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Equity market swoon on TARA failure smacks carry trades for enormous losses

Tue, Sep 30 2008, 08:19 GMT
by John Hardy

Saxo Bank

Contagion risks to "real" economy grow by the day as Congress not likely to act again until late this week.

MAJOR HEADLINES

• New Zealand Aug. Building Permits fell -7.9%

• UK Sep. GfK Consumer Confidence rose to -32 from -40

• Japan Sep. Nomura/JMMA Manufacturing PMI out at 44.2 vs. 46.9 in Aug.

• Japan Aug. Jobless Rate rose to 4.2% vs. 4.1% expected and 4.0% in Jul.

• Japan Aug. Household Spending fell -4.0% vs. -1.3% expected

• Japan Aug. Industrial Production fell -6.9% YoY vs. -6.0% expected

• Australia Aug. Retail Sales Trend out at +0.3% vs. +0.1% expected

• Australia Aug. Building Approvals out at -8.6% YoY vs. -4.5% expected

• New Zealand Sep. NBNZ Business Confidence out at 1.6 vs. -20.5 in Aug.

• Japan Aug. Housing Starts rose 53.6% vs. 49.8% expected

• Japan Sep. Small Business Confidence fell to 40.2 vs. 41.5 expected

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• Sweden Aug. Retail Sales (0730)

• Germany Sep. Unemployment Rate and Change in Unemployment (0755)

• Norway Aug. Retail Sales (0800)

• Switzerland Aug. UBS Consumption Indicator (0800) * UK Q2 Final GDP (0830)

• UK Q2 Current Account (0830)

• EuroZone Sep. CPI Estimate (0900)

• Canada Aug. Industrial Product Price and Raw Materials Price Index (1230)

• Canada Jul. GDP (1230)

• US Jul. S&P/CaseShiller Home Price Index (1300)

• US Sep. Chicago PMI (1345)

• US Sep. Consumer Confidence (1400)

• US Fed's Lockhart to Speak (1700)

• US ABC Weekly Consumer Confidence (2100)

• Australia Sep. AiG Performance of Manufacturing (2330)

• Japan Q3 Tankan Survey (2350)

• China Sep. Manufacturing PMI (0100)

Market Comments

Yesterday's historic swoon in equity markets was triggered by the shocking rejection by the US House of Representatives on the TARA bailout package. Carry trades followed the equity indices into the cellar in a nasty bloodletting - for equities, most of the drop took place in the space of 5 minutes as the outcome of the vote became clear, while carry trades bled well into the Asian session, with AUDJPY posting a low that was over 6.5% below the Friday close overnight. If there is anything that the markets don't like, it is uncertainty, and yesterday obviously created plenty of it, as the US averages saw their second worst percentage drop in decades.
The timing of the House vote on the TARA package could not have been more sensitive, as month- and quarter-end looms for financial institutions and hedge funds today.

The US Congress is not likely to act during the next couple of days of the Jewish new-year holiday, but considering the reaction in markets yesterday and possible further weakness in the coming couple of days, we would not be surprised to see a revote on Thursday or Friday on the package. Only 10-12 votes, after all, need to be changed to bring about the necessary majority for passage, and the markets are casting a very influential vote of their own. A change here and a change there to the language of the bill, and it may yet pass in a couple of days' time.

The Fed and Treasury opened the liquidity to an outright torrent yesterday, by more than doubling the swap lines with the rest of the world's central banks to a ceiling of a mind-boggling $620 billion dollars. We wouldn't be surprised if this kind of measure is expanded again in coming days. The Fed and the Treasury can still do more on the liquidity side to continue to keep the system on life support. Still, as the credit market remain frozen, anecdotal effects of this crunch are beginning to surface, such as the inability of companies to pay wages. Every passing day of credit markets not easing will increase the risk of a further negative and self-reinforcing spiral. Let's hope that relief comes soon.

One thing is most glaringly obvious at this time: the BOE and ECB rate policies are completely out of whack with the current market environment and one has to wonder what the central bank heads and committees are thinking at this point. The BOE ought to cut 200 bps immediately and the ECB 125 bps. How long can these institutions chat up inflation risks as their economies go down in flames? It would seem that the time for an inter-meeting ad hoc rate cut is now in order to instill some confidence that they might considering doing whatever possible to stem further tail risks here. UK Mortgage Lending, for example, has literally stopped - period (GBP 0.1 Billion in Net Lending for Aug, vs. levels of GBP 10 Billion just a year ago)

In the meantime, volatility is likely to remain enormous and the trading environment treacherous. The markets will be difficult to trade - we wouldn't be surprised to see a large bounce in risk appetite in the coming days if signs of a new go at the TARA package become evident, but we dare not guess from what level this rally might take place...

Chart: EURUSD

The USD initially came under pressure yesterday on the failure of the US House of Representatives to pass the TARA bailout package, but later in the day and into the Asian session, the greenback showed that the contagion risks in this credit crunch are not confined to the US and Europe has plenty to worry about as well. The recent swoon in this pair suggests that a retest of the sub-1.4000 lows is the more likely scenario as long as the 1.4550 resistance area continues to hold.

Published on  Tue, Sep 30 2008, 08:25 GMT