President Obama is now trying to deliver the bailout package that is expected to cost USD 825 billion (well, that's a trifle short of a trillion) and save (and aksi create) a total of 4 million jobs over a 2 year time span.
Almost a fourth of this amount comprises tax measures yet the plan is not fully backed by the Republicans because the Government is also "wasting money" on spending public money. However, the package is quite broad and covers energy (including renewable energy program spend), education, healthcare etc. Infrastructure seems to be getting a reasonable share of the spend. The plan is likely to be cleared by Feb 16, 2009, but before that we would also see what the FOMC has decided to do on Monetary Policy front on the 29th January. Well, no rate decisions are left to be taken I suppose, but markets will look for new signals from FOMC. From the reception that the Obama plan has received in equity markets, we are destined to see a small bounce in indices before markets realise that a) the plan is undersized to handle the problem, b) major problems relating to capital and health of banking sector are not handled in the package and c) that demand is unlikely to be sustained as tax payers may use the estimated $ 1,000 per capita to retire debt (in view of the deflationary environment). Of course, the wild estimates of cost of jobs ($ 275,000 per job created) has also raised hackles of Republicans though Democrats say that the cost is likely to be only a fourth. Already doubts have been raised whether this size of the bailout is sufficient.
Quite clearly, the senses of markets have been blunted due to the hits that they have been getting in terms of data, bank crises, corporate losses etc. The success of bailout packages aimed at handling economic crises as well as TARP kind of packages that are aimed at rescuing banks are not raising spirits thanks to the dulling senses.
Meanwhile, an interesting piece of data reveals that banks that have received bailouts have actually stopped lending!!. Thus these are the obvious questions - were banks saved to save jobs or were they saved in order to lend?. While the objective of savings banks initially was to protect the economies, failure of banks to lend is now becoming an embarassment for governments - why were the banks saved if they were not to help save jobs or create employment? why was public money being used to save jobs of fat cat bankers?
Let us address the question - why are banks not lending? Because, obviously they face uncertainty (future losses, capital position)and bad credit climate among others. Banks also find that corporates are overleveraged thanks to the lax credit standards of the past and are making losses due to disappearance of demand and high cost of funding. As a result good borrowers are getting scarce. High credit spreads add to the bad climate and finally convert the situation into a scare climate. The move of the Fed and other Central Banks to provide broad credit comfort is supposed to improve the climate.
Clearly we are getting nowhere. Policy makers are applying learnings from the Depression era and are pushing for spending as opposed to other steps and they seem to be getting nowhere!
Monday, January 26, 2009
Sunday, January 18, 2009
The return of crisis?
Bank Results during the last week in the US have brought back the fears of armagaedon. Exactly 4 months after the Lehman Collapse and the rescue of Merrill and the momentous decision of Investment Banks such as Goldman to convert into Commercial Banks in order to live for "another day", banks are again at crossroads. Their capital depleted by the writedowns of more than one trillion US Dollars, banks are unable to handle the high levels of toxic assets and MTM impacts. Banks are in need of more capital eventhough they have already received about two hundred billions dollars of capital and several billion dollars worth of guarantees and loans. They need to cut the size of the balance sheets now that their results for last quarter of 2008 show more losses and the size of the capital cannot suppport the current levels of leverage on their balance sheets.
Thus, the low interest rates and the deluge of liquidity are of little use as these cannot be turned into advantages due to balance sheet constraints as well as the lack of quality borrowers due to demand destruction.
Now, new plans are being drafted to handle the balance sheet problem i.e., capitalisation level plus the toxic assets problem. One plan is to take out toxic assets from banks and create a new bank that would hold these. The new bank would be capitalised and would borrow to fund the assets. Hopefully, in due course the bank would sell the assets once markets recover and it can be wound up if the plan succeeds. Another plan is to let banks sequester the bad assets on the balance sheet and allow a one-time concession on capital and other norms for such assets in view of the current extraordinary situation. The healthy part of the bank could be capitalised and can hopefully get into business.
While the first one seems cleaner, memories from the SL scandal in the US may come in the way. At that time Banks were allowed to sell their problem loans/assets at inflated price levels (relative to their quality). However, in the given situation since toxic assets and capital are constraints to orderly lending, one of the plans will most likely be put into action.
However, in the given situation this could only help to bring comfort to depositors and lenders of such banks while borrowers are unlikely to benefit immediately. Why? Because demand destruction is not yet complete and only a resurgence of demand can bring in demand for funds.
