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5 CREDIT BUBBLE
BULLETIN At
the heart of disorder By Doug
Noland
much of the year, a crucial dynamic
that masked rapidly developing fragilities and
vulnerabilities. These flows were surely critical
in supporting speculative trading positions away
from the mortgage bust.
In particular, I
believe the general backdrop delayed a problematic
unwind of leveraged and highly speculative
positions in corporate credits (securities,
derivatives and other structured products).
Shorting mortgage-related credit last year
provided a convenient mechanism for hedging
corporate credit and equity market risk.
Meanwhile, the combination of profitable (mortgage
bust-related)
shorts and hedges - in
concert with industry fund inflows - emboldened
the speculators to press their (huge) bets on
technology, energy, the emerging markets, global
equities, and other speculative bubbles. The
relative resiliency of the US corporate credit
market and global markets through 2007 played a
critical role in delaying impending economic and
stock market adjustment.
Well, I believe
the dam broke in January. The leveraged players
were hit with losses from all directions. Their
long positions were immediately slammed with
simultaneous bursting bubbles round the globe.
Meanwhile, a rush to unwind positions led to
upward pressure on the heavily shorted sectors,
only compounding the leverage speculating
community’s predicament. Last year fostered an
extraordinary dynamic of ballooning "crowded
trades", and January saw the bursting of this
multifaceted bubble.
The leveraged
speculating community has suffered the occasional
tough month - last August providing a recent case
in point. Each time, however, performance quickly
bounced back. In true bubble fashion