Impact of Tighter Credit Conditions on Consumers
From USA Today: “Each week brings fresh evidence of how the credit crisis is causing damage. Last week, for example, the stock market fell after Goldman Sachs downgraded the nation's largest bank, Citigroup, to a sell. Goldman said the bank would likely have to write down $15 billion over the next two quarters, mainly because of its exposure to risky mortgage securities. And darker days probably lie ahead: Mortgage-related losses industry wide are likely to mount through 2009 and further bruise financial institutions, says Mark Zandi, chief economist at Moody's Economy.com. Such losses eat away at banks' capital reserves. That means they can't lend as much money. Goldman Sachs analysts predict that, overall, banks' exposure to risky mortgages could reduce the credit available to consumers and businesses by a staggering $2 trillion… Gary Perlin, Capital One's chief financial officer, said at an analysts' conference this month that the company has become more selective about granting credit cards and auto loans. And JPMorgan Chase says it's being more careful about issuing home-equity credit lines and auto loans, mainly for consumers with poor credit. "When there's less credit extended," says Jack Malvey, chief global fixed-income strategist at Lehman Bros., "it reduces world economic growth and puts the U.S. at risk of recession. The real damage of that could be measured in hundreds of billions of dollars and, depending on what happens to the world economy, it could be $1 trillion."… Credit bureau TransUnion's TrueCredit.com division has begun recommending that consumers maintain a credit score of at least 680 to qualify for prime rates. For years, TransUnion had recommended a score of only 650 or above.
Its rival Equifax has introduced a service to analyze a lender's portfolio to figure out the probability that existing customers or new applicants have adjustable-rate mortgages. Based partly on this factor, lenders could decide to withhold, or to increase, credit to certain consumers….In recent years, consumers have borrowed record-high amounts from credit cards. Revolving balances on credit cards are at an all-time peak, with U.S. households owing a monthly average of $6,960 in the year that ended in September 2007, up 41% from four years ago, according to Synovate, a research firm in New York… By the time the housing slump bottoms out, $1.7 trillion in housing wealth will have been lost, economic consulting firm Global Insight estimates. For each dollar that a home falls in value, consumer spending falls by 4 cents to 9 cents, Fed Chairman Ben Bernanke recently told Congress. That could lead to a drop in consumer spending of as much as $153 billion over several years. While that's no pittance, it's only a fraction of the $9.2 trillion that consumers spent in 2006. Consumers, in turn, are likely to have difficulty gaining access to money. Peters, the Morgan Stanley credit strategist, says the "virtuous cycle of packaging and selling credit has turned vicious." "The impact on the economy and consumers has yet to fully play out," he says. "We're still in the early stages.’”
From Merrill Lynch: “…since the last round of rate relief in late October, the Dow is down nearly 1000 points (was that supposed to happen?). Not only is the stock market down but 9 out of the 10 sectors are in the red, including those allegedly 'recession-proof' groups such as the materials, tech and industrials, which are down more than 8% on average (the only sector up is consumer staples - +0.5% - which is where you want to be in a recessionary backdrop). The VIX has surged 31.3% to a four-year high (but isn't Fed easing supposed to awaken investor "animal spirits"?); Libor and jumbo mortgage rates have actually risen (oh, great - so the Fed rate cut has reduced borrowing costs for Uncle Sam and that's it); and credit spreads have widened sharply (what happened to that great "liquidity" story?). The commercial paper market continues to shrink at a rate that boggles the mind - by $20.8 bln in the November 21 week and by more than $30 bln since the last Fed rate cut. And what this means is that the "shadow banking system" is contracting and more unanticipated assets are showing up on bank balance sheets at the same time. This bulge in the banking sector balance sheet then ties up regulatory capital and in turn ends up curtailing lending growth - this is how credit crunches get started… Since the last FOMC meeting, the futures market has gone from pricing in a December 11 rate cut from 30% odds to practically 100% today; and one must wonder whether the Fed will end up going 50 bps.”
