forecast in terms of corporate earnings: down!

[2] Bank Credit Analyst's own ... Goldilocks-Stagflation indicator! Since Friday, the Goldilocks-Stagflation indicator has competition: Bank Credit Analyst, the top-notch Canadian consultants, have launched their own indicator. Unlike our measure, which is market-based, BCA's is a quantity indicator: it results from computing stories that mention "goldilocks", "rising inflation" and "recession". See for yourself.