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Weekly Market Commentary

Interest rate markets are dysfunctional and polarised, credit quality and relative liquidity the key issues

Fri, Sep 26 2008, 14:30 GMT
by Nicole Elliott

Mizuho Corporate Bank

Overview

The credit crunch that has been battering ‘Wall Street’ for months has moved well and truly on to ‘Main Street’. Banking woes, potential recession and unemployment are now front page news and Joe Average is understandably worrying about how to protect his savings. Massive price swings on equity indices, up on a US $700B planned rescue package then down again this week, keep journalists happy yet they are missing the point: the chronic lack of trust between bank counterparties is the cause, share price slides and a flight to quality the result. Stock indices dropped from pivotal levels, now resistance at what had been support, Dubai and Egypt faring the worst, Argentina best. Interest rate markets are dysfunctional and polarised, credit quality and relative liquidity the key issues. One-month US Treasury Bills yield 10 basis points annualised, and last week three-month ones dipped briefly to a negative interest. Interbank rates are higher and most Treasury Bond yields are roughly unchanged, Brazilian, Russian and Singapore’s a bit higher. As a side-show, the US dollar recovered a little against most currencies (especially Scandinavian ones) after plummeting in value the previous week; the Yen gained against all as the Japanese banking system is increasingly seen as a safe haven. Commodities dull, moving in line with FX.

Political and Economic Developments

The global banking crisis got grimmer. Monday Denmark’s Central Bank rescued the country’s 6th largest bank, EBH Bank, its second rescue in ten weeks after two others agreed to be bought out last week. Wednesday Gulf Arab states’ Central Banks said they were ready to provide more liquidity if needed in the parched interbank market (which sounds a little hollow as for months they have been trying to reign in rampant credit growth). Kazakhstan established a $5B rescue fund for its banks. Hong Kong’s Bank of East Asia suffered a run by depositors who queued all night to get hold of their money Thursday. In a surprise move Taiwan’s Central Bank of China trimmed rates by 12.5 basis points to 3.50%, the first cut in years. Washington Mutual was seized by US bank regulators last night and promptly sold to JP Morgan for $1.9B, the biggest banking bust in history. US politicians dither over signing a massive blank cheque.
Ireland, the ‘Celtic Tiger’ with the Eurozone’s best economic performance since the single currency was introduced, is in recession with two consecutive quarters of negative economic growth (budget deficit set to break the 3% cap).

Japan saw a Trade Deficit in August, the first on a seasonally adjusted basis since 1980, as vehicle sales into the US plunged (overall exports to the country –22%) and oil imports surge 17% by value.

Underlying Themes

Remember saving for a rainy day? Living within your means, fiscal prudence, regulators who understood their job, politicians with vision and party support? All seem a distant memory now and many young people have never lived (or thought) like this. The public’s faith in economists and elected officials to get them out of this mess is touching, but probably misguided. Throwing money at the problem, Japanese style, carries no guarantees and usually prolongs the death throes of the fatally wounded. A short sharp shock on such a massive global scale is more than most can stomach. We will probably suffer the worst of both, a compromise between the two. This will kill off some enterprises regardless of soundness only because their credit dries up. It will help the mismanaged hide inefficiencies and for investment fund managers to pretend they are making decent returns.
   

What to watch for next week

Sunday 28th Parliamentary elections in Austria, Bavaria and Belarus. Monday Eid al Fitr holidays start in many Muslim countries as well as holidays in China, Israel and several other Asian ones; Australia and Egypt Monday 6th October. Monday Japanese August Retail Sales, UK Consumer Credit, US Personal Income, Core PCE and Eurozone September Confidence. Tuesday Japan’s August Jobless, Industrial Production, Construction Orders, Household Spending and September Small Business Confidence. German August Retail Sales and September Unemployment, UK GfK Consumer Confidence and final Q2 GDP, EZ15 September CPI, US Consumer Confidence, Chicago Purchasing Managers and July CaseShiller Home Prices. Wednesday 1st October Japan Q3 Tank    an Survey, UK Manufacturing PMI, US September Challenger Job Cuts, ADP Employment Change, Manufacturing ISM, Vehicle Sales and Euro area August Unemployment. Thursday UK September Nationwide House Prices and Construction PMI, Bank of England Q3 Credit Conditions Survey, Eurozone August PPI, the ECB decides o rates (expected unchanged at 4.25%), US Factory Orders. Friday September Services PMIs, UK Q2 Housing Equity Withdrawl, EZ15 August Retail Sales, US September Non-Farm Payrolls, Unemployment and Non-Manufacturing ISM.

Positioning and Technical Analysis

Thin conditions, either because of holidays or frozen with fear, mean choppy markets and/or large moves are very possible. If not next week then by mid-October we feel moves should pick up speed. The spread of unsecured bank yields over quality collateral should widen even more, to the sorts of levels normally associated with usury and extortion. Because the epicentre of the storm is the US dollar, the currency should weaken (and commodities move in line). Equity indices look set to plunge next month, the question being who goes the furthest. Some are suggesting we are close to a capitulation point; we disagree. When billions are being thrown at the financial sector meltdown is still (believe it or not) a long way off. Plan accordingly and remember, the taxpayer always picks up the tab.

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Published on  Fri, Sep 26 2008, 14:36 GMT