Thus, in the interim, while the health of banks is taken care of, they would not really lend. So, what would they do? They will go and buy more Treasuries. The logic is simple - buying Treasuries gives enough returns considering the near zero funding rates for banks, capital requirements are minimised and there is no NPL problem. So, the crisis for banks may be solved but the real economy is unlikely to benefit.
Thus, the low interest rates and the deluge of liquidity are of little use as these cannot be turned into advantages due to balance sheet constraints as well as the lack of quality borrowers due to demand destruction.
Now, new plans are being drafted to handle the balance sheet problem i.e., capitalisation level plus the toxic assets problem. One plan is to take out toxic assets from banks and create a new bank that would hold these. The new bank would be capitalised and would borrow to fund the assets. Hopefully, in due course the bank would sell the assets once markets recover and it can be wound up if the plan succeeds. Another plan is to let banks sequester the bad assets on the balance sheet and allow a one-time concession on capital and other norms for such assets in view of the current extraordinary situation. The healthy part of the bank could be capitalised and can hopefully get into business.
While the first one seems cleaner, memories from the SL scandal in the US may come in the way. At that time Banks were allowed to sell their problem loans/assets at inflated price levels (relative to their quality). However, in the given situation since toxic assets and capital are constraints to orderly lending, one of the plans will most likely be put into action.
However, in the given situation this could only help to bring comfort to depositors and lenders of such banks while borrowers are unlikely to benefit immediately. Why? Because demand destruction is not yet complete and only a resurgence of demand can bring in demand for funds.
Thus, in the interim, while the health of banks is taken care of, they would not really lend. So, what would they do? They will go and buy more Treasuries. The logic is simple - buying Treasuries gives enough returns considering the near zero funding rates for banks, capital requirements are minimised and there is no NPL problem. So, the crisis for banks may be solved but the real economy is unlikely to benefit.
Sunday, January 11, 2009
Is the optimism justified? - Why current optimism may be premature
You would have watched the small attempts of bulls to ignite a rally across the global markets. While analysts (the sell side variety!)are back and urging investors to buy, some signals and unresolved questions suggest that these attempts are unlikely to succeed this time round as I show in this posting -
1. Low volumes on Exchanges - While equities have posted rallies of about 10-15 percentage points during the post October phase volumes have been low. Any chartist will tell you that volume is an important indicator.
2. We are in a sidewise pattern on equities - To me this is an indicator of uncertainty especially when I add volume to the price indicators. Of course this need not be bearish always and can well represent consolidation before a leg up though I doubt that enough logic exists for this logic at this stage.
3. Most estimates speak of a recession (or depression in whatever form)that is likely to stay till well into the year 2010 - i.e., in US that would be a 30 month recession which would rank as one of the longest one. Some months ago people had hoped that 2009 would bring in a reversal to the recessionary trend. The huge job losses of about 2 million plus last year in the US alone(revisions to the payroll numbers however suggest much higher job losses) have pushed unemployment to 7.2 pct with possibly more damage due in 2009. The Obama administration has steadily ratcheted up the employment target of its (now) trillion dollar plus intervention plan to bring about a reversal to the ongoing recession. Obama now talks of creating 4 million jobs compared to 2 million plus a few weeks ago.
4. Along with the trillions worth of interventions by Central Banks, Governments are bringing in their share of trillions. Meanwhile, the velocity of money is slowing significantly across the recession hit ecnomies. So banks continue to hold huge quantities of funds but the multiplier effect is being weakened. To my mind this is a stark reflection of the insufficient demand and overwhelming fear of the unknown.
5. The steps by Central Banks and Treasuries are overtly inflationary which is a big reversal in stance in a few months. This brings out the truth - that Central Banks sense a depression is already in or is round the corner. In monetary policy terms that is turning while to black and you cannot accomplish that in a few months nor can you reverse the effect in a few months. I am saying that an inflationary policy will take months to take effect and you dont make such a policy if you intend to reverse it in months.
Given the above, why should equity markets rally now? I dont see a logical reason. On the other hand the fall in yields has begun to reverse - a result of unreasonable panic in some countries but clearly rational in the US and some other places. But, again I am unable to say yet whether this reversal can be sustained; after all, the buying up of various debt instruments by the Treasury in the US and similar steps in other economies should pull yields down and new issuance is yet to hit the roof. A second fall in yields thus seems in order and therefore, a reversal should wait for another 3-6 months.