Dow Theory Indicates Stocks Entering Bear Market
From UBS (last Wednesday morning): “Both the Dow Industrials and the S&P 500 are nearing critical support levels that could come into play today if things turn ugly. .. there is a very well-defined, 4.5 year Bull trend in the S&P 500 that comes in today at roughly 1,409. There is well-defined Bearish Divergence seen in the Weekly chart (higher highs in price July to October and lower highs in momentum over the same time) and momentum points South…Dow Theory. Dow Theory holds that Transports and the broader Dow should move in the same direction and when there is divergence, a change in trend is likely for the stock market. The theory goes that the Industrials can’t bask in the glow of higher prices when the shippers who move the goods are struggling. Both the Dow Industrials and the Dow Transports hit intermediate lows on August 16th, 2007—the day before the Fed surprised the market with a Discount Rate cut. What’s worrisome is that the Transports have taken out and closed below their August 16th low—a troubling divergence between the Transports and the Dow Industrials…the August 16th lows in the DJIA (12,518) are a huge support for the broader stock market—a close below this level would bring technical confirmation that a bear market us upon us. There’s also Bearish Divergence in the two charts as well: note how the Dow Industrials made higher highs in the July to October period (like S&P’s) while the Transports made ever-lower highs. Troubling to say the least.”
From MarketWatch: “With the Dow Jones Industrial Average's finish on Wednesday below its August lows, the three Dow Theory newsletters I track are solidly in the bearish camp… Why should you care about the Dow Theory? One reason is that many investors pay close attention to it. I suspect that was one of the reasons that the DJIA seesawed all day Wednesday above and below its August closing low of 12,846. In fact, it wasn't until the final few minutes of trading that it became clear that it would close below that level, and thereby trigger a Dow Theory sell signal. The Dow Theory's popularity should trigger additional selling when investors currently on vacation return from their Thanksgiving holidays, either on Friday, or more likely this coming Monday. Another reason to pay attention to the Dow Theory: Its long-term track record is good. Confirmation comes from none other than the Ivory Tower, which traditionally has pooh-poohed the notion that the stock market could be timed. Consider a study conducted in the mid-1990s by three finance professors -- Stephen J. Brown of New York University, William Goetzmann of Yale University and Alok Kumar of the University of Texas at Austin. They fed Hamilton's market-timing editorials from the early decades of the last century into neural networks, a type of artificial intelligence software that can be "trained" to detect patterns. Upon testing this neural network version of the Dow Theory over the nearly 70-year period from 1930 to the end of 1997, they found that it beat a buy-and-hold by an annual average of 4.4 percentage points per year.”
Fed To Help Ease Year-End Funding Pressures
From the Fed: "In response to heightened pressures in money markets for funding
through the year-end, the Federal Reserve Bank of New York's Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year. The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion. The timing and amounts of subsequent term operations spanning the year-end will be influenced by market and reserve developments. In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC's target rate around year-end."
From Barclays: “…the Fed Funds vs. LIBOR basis swap…spread has moved much wider from its August level. The second more subtle observation is that the forwards have continued to creep higher over time. My interpretation of this is that the market is finally starting to see that the denouement of the current credit problems will not lead back to the excess liquidity of the 2005/2006 cycle. More simply, even after we move beyond a period of extreme tight liquidity, we will rest at a level of Fed Funds at around 20 bps. This is consistent with banks actually serving their traditional roles as lenders of capitals with true funding needs – in stark contrast to 2005-2006 when banks were mainly financial intermediaries.”
From Morgan Stanley: “The repo desk thinks that the rates accepted at Wednesday's operation could give a clear, and to many people surprising, indication of the sort of balance sheet pressures being faced over year end. Today's daily operation yielded average rates of 4.20% for Treasuries, 4.65% for agencies, and 4.70% for mortgages. Based on where repo rates are currently trading over the year end turn, he thinks at Wednesday's term operation Treasuries will have a 3-handle, agencies will be in the high 4's, and mortgages will have a 5-handle. This would be a stark illustration in particular of the balance sheet issues seen funding mortgages over year end. He thinks if the Fed does enough of these operations it could help the LIBOR situation, but the looming near-term at least psychological negative in the LIBOR market is expected to be a 35 bp surge in the 1-month rate (which was 4.80% today) on Thursday when it moves to start encompassing the year end turn.”
