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.
Sunday, December 28, 2008
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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