Then we have the corporate results that are likely to throw up bad vibes. The success of the measures taken by Treasuries and Central Banks so far has been little - yes, we have seen a thaw in credit and money markets and some initial signs of lending. But, how will GDP grow so soon in the face of further weakness in employment and demand. With GDP of emerging markets worsening and employment being hit how is trade to expand? And as I said earlier, the juggernaut cannot be haulted so soon from sliding down and its climb up is likely to take time.
I guess I have enough arguments that point to the threat that the budding optimism may die soon. A bottom is yet to be completed.
1. Low volumes on Exchanges - While equities have posted rallies of about 10-15 percentage points during the post October phase volumes have been low. Any chartist will tell you that volume is an important indicator.
2. We are in a sidewise pattern on equities - To me this is an indicator of uncertainty especially when I add volume to the price indicators. Of course this need not be bearish always and can well represent consolidation before a leg up though I doubt that enough logic exists for this logic at this stage.
3. Most estimates speak of a recession (or depression in whatever form)that is likely to stay till well into the year 2010 - i.e., in US that would be a 30 month recession which would rank as one of the longest one. Some months ago people had hoped that 2009 would bring in a reversal to the recessionary trend. The huge job losses of about 2 million plus last year in the US alone(revisions to the payroll numbers however suggest much higher job losses) have pushed unemployment to 7.2 pct with possibly more damage due in 2009. The Obama administration has steadily ratcheted up the employment target of its (now) trillion dollar plus intervention plan to bring about a reversal to the ongoing recession. Obama now talks of creating 4 million jobs compared to 2 million plus a few weeks ago.
4. Along with the trillions worth of interventions by Central Banks, Governments are bringing in their share of trillions. Meanwhile, the velocity of money is slowing significantly across the recession hit ecnomies. So banks continue to hold huge quantities of funds but the multiplier effect is being weakened. To my mind this is a stark reflection of the insufficient demand and overwhelming fear of the unknown.
5. The steps by Central Banks and Treasuries are overtly inflationary which is a big reversal in stance in a few months. This brings out the truth - that Central Banks sense a depression is already in or is round the corner. In monetary policy terms that is turning while to black and you cannot accomplish that in a few months nor can you reverse the effect in a few months. I am saying that an inflationary policy will take months to take effect and you dont make such a policy if you intend to reverse it in months.
Given the above, why should equity markets rally now? I dont see a logical reason. On the other hand the fall in yields has begun to reverse - a result of unreasonable panic in some countries but clearly rational in the US and some other places. But, again I am unable to say yet whether this reversal can be sustained; after all, the buying up of various debt instruments by the Treasury in the US and similar steps in other economies should pull yields down and new issuance is yet to hit the roof. A second fall in yields thus seems in order and therefore, a reversal should wait for another 3-6 months.
Then we have the corporate results that are likely to throw up bad vibes. The success of the measures taken by Treasuries and Central Banks so far has been little - yes, we have seen a thaw in credit and money markets and some initial signs of lending. But, how will GDP grow so soon in the face of further weakness in employment and demand. With GDP of emerging markets worsening and employment being hit how is trade to expand? And as I said earlier, the juggernaut cannot be haulted so soon from sliding down and its climb up is likely to take time.
I guess I have enough arguments that point to the threat that the budding optimism may die soon. A bottom is yet to be completed.
Sunday, January 4, 2009
Will trade and GDP revive in 2009?
The latest headlines reveal that the US Manufacturing Sector has weakened further and Singapore has increased the targeted contraction of its economy to 2% in 2009.
The US data is reflective of the manufacturing sector while the Singapore data reflects the state of global trade. Putting both the data together gives a composite picture - that the US manufacturing sector is worsening at a rapid pace while the consumer demand is faltering.
During the last three decades collective efforts of the major developed economies and of the major developing economies have laid out clear roles for both - the developed economies were the demand engines the developing economies were the supply sources. The former supplied capital and the latter consumed the capital and in return provided cheap goods to the former.
This crisis clearly reflects the strength of the demand side - the last two decades plus have seen the developing economies strengthen in terms of GDP as a result of meeting the demand of the developed bloc. During the last one year or so, this demand has faltered with clearly disastrous consequences to the emerging markets. Those consequences are still not clear to the world. In the initial phase of the crisis, say, till about June 2008 the emerging economies had the view that the emerging economies were strong enough to rescue the world. However, since then evidence suggests that the only accomplishment has been a delay to the advent of recession in emerging markets. The fall in trade is hitting these markets quite badly bringing in secondary and tertiary impacts on GDP growth.