From JP Morgan: “Following this morning's announcement of longer-term repo operations to supply year-end liquidity, the NY Fed also announced temporary changes to the securities lending program of the System Open Market Account (SOMA). The securities lending program makes the SOMA's $775 billion portfolio of Treasury securities available for borrowing by primary dealers (collateralized by other Treasury securities) in order to promote clearing and liquidity in the Treasury market. Previously, the SOMA would lend 65% of its holding of any given Treasury security -- that limit has been raised to 90%. Moreover, each primary dealer was limited to 20% with a maximum $500 million per issue (of the 65% available for borrowing) -- those limits have been raised to 25% with a maximum $750 million per issue (of the 90% available for borrowing). Finally, the minimum maturity of securities lent was 13 days, that has been shortened to 6 days. Today's two successive actions by the NY Fed appear aimed at encouraging confidence that the Fed is prepared to act to stem the stresses associated with year-end funding needs.”
Contagion Spreading to Asia as Short-Term Interest Rates Plummet
From the Telegraph: “The global credit crisis has hit Asia with a vengeance for the first time, triggering a massive flight to safety as investors across the region pull out of risky assets. Yields on three-month deposits in China and Korea have plummeted to near 1pc in a spectacular fall over recent days, caused by panic withdrawls from money market funds and credit derivatives… Korean and Chinese three-month yields have fallen from 4pc to 1pc in a matter of days in a eerie replay of events on Wall Street in late August when flight from banks and the US commercial paper markets caused yields on three-month Treasuries to falls at the fastest rate ever recorded. Asian investors appear to be opting for deposit accounts with government guarantees. It is unclear what prompted this latest "heart attack" in the credit system, though rumours abound that Asian banks have yet to own up to their share of the expected $400bn to $500bn losses from the US mortgage debacle… In a rare move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads"… Charles Dumas, chief strategist for Lombard Street Research, said credit woes had led to an alarming spike in the 'Ted spread' between commercial Libor and US Treasury bills, now near 150 basis points. "Libor is at a premium to T-bills not matched the great crash in 1987," he said.”
Rating Agency Reviews of Monoline Insurers Expected Soon
From Dow Jones: “As soon as this week, markets may get a clearer picture of the vulnerabilities of bond insurers to the broadening subprime mortgage contagion. The sector has been pummeled by uncertainty in the past weeks, with share prices tumbling and credit protection costs jumping higher. Investors fear that if the bond insurers, linchpins of the asset-backed, structured finance and municipal bond markets, lose their triple-A ratings, the ramifications for the broader fixed-income markets could be dire.
As the worries have mounted, investors are shunning insured deals, bringing parts of the asset-backed market to a standstill. Bond insurers live off their stellar creditworthiness. Other, less-well-rated issuers tap the insurers to guarantee, or in industry parlance, wrap their bonds to give them a better rating. That makes it cheaper for the issuers to raise funds. But as the subprime mortgage market woes have spread, setting off a broader credit crunch, the ratings firms are taking a closer look at the bond insurers. In particular, they’re looking at their business of selling credit default swaps to insure structured securities such as collateralized debt obligations, or CDOs, many of which are backed by subprime mortgages. Moody’s Investors Service is expected this week or the next to issue a report evaluating the the capital cushion needed to maintain the firms’ Triple-A ratings. Fitch Ratings’ update may be released in early December. Standard & Poor’s Ratings Service plans to complete its review within the next two or three weeks. “Results will be worse and put some of the monolines in a position where they’ll have to raise more capital,” Seth Glasser, director of U.S. credit research at Barclays Capital, recently predicted in a conference call about the stress tests. Downgrades would follow if the insurers have insufficient capital.”
Misc
From Merrill Lynch: “We believe we are going to see a recession in '08”
From UBS: “On Wednesday the Treasury 2yr versus Fed Funds spread re-tested -150bp for only the third time in the last 20+ years. In the last two times that this spread has reached such stretched/stressed levels, a recession has followed.”
From Barclays: “…the slowdown in Home Price Appreciation (HPA) will lead to much slower prepayments which, in turn, will cause mortgages to lengthen in duration. In the vol sector, this ripple effect will lead to much greater demand for vol from mortgage hedgers, particularly in longer dated options.”
