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Weekly Market Commentary

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Counterparty risk is at the core of current woes

Mon, Oct 6 2008, 10:05 GMT
by Nicole Elliott

Mizuho Corporate Bank

Overview

Counterparty risk is at the core of current woes. Credit Default Swaps and Credit Spreads have widened, $200B has been withdrawn from the Commercial Paper market (total now $1,600B), top names cannot issue bonds, Corporates draw down existing Credit Lines and Hedge Funds lock investors in for months. Big moves in many instruments have ensured that implied volatility is close to its highest in at least fifteen years, the Euro’s one-month at-the-money hitting a record 17.9% as it suffers its biggest weekly decline ever against the US currency, which has gained considerably against all others except the Yen, so that Yen crosses are at their lowest levels in two years; unwinding of the ‘carry trade’ and repatriation into America the cause. The USD money market is the most chaotic we have ever lived through, worse than October 1987 and the 1990’s Savings & Loan crisis; overnight Libor ranged from 10.00% one morning to 1.00% that same afternoon. How can anyone be expected to run a bank, or any other business for that matter, with these huge gyrations? Cash has been pouring into Treasuries, especially two-year and today thirty-year Bunds, safe-haven status eclipsing inflation fears. Equity indices are down, anywhere between 3% and 8% for most, Dow Jones Transportation Average hardest hit –12% this week; many Asian and Middle Eastern ones were closed for holidays. Commodities are also lower making some pause to consider the implications for emerging market exporters of these things adding to worries regarding investment flows.

Political and Economic Developments

The global financial crisis has been front page news almost everywhere, every day this week. While US politicians ponder an unprecedented $700B bank rescue package, the Greek and Irish governments went a big step further by guaranteeing all the debt of their financial institutions. Squeals from other Eurozone countries and the Competition Commissioner Neelie Kroes wades in. Meanwhile Germany’s Hypo Real Estate got €35B and Benelux Bank Fortis €11.2B government bail-outs, Iceland’s Glitnir Bank and the UK’s Bradford & Bingley were nationalised, Citi got to gobble up Wachovia for next to nothing, only to be gazumped by Wells Fargo today. Tuesday Britain’s FSA increases to £50K per customer deposit compensation. US Weekly Unemployment Claims are at 497K, Continuing Claims 3591K, levels consistent with recession. US September Non-farm Payrolls –159K and Unemployment 6.1%, August Personal Spending flat. Eurozone Unemployment inched up to 7.5%, Japan’s to 4.2% (the highest in two years) and the Job-to-Applicant ratio dropped to 0.86, lower than at any time in four years. The Quarterly Tankan numbers were grim. UK September Nationwide House Prices dropped 1.7% on the month and a record 12.4% Y/Y, Q2 Housing Equity Withdrawl halved from Q1 while Net Lending secured on dwellings and Mortgage Approvals slumped to record lows.

Underlying Themes

US September motor vehicle sales collapsed to their lowest levels in fifteen years and at the Paris motor show they are still trying to sell shiny new cars by draping leggy lovelies over them. For goodness sake, get with the plot! Total sales of vehicles in the US dropped 23.7% from a year ago, hardest hit domestic and imported trucks. German September new car registrations –1.5% to 261,400, and Spanish ones –32.0%. Similar results in the rest of Europe except France where government incentives helped them rise 8.4% on the month. BMW and Ford CEO’s see no improvement in 2009, SEAT to cut production 5% next month and Ford Southampton is operating a four-day week. A study by Grant Thornton LLP suggests that 1 in 5 (3800) US car dealerships could fail next year, hit by falling sales, operating losses and a lack of credit. Sunday Alabama-based Heard Enterprises, one of the biggest GM dealerships which had a revenue of $2.5B at its peak, filed for bankruptcy.

What to watch for next week

President Sarkozy has hastily convened a credit crisis summit in Paris this weekend and the haggling has already started. Monday holidays in Australia and Egypt while the Bank of Japan starts a two-day rate-setting meeting (expected unchanged at 0.50%), UK August Industrial Production, Eurozone October Sentix Investor Confidence and EU finance ministers meet in Brussels. Tuesday German August Factory Orders, US Consumer Credit, UK September NIESR GDP and Minutes of the 16/9 FOMC. Wednesday German August Industrial Production, Japan September Bankruptcies, Economy Watchers’ Survey, UK Consumer Confidence and BRC Shop Price Index, EZ15 final Q2 GDP and US August Pending Home Sales. Thursday Japan August Machine Orders, German and UK Trade Balances, US Wholesale Inventories, the ECB’s Monthly Report and the Bank of England decides on rates (probably unchanged at 5.00% though some think a 25 basis point cut would help). Friday Bank of Japan September Minutes, Money Supply, US Import Price Index and August Trade Balance while G7 finance ministers meet in Washington. Parliamentary elections Lithuania Sunday and Monday the 13th is a Japanese holiday.

Positioning and Technical Analysis

The more defensive the strategy, the better. Current financial turmoil still has a long way to run and will probably gather pace and whip up more fear as it goes along. Remember, many US and European companies must produce audited accounts for the year ending December, some closing their books by Thanksgiving, so the temperature should rise rather than fall over the next six weeks. Lets see what new bits of ‘sticking plaster’ the authorities can come up with.

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Published on  Wed, Oct 8 2008, 11:20 GMT