In this situation, the limits of pulling oneself up by the bootstraps are evident. Emerging markets are attempting to protect growth rates by investing largish sums within their boundaries on such sectors as infrastructure in the hopes that employment generation plus spending will stop a further slide in their health.
The current crisis and the long distance impact on unrelated sectors/markets suggests that all variables should now be kept under an oversight.
Dollar strength should be one such factor. As the weakness in the US is amply demonstrated now, thanks to this crisis, it is natural that the Dollar should suffer. Many seem to have decided that the Dollar will continue to remain strong forgetting that its correction is the best bet for the US to take to get out this crisis.
So, the question is when this may happen rather than whether it would happen. It is my guess that this will happen by June 2009. After an initial period of instability dollar weakness should set in. This would be good news as the US becomes competitive again. However, with most other major currencies displaying similar weaknesses, it appears that it is the emerging market currencies that should strengthen.
Thus a weakness in the US Dollar can bring about a further bout of volatility. In the medium term emerging market economies will grow stronger whereas the Dollar should weaken and the emerging market currencies should strengthen.
The US data is reflective of the manufacturing sector while the Singapore data reflects the state of global trade. Putting both the data together gives a composite picture - that the US manufacturing sector is worsening at a rapid pace while the consumer demand is faltering.
During the last three decades collective efforts of the major developed economies and of the major developing economies have laid out clear roles for both - the developed economies were the demand engines the developing economies were the supply sources. The former supplied capital and the latter consumed the capital and in return provided cheap goods to the former.
This crisis clearly reflects the strength of the demand side - the last two decades plus have seen the developing economies strengthen in terms of GDP as a result of meeting the demand of the developed bloc. During the last one year or so, this demand has faltered with clearly disastrous consequences to the emerging markets. Those consequences are still not clear to the world. In the initial phase of the crisis, say, till about June 2008 the emerging economies had the view that the emerging economies were strong enough to rescue the world. However, since then evidence suggests that the only accomplishment has been a delay to the advent of recession in emerging markets. The fall in trade is hitting these markets quite badly bringing in secondary and tertiary impacts on GDP growth.
In this situation, the limits of pulling oneself up by the bootstraps are evident. Emerging markets are attempting to protect growth rates by investing largish sums within their boundaries on such sectors as infrastructure in the hopes that employment generation plus spending will stop a further slide in their health.
The current crisis and the long distance impact on unrelated sectors/markets suggests that all variables should now be kept under an oversight.
Dollar strength should be one such factor. As the weakness in the US is amply demonstrated now, thanks to this crisis, it is natural that the Dollar should suffer. Many seem to have decided that the Dollar will continue to remain strong forgetting that its correction is the best bet for the US to take to get out this crisis.
So, the question is when this may happen rather than whether it would happen. It is my guess that this will happen by June 2009. After an initial period of instability dollar weakness should set in. This would be good news as the US becomes competitive again. However, with most other major currencies displaying similar weaknesses, it appears that it is the emerging market currencies that should strengthen.
Thus a weakness in the US Dollar can bring about a further bout of volatility. In the medium term emerging market economies will grow stronger whereas the Dollar should weaken and the emerging market currencies should strengthen.
Sunday, December 28, 2008
2008-A year of pain. What about 2009?
The year 2008 has been disastrous for the global markets and for global economies as the deflation fears have established firmly in the minds of people. Economists and Policymakers are debating the methods of Keynes and the events of 1930s are helping to drive policy action.
Thanks to the "learnings" from that period current actions have been more comprehensive, co-ordinated across nations and are promising. However, as we have seen, each crisis has different ingredients and hence the solution must be different. It appears that policy makers are preparing for a situation where there arsenal is powerless, increasingly, and thus we now have a recession with a potential reversal not before calendar 2010.
In the new year the challenges that the world faces would come from emerging markets - in fact those challenges are already visible. Bric economies have begun to slide down and this unravelling has been a major learning from this crisis. In an inter-connected world crises travel across countries. Yet, given their high growth rates and an inherent desire of their populations to grow their Per Capita incomes, new hopes are rising that the emerging markets, especially the Bric economies could be the accelerators and help the developed world to climb up the hill. The trouble with this argument is the lack of sufficient domestic investment in emerging markets and their dependence on exports to the developed world. The world cheered as these economies became the new factories producing cheap goods for the developed world and helped control inflation but the world is now surprised that those economies cannot become the providers of demand or help take up the slack that arose from the slowdown in advanced economies. Hopefully, coordinated action that we are seeing from the emerging economies will help to slowly bring about a quiet recovery. If they fail this recession will be much harder on the developed economies.