From RBSGC: “MBS holdings by US banks increased $7 bn with pass-through and CMO holdings higher by $5 bn and $2 bn, respectively. MBS holdings were down $43 bn since the start of this year. Deposits increased $74 bn over the past week. Since the start of this year, deposits increased $518 bn. Commercial and industrial loans increased $6 bn for all banks over the week. Since the start of the year, C&I loans increased $209 bn. Whole loan holdings decreased $25 bn over the week. Since the beginning of the year, whole loan holdings increased by $186 bn.”
From Bank of America: “Given huge liquidity premiums in the market both because of flight to quality and balance sheet issues affecting 4 large dealers with Nov 30 y/e, we expect a lot of volatility in the rolls this time around and a fairly wide band of uncertainty around the opening levels. We expect the 2yr and 5yr [Treasury] auction sizes to be unchanged at $20bn and $13bn respectively. This would raise $13.8bn of new cash for the Treasury.”
From the Wall Street Journal: “In recent weeks, regulators have quietly ordered China’s commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals. A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don’t exceed the total outstanding on Oct. 31. The official described the request as “guidance aimed at supporting the macro-control measures being implemented."”
From Merrill Lynch: “Chicago Fed National Activity Index is one of the most reliable real-time indictors of economic activity…This index slid 0.73 points in October from a -0.25 average in 3Q - it is now down three months in a row and in five of the past six. We haven't seen a number that low since April 2003 when the corporate sector froze up between the onset of Sarbanes-Oxley and the Iraq war and the Fed was fretting over deflation risks and the jobless recovery.”
From RBSGC: “…the Defined Benefit pension world has closed a massive asset/liability gap that may have been as much as $400 mn 5 years ago. That's due almost entirely to gains on their equity assets. But over the course of these 5 yrs the asset allocation has swung to heavily overweighted equities -- equities as a % of the total have increased by 10-12%. Point being, with FASB in force next year there is a good reason to find pension funds reallocating to a less volatile mix, i.e. more fixed income and fewer stocks.”
End-of-Day Market Update
From UBS: “Treasuries enjoyed a parabolic ascent today as yields on notes and bonds fell by 14-17 bps on the day. Although the curve has tended to steepen during rallies such as this, we actually saw the 2s10s curve more than 2bps flatter at 3pm. Impressively, the curve was back steeper by late in the session as stocks fell by more than 200pts… Swaps saw receiving in the long end on both rates and spread, and spreads narrowed across the board; particularly in the back end. Agencies had only light flows, and although they richened to swaps in the front end, 10-year agencies cheapened to between Libor flat and L+1 by 3pm. Mortgages also had a fairly quiet day, with FNMA 5.5's going 3 ticks tighter to Treasuries and 1.5 wider to swaps, and 6's widening a plus to Treasuries and 3 ticks to swaps.”
From RBSGC: “Stocks reverse gains with Dec S&P closing at a new low under 1425 for an outside day down. The bond market got a strong FLATTENING bid on Monday for some obvious and not so obvious reasons. That reversed later in the day as stocks caved in, but was the dominant theme. In the first instance, stocks gave up the limited gain of Friday and with no key fundamental news tended to capture attention. We note that both Fannie and Freddie were down nearly 10% at one point. News? Nothing specific though some analyst did cut buy recommendations -- with the stock down nearly 64% YTD we wonder why that type of recommendation would be deemed new information. The new element we've NOT seen until today was convexity related buying as swap yields in the 10yr sector came through 4.75% and MBS outperformerd Treasuries. This forced some duration buying… And our long expectation that weaker stocks and the calendar will drive pension funds to reallocate could be at least partial explanation for the very long end's outperformance. Flows were below average today…”
From Deutsche Bank: “10-yr bond yields decline to new lows, carry currencies soften, TED spread widens, LIBOR basis spread also wider in the US…”
Three month T-Bill yield fell 11bp to 3.10%.