We can now also see why a prediction for the dollar has become difficult - if the US is to come out of the mess it needs to export some stuff to other countries (who in turn would have to generate demand). Its currency yields next to nothing. Such conditions ideally bring about a reversal to recessions. A fear of deflation seems to be now haunting everyone which along with the unwillingness of lenders to give money to anyone is hitting credit markets. The other developed economies (with the exclusion of Europe where a major slowdown is some months away) results in the danger of all of them being put into one basket. So, on the twin scales of returns and growth, it would appear that the US should suffer in short-term and show promise in the longer term. However, the fall in long term yields (nominal and inflation-adjusted) promise no long term growth prospect!. So, as you can see the equations do not match up. And hence the state of markets. Hoefully, the new year will throw up some leads and help markets to decide which way to go.
PS: Apologies!I could not update the blog last week. The breakdown/slowdown of the net was one reason while my laziness was the other reason.
Thanks to the "learnings" from that period current actions have been more comprehensive, co-ordinated across nations and are promising. However, as we have seen, each crisis has different ingredients and hence the solution must be different. It appears that policy makers are preparing for a situation where there arsenal is powerless, increasingly, and thus we now have a recession with a potential reversal not before calendar 2010.
In the new year the challenges that the world faces would come from emerging markets - in fact those challenges are already visible. Bric economies have begun to slide down and this unravelling has been a major learning from this crisis. In an inter-connected world crises travel across countries. Yet, given their high growth rates and an inherent desire of their populations to grow their Per Capita incomes, new hopes are rising that the emerging markets, especially the Bric economies could be the accelerators and help the developed world to climb up the hill. The trouble with this argument is the lack of sufficient domestic investment in emerging markets and their dependence on exports to the developed world. The world cheered as these economies became the new factories producing cheap goods for the developed world and helped control inflation but the world is now surprised that those economies cannot become the providers of demand or help take up the slack that arose from the slowdown in advanced economies. Hopefully, coordinated action that we are seeing from the emerging economies will help to slowly bring about a quiet recovery. If they fail this recession will be much harder on the developed economies.
We can now also see why a prediction for the dollar has become difficult - if the US is to come out of the mess it needs to export some stuff to other countries (who in turn would have to generate demand). Its currency yields next to nothing. Such conditions ideally bring about a reversal to recessions. A fear of deflation seems to be now haunting everyone which along with the unwillingness of lenders to give money to anyone is hitting credit markets. The other developed economies (with the exclusion of Europe where a major slowdown is some months away) results in the danger of all of them being put into one basket. So, on the twin scales of returns and growth, it would appear that the US should suffer in short-term and show promise in the longer term. However, the fall in long term yields (nominal and inflation-adjusted) promise no long term growth prospect!. So, as you can see the equations do not match up. And hence the state of markets. Hoefully, the new year will throw up some leads and help markets to decide which way to go.
PS: Apologies!I could not update the blog last week. The breakdown/slowdown of the net was one reason while my laziness was the other reason.
Sunday, December 14, 2008
Negative Yields?! Everything is possible now
This week for the first time since the depression of 1929 the yields on US Treasuries turned negative i.e., investment in such Treasuries would pay back a lower amount on maturity. The three month Treasury bills gave a return of negative 0.005 pct. As the Treasury yields plumbed new lows the credit spreads of high-investment corporate papers worsened further. Spreads have actually doubled during the last 9 to 12 months reflecting the fear factor. CDS on Sovereigns have increased 8-10 times even for G7 countries during the same period!. Net of such spreads yields have dropped to ridiculously low levels reflecting the starkness of fear which is pervading in the world today. Certain indicators such as TED spread which is now at about 2 pct and yields on 30-day Commercial paper (at below 1 pct)etc seem to suggest that the liquidity overhang was helping to bring in some relief and credits were able to access better rates. However, the negative yields on Treasuries threatens to upset the improvement in the markets.
Madness or Fear -
November saw the dividend yield on S&P Index overtake the yield on Treasuries for the first time since three decades showing up the extreme pessimism that has set into the credit markets. This week brought in negative nominal yields after almost
8 decades reflecting the extreme fear prevailing in the market.
The week also saw the evaporation of any residual hopes that Automakers in the US had of a Federal Bailout as the Senate decided that Bankruptcy was afterall not a bad option for the Big Three. The Executive Wing had to immediately step in to promise its support from the TARP in another example of the twists and turns that the programme has been subjected to. It has evolved into a programme that was targeted at purchasing trouobled assets but has actually provided capital/funding to the banking sector and is now addressing the funding constraints of the auto sector. The prospect of use of TARP funds for the Autosector has helped recovery of global markets on Friday.
This episode is the latest one in the series; there will be more to come. This episode which has taken weeks to reach the current stage, shows that governments are increasingly being forced by markets to intervene and support industries. Unfortunately, all these measures seem aimed at supporting the supply side. Markets have anyway decided that this measure is a short-term fix and has a good chance of ending in zero improvement unless the US economy stablises or the Government follows up with more wholesome measures (covering the entire economy). However, the problem is on the other side where consumers fear losing livelihood and bankruptcy (and foreclosures due to inability to service their mortgages). It will take time for the demand side to revive. Until then, pushing the supply side can only worsen the supply/demand equation and lead to pricing weakness to exacerbate.
Currencies
Finally, the week saw the EUR and GBP reverse from their lows. After straining for weeks, on Friday, the Japanese Yen managed to break through the 90 barrier against the Dollar after news of failure of Auto bailout by the Senate hit the market and reached a 13-year high of 89. The move from 91.50 was worth more than 2.50 pct but the move exhausted within the day itself. A move of 3 pct is counted as a large move in the markets. However, the reversal came not from any BOJ intervention (as many had been hoping for sometime), but by the assurances of the US Administration that it would use TARP funds to organise the bailout. The move in the Jap Yen, the mother of all carry currencies on the back of the failure of the Auto bailout as well as the reversal on news of infusion of TARP funds suggests that nerves are really frayed at this stage. But, the key input for markets was the apparently nonchalant reaction of the Japanese to the fall in USD/JPY. Does this mean that we do not have a line in sand any longer? For all those holding long USD/JPY positions on derivatives, or running Yen denominated loans nothing could be more worrisome than this. We need to watch for markets' reaction on Monday. However, if the reactions of equity markets on Friday (in London and US) are any indications, it seems that the break down of the USD/JPY may take some more time.
Meanwhile, the nice rally in EUR/USD helped pull up commodities. EURO is close to resistance zone, so this week's action is important as we run into Christmas holidays from next week. The action on emerging markets' currencies has been a little mixed with the Korean and Russian currencies showing some weakness while many other currencies have strengthened along with stock markets.
The recent moves, with small rallies adding to each other, suggest that we are in the midst of a bear market rally. Equity markets are likely to lose when the quarterly results begin to come out. With all countries (that count) effectively in recession, or suffering from big drops in GDP growth rates there is no way that a rally in equity markets can be sustained so soon. More pain is on the way.
Madness or Fear -
November saw the dividend yield on S&P Index overtake the yield on Treasuries for the first time since three decades showing up the extreme pessimism that has set into the credit markets. This week brought in negative nominal yields after almost
8 decades reflecting the extreme fear prevailing in the market.
The week also saw the evaporation of any residual hopes that Automakers in the US had of a Federal Bailout as the Senate decided that Bankruptcy was afterall not a bad option for the Big Three. The Executive Wing had to immediately step in to promise its support from the TARP in another example of the twists and turns that the programme has been subjected to. It has evolved into a programme that was targeted at purchasing trouobled assets but has actually provided capital/funding to the banking sector and is now addressing the funding constraints of the auto sector. The prospect of use of TARP funds for the Autosector has helped recovery of global markets on Friday.
This episode is the latest one in the series; there will be more to come. This episode which has taken weeks to reach the current stage, shows that governments are increasingly being forced by markets to intervene and support industries. Unfortunately, all these measures seem aimed at supporting the supply side. Markets have anyway decided that this measure is a short-term fix and has a good chance of ending in zero improvement unless the US economy stablises or the Government follows up with more wholesome measures (covering the entire economy). However, the problem is on the other side where consumers fear losing livelihood and bankruptcy (and foreclosures due to inability to service their mortgages). It will take time for the demand side to revive. Until then, pushing the supply side can only worsen the supply/demand equation and lead to pricing weakness to exacerbate.