Two year T-Note yield fell 21bp to 2.87%
Ten year T-Note yield fell 17bp to 3.83%
Dow fell 237 to 12,743
S&P 500 fell 33.5 to 1407
Dollar index fell .29 to 74.76, another new record low
Yen fell .94 to 107.37 per dollar
Euro rose .003 to 1.487, a new record high close
Gold unchanged at $824
Oil fell $1.15 to $97.03
*All prices as of 4:45pm
From USA Today: “Each week brings fresh evidence of how the credit crisis is causing damage. Last week, for example, the stock market fell after Goldman Sachs downgraded the nation's largest bank, Citigroup, to a sell. Goldman said the bank would likely have to write down $15 billion over the next two quarters, mainly because of its exposure to risky mortgage securities. And darker days probably lie ahead: Mortgage-related losses industry wide are likely to mount through 2009 and further bruise financial institutions, says Mark Zandi, chief economist at Moody's Economy.com. Such losses eat away at banks' capital reserves. That means they can't lend as much money. Goldman Sachs analysts predict that, overall, banks' exposure to risky mortgages could reduce the credit available to consumers and businesses by a staggering $2 trillion… Gary Perlin, Capital One's chief financial officer, said at an analysts' conference this month that the company has become more selective about granting credit cards and auto loans. And JPMorgan Chase says it's being more careful about issuing home-equity credit lines and auto loans, mainly for consumers with poor credit. "When there's less credit extended," says Jack Malvey, chief global fixed-income strategist at Lehman Bros., "it reduces world economic growth and puts the U.S. at risk of recession. The real damage of that could be measured in hundreds of billions of dollars and, depending on what happens to the world economy, it could be $1 trillion."… Credit bureau TransUnion's TrueCredit.com division has begun recommending that consumers maintain a credit score of at least 680 to qualify for prime rates. For years, TransUnion had recommended a score of only 650 or above.
Its rival Equifax has introduced a service to analyze a lender's portfolio to figure out the probability that existing customers or new applicants have adjustable-rate mortgages. Based partly on this factor, lenders could decide to withhold, or to increase, credit to certain consumers….In recent years, consumers have borrowed record-high amounts from credit cards. Revolving balances on credit cards are at an all-time peak, with U.S. households owing a monthly average of $6,960 in the year that ended in September 2007, up 41% from four years ago, according to Synovate, a research firm in New York… By the time the housing slump bottoms out, $1.7 trillion in housing wealth will have been lost, economic consulting firm Global Insight estimates. For each dollar that a home falls in value, consumer spending falls by 4 cents to 9 cents, Fed Chairman Ben Bernanke recently told Congress. That could lead to a drop in consumer spending of as much as $153 billion over several years. While that's no pittance, it's only a fraction of the $9.2 trillion that consumers spent in 2006. Consumers, in turn, are likely to have difficulty gaining access to money. Peters, the Morgan Stanley credit strategist, says the "virtuous cycle of packaging and selling credit has turned vicious." "The impact on the economy and consumers has yet to fully play out," he says. "We're still in the early stages.’”
From Merrill Lynch: “…since the last round of rate relief in late October, the Dow is down nearly 1000 points (was that supposed to happen?). Not only is the stock market down but 9 out of the 10 sectors are in the red, including those allegedly 'recession-proof' groups such as the materials, tech and industrials, which are down more than 8% on average (the only sector up is consumer staples - +0.5% - which is where you want to be in a recessionary backdrop). The VIX has surged 31.3% to a four-year high (but isn't Fed easing supposed to awaken investor "animal spirits"?); Libor and jumbo mortgage rates have actually risen (oh, great - so the Fed rate cut has reduced borrowing costs for Uncle Sam and that's it); and credit spreads have widened sharply (what happened to that great "liquidity" story?). The commercial paper market continues to shrink at a rate that boggles the mind - by $20.8 bln in the November 21 week and by more than $30 bln since the last Fed rate cut. And what this means is that the "shadow banking system" is contracting and more unanticipated assets are showing up on bank balance sheets at the same time. This bulge in the banking sector balance sheet then ties up regulatory capital and in turn ends up curtailing lending growth - this is how credit crunches get started… Since the last FOMC meeting, the futures market has gone from pricing in a December 11 rate cut from 30% odds to practically 100% today; and one must wonder whether the Fed will end up going 50 bps.”