Currencies
Finally, the week saw the EUR and GBP reverse from their lows. After straining for weeks, on Friday, the Japanese Yen managed to break through the 90 barrier against the Dollar after news of failure of Auto bailout by the Senate hit the market and reached a 13-year high of 89. The move from 91.50 was worth more than 2.50 pct but the move exhausted within the day itself. A move of 3 pct is counted as a large move in the markets. However, the reversal came not from any BOJ intervention (as many had been hoping for sometime), but by the assurances of the US Administration that it would use TARP funds to organise the bailout. The move in the Jap Yen, the mother of all carry currencies on the back of the failure of the Auto bailout as well as the reversal on news of infusion of TARP funds suggests that nerves are really frayed at this stage. But, the key input for markets was the apparently nonchalant reaction of the Japanese to the fall in USD/JPY. Does this mean that we do not have a line in sand any longer? For all those holding long USD/JPY positions on derivatives, or running Yen denominated loans nothing could be more worrisome than this. We need to watch for markets' reaction on Monday. However, if the reactions of equity markets on Friday (in London and US) are any indications, it seems that the break down of the USD/JPY may take some more time.
Meanwhile, the nice rally in EUR/USD helped pull up commodities. EURO is close to resistance zone, so this week's action is important as we run into Christmas holidays from next week. The action on emerging markets' currencies has been a little mixed with the Korean and Russian currencies showing some weakness while many other currencies have strengthened along with stock markets.
The recent moves, with small rallies adding to each other, suggest that we are in the midst of a bear market rally. Equity markets are likely to lose when the quarterly results begin to come out. With all countries (that count) effectively in recession, or suffering from big drops in GDP growth rates there is no way that a rally in equity markets can be sustained so soon. More pain is on the way.
Sunday, December 7, 2008
Strategies for current times
I find that more and more people are puzzled by the Dollar's strength amid the recent global volatility.
I am one of them - the sub-prime crisis originated in the US, the twin deficits are largest in the US, its unemployment is almost 7 pct, its banks are on oxygen supply, its manufacturing and GDP is in shambles. And, the median expectations suggest a depression lasting the full of 2009.
On the other hand, the Eurozone has smaller deficits though it is facing a similar problem on GDP and unemployment. Many OECD countries are passing through a bad phase.
Yet, the dollar has continued to strengthen relentlessly. Recently, though it seems to be forming a top. I would suggest that the dollar's strength is creating for the US economy. When and how would the dollar weaken? We have reached the possible end of monetary policy ammunition of the US - on Dec 16, the Fed could cut rates by upto 75 bp as per median expectations. Liquidity has been flooded into the markets. On the other hand the new evidence from data suggests that the recession is going to be longer and a return to normal conditions before growth has a chance will have to wait till the end of 2009.
Thus, some of the above could impact the dollar negatively - low bond yields may dampen dollar investment flows, Countries with excess current account surpluses are not opening up their borders to imports which could hit the US more than others, the Treasury bonds may turn unattractive due to their low yields and low real yields, a big rise in deficit could bring about a selloff in bonds due to inflationary expectations.
Companies that have non-dollar exposures may look at hedging these.
I am one of them - the sub-prime crisis originated in the US, the twin deficits are largest in the US, its unemployment is almost 7 pct, its banks are on oxygen supply, its manufacturing and GDP is in shambles. And, the median expectations suggest a depression lasting the full of 2009.
On the other hand, the Eurozone has smaller deficits though it is facing a similar problem on GDP and unemployment. Many OECD countries are passing through a bad phase.
Yet, the dollar has continued to strengthen relentlessly. Recently, though it seems to be forming a top. I would suggest that the dollar's strength is creating for the US economy. When and how would the dollar weaken? We have reached the possible end of monetary policy ammunition of the US - on Dec 16, the Fed could cut rates by upto 75 bp as per median expectations. Liquidity has been flooded into the markets. On the other hand the new evidence from data suggests that the recession is going to be longer and a return to normal conditions before growth has a chance will have to wait till the end of 2009.
Thus, some of the above could impact the dollar negatively - low bond yields may dampen dollar investment flows, Countries with excess current account surpluses are not opening up their borders to imports which could hit the US more than others, the Treasury bonds may turn unattractive due to their low yields and low real yields, a big rise in deficit could bring about a selloff in bonds due to inflationary expectations.
Companies that have non-dollar exposures may look at hedging these.
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