Dow Theory Indicates Stocks Entering Bear Market
From UBS (last Wednesday morning): “Both the Dow Industrials and the S&P 500 are nearing critical support levels that could come into play today if things turn ugly. .. there is a very well-defined, 4.5 year Bull trend in the S&P 500 that comes in today at roughly 1,409. There is well-defined Bearish Divergence seen in the Weekly chart (higher highs in price July to October and lower highs in momentum over the same time) and momentum points South…Dow Theory. Dow Theory holds that Transports and the broader Dow should move in the same direction and when there is divergence, a change in trend is likely for the stock market. The theory goes that the Industrials can’t bask in the glow of higher prices when the shippers who move the goods are struggling. Both the Dow Industrials and the Dow Transports hit intermediate lows on August 16th, 2007—the day before the Fed surprised the market with a Discount Rate cut. What’s worrisome is that the Transports have taken out and closed below their August 16th low—a troubling divergence between the Transports and the Dow Industrials…the August 16th lows in the DJIA (12,518) are a huge support for the broader stock market—a close below this level would bring technical confirmation that a bear market us upon us. There’s also Bearish Divergence in the two charts as well: note how the Dow Industrials made higher highs in the July to October period (like S&P’s) while the Transports made ever-lower highs. Troubling to say the least.”
From MarketWatch: “With the Dow Jones Industrial Average's finish on Wednesday below its August lows, the three Dow Theory newsletters I track are solidly in the bearish camp… Why should you care about the Dow Theory? One reason is that many investors pay close attention to it. I suspect that was one of the reasons that the DJIA seesawed all day Wednesday above and below its August closing low of 12,846. In fact, it wasn't until the final few minutes of trading that it became clear that it would close below that level, and thereby trigger a Dow Theory sell signal. The Dow Theory's popularity should trigger additional selling when investors currently on vacation return from their Thanksgiving holidays, either on Friday, or more likely this coming Monday. Another reason to pay attention to the Dow Theory: Its long-term track record is good. Confirmation comes from none other than the Ivory Tower, which traditionally has pooh-poohed the notion that the stock market could be timed. Consider a study conducted in the mid-1990s by three finance professors -- Stephen J. Brown of New York University, William Goetzmann of Yale University and Alok Kumar of the University of Texas at Austin. They fed Hamilton's market-timing editorials from the early decades of the last century into neural networks, a type of artificial intelligence software that can be "trained" to detect patterns. Upon testing this neural network version of the Dow Theory over the nearly 70-year period from 1930 to the end of 1997, they found that it beat a buy-and-hold by an annual average of 4.4 percentage points per year.”
Fed To Help Ease Year-End Funding Pressures
From the Fed: "In response to heightened pressures in money markets for funding
through the year-end, the Federal Reserve Bank of New York's Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year. The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion. The timing and amounts of subsequent term operations spanning the year-end will be influenced by market and reserve developments. In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC's target rate around year-end."
From Barclays: “…the Fed Funds vs. LIBOR basis swap…spread has moved much wider from its August level. The second more subtle observation is that the forwards have continued to creep higher over time. My interpretation of this is that the market is finally starting to see that the denouement of the current credit problems will not lead back to the excess liquidity of the 2005/2006 cycle. More simply, even after we move beyond a period of extreme tight liquidity, we will rest at a level of Fed Funds at around 20 bps. This is consistent with banks actually serving their traditional roles as lenders of capitals with true funding needs – in stark contrast to 2005-2006 when banks were mainly financial intermediaries.”
From Morgan Stanley: “The repo desk thinks that the rates accepted at Wednesday's operation could give a clear, and to many people surprising, indication of the sort of balance sheet pressures being faced over year end. Today's daily operation yielded average rates of 4.20% for Treasuries, 4.65% for agencies, and 4.70% for mortgages. Based on where repo rates are currently trading over the year end turn, he thinks at Wednesday's term operation Treasuries will have a 3-handle, agencies will be in the high 4's, and mortgages will have a 5-handle. This would be a stark illustration in particular of the balance sheet issues seen funding mortgages over year end. He thinks if the Fed does enough of these operations it could help the LIBOR situation, but the looming near-term at least psychological negative in the LIBOR market is expected to be a 35 bp surge in the 1-month rate (which was 4.80% today) on Thursday when it moves to start encompassing the year end turn.”
From JP Morgan: “Following this morning's announcement of longer-term repo operations to supply year-end liquidity, the NY Fed also announced temporary changes to the securities lending program of the System Open Market Account (SOMA). The securities lending program makes the SOMA's $775 billion portfolio of Treasury securities available for borrowing by primary dealers (collateralized by other Treasury securities) in order to promote clearing and liquidity in the Treasury market. Previously, the SOMA would lend 65% of its holding of any given Treasury security -- that limit has been raised to 90%. Moreover, each primary dealer was limited to 20% with a maximum $500 million per issue (of the 65% available for borrowing) -- those limits have been raised to 25% with a maximum $750 million per issue (of the 90% available for borrowing). Finally, the minimum maturity of securities lent was 13 days, that has been shortened to 6 days. Today's two successive actions by the NY Fed appear aimed at encouraging confidence that the Fed is prepared to act to stem the stresses associated with year-end funding needs.”
Contagion Spreading to Asia as Short-Term Interest Rates Plummet
From the Telegraph: “The global credit crisis has hit Asia with a vengeance for the first time, triggering a massive flight to safety as investors across the region pull out of risky assets. Yields on three-month deposits in China and Korea have plummeted to near 1pc in a spectacular fall over recent days, caused by panic withdrawls from money market funds and credit derivatives… Korean and Chinese three-month yields have fallen from 4pc to 1pc in a matter of days in a eerie replay of events on Wall Street in late August when flight from banks and the US commercial paper markets caused yields on three-month Treasuries to falls at the fastest rate ever recorded. Asian investors appear to be opting for deposit accounts with government guarantees. It is unclear what prompted this latest "heart attack" in the credit system, though rumours abound that Asian banks have yet to own up to their share of the expected $400bn to $500bn losses from the US mortgage debacle… In a rare move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads"… Charles Dumas, chief strategist for Lombard Street Research, said credit woes had led to an alarming spike in the 'Ted spread' between commercial Libor and US Treasury bills, now near 150 basis points. "Libor is at a premium to T-bills not matched the great crash in 1987," he said.”
Rating Agency Reviews of Monoline Insurers Expected Soon
From Dow Jones: “As soon as this week, markets may get a clearer picture of the vulnerabilities of bond insurers to the broadening subprime mortgage contagion. The sector has been pummeled by uncertainty in the past weeks, with share prices tumbling and credit protection costs jumping higher. Investors fear that if the bond insurers, linchpins of the asset-backed, structured finance and municipal bond markets, lose their triple-A ratings, the ramifications for the broader fixed-income markets could be dire.
As the worries have mounted, investors are shunning insured deals, bringing parts of the asset-backed market to a standstill. Bond insurers live off their stellar creditworthiness. Other, less-well-rated issuers tap the insurers to guarantee, or in industry parlance, wrap their bonds to give them a better rating. That makes it cheaper for the issuers to raise funds. But as the subprime mortgage market woes have spread, setting off a broader credit crunch, the ratings firms are taking a closer look at the bond insurers. In particular, they’re looking at their business of selling credit default swaps to insure structured securities such as collateralized debt obligations, or CDOs, many of which are backed by subprime mortgages. Moody’s Investors Service is expected this week or the next to issue a report evaluating the the capital cushion needed to maintain the firms’ Triple-A ratings. Fitch Ratings’ update may be released in early December. Standard & Poor’s Ratings Service plans to complete its review within the next two or three weeks. “Results will be worse and put some of the monolines in a position where they’ll have to raise more capital,” Seth Glasser, director of U.S. credit research at Barclays Capital, recently predicted in a conference call about the stress tests. Downgrades would follow if the insurers have insufficient capital.”
Misc
From Merrill Lynch: “We believe we are going to see a recession in '08”
From UBS: “On Wednesday the Treasury 2yr versus Fed Funds spread re-tested -150bp for only the third time in the last 20+ years. In the last two times that this spread has reached such stretched/stressed levels, a recession has followed.”
From Barclays: “…the slowdown in Home Price Appreciation (HPA) will lead to much slower prepayments which, in turn, will cause mortgages to lengthen in duration. In the vol sector, this ripple effect will lead to much greater demand for vol from mortgage hedgers, particularly in longer dated options.”
From RBSGC: “MBS holdings by US banks increased $7 bn with pass-through and CMO holdings higher by $5 bn and $2 bn, respectively. MBS holdings were down $43 bn since the start of this year. Deposits increased $74 bn over the past week. Since the start of this year, deposits increased $518 bn. Commercial and industrial loans increased $6 bn for all banks over the week. Since the start of the year, C&I loans increased $209 bn. Whole loan holdings decreased $25 bn over the week. Since the beginning of the year, whole loan holdings increased by $186 bn.”
From Bank of America: “Given huge liquidity premiums in the market both because of flight to quality and balance sheet issues affecting 4 large dealers with Nov 30 y/e, we expect a lot of volatility in the rolls this time around and a fairly wide band of uncertainty around the opening levels. We expect the 2yr and 5yr [Treasury] auction sizes to be unchanged at $20bn and $13bn respectively. This would raise $13.8bn of new cash for the Treasury.”
From the Wall Street Journal: “In recent weeks, regulators have quietly ordered China’s commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals. A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don’t exceed the total outstanding on Oct. 31. The official described the request as “guidance aimed at supporting the macro-control measures being implemented."”
From Merrill Lynch: “Chicago Fed National Activity Index is one of the most reliable real-time indictors of economic activity…This index slid 0.73 points in October from a -0.25 average in 3Q - it is now down three months in a row and in five of the past six. We haven't seen a number that low since April 2003 when the corporate sector froze up between the onset of Sarbanes-Oxley and the Iraq war and the Fed was fretting over deflation risks and the jobless recovery.”
From RBSGC: “…the Defined Benefit pension world has closed a massive asset/liability gap that may have been as much as $400 mn 5 years ago. That's due almost entirely to gains on their equity assets. But over the course of these 5 yrs the asset allocation has swung to heavily overweighted equities -- equities as a % of the total have increased by 10-12%. Point being, with FASB in force next year there is a good reason to find pension funds reallocating to a less volatile mix, i.e. more fixed income and fewer stocks.”
End-of-Day Market Update
From UBS: “Treasuries enjoyed a parabolic ascent today as yields on notes and bonds fell by 14-17 bps on the day. Although the curve has tended to steepen during rallies such as this, we actually saw the 2s10s curve more than 2bps flatter at 3pm. Impressively, the curve was back steeper by late in the session as stocks fell by more than 200pts… Swaps saw receiving in the long end on both rates and spread, and spreads narrowed across the board; particularly in the back end. Agencies had only light flows, and although they richened to swaps in the front end, 10-year agencies cheapened to between Libor flat and L+1 by 3pm. Mortgages also had a fairly quiet day, with FNMA 5.5's going 3 ticks tighter to Treasuries and 1.5 wider to swaps, and 6's widening a plus to Treasuries and 3 ticks to swaps.”
From RBSGC: “Stocks reverse gains with Dec S&P closing at a new low under 1425 for an outside day down. The bond market got a strong FLATTENING bid on Monday for some obvious and not so obvious reasons. That reversed later in the day as stocks caved in, but was the dominant theme. In the first instance, stocks gave up the limited gain of Friday and with no key fundamental news tended to capture attention. We note that both Fannie and Freddie were down nearly 10% at one point. News? Nothing specific though some analyst did cut buy recommendations -- with the stock down nearly 64% YTD we wonder why that type of recommendation would be deemed new information. The new element we've NOT seen until today was convexity related buying as swap yields in the 10yr sector came through 4.75% and MBS outperformerd Treasuries. This forced some duration buying… And our long expectation that weaker stocks and the calendar will drive pension funds to reallocate could be at least partial explanation for the very long end's outperformance. Flows were below average today…”
From Deutsche Bank: “10-yr bond yields decline to new lows, carry currencies soften, TED spread widens, LIBOR basis spread also wider in the US…”
Three month T-Bill yield fell 11bp to 3.10%.
Two year T-Note yield fell 21bp to 2.87%
Ten year T-Note yield fell 17bp to 3.83%
Dow fell 237 to 12,743
S&P 500 fell 33.5 to 1407
Dollar index fell .29 to 74.76, another new record low
Yen fell .94 to 107.37 per dollar
Euro rose .003 to 1.487, a new record high close
Gold unchanged at $824
Oil fell $1.15 to $97.03
*All prices as of 4:45pm
Two Year Treasury Yield
Ten Year Treasury Yield
Dow Jones Industrial Average
Dow Jones Transportation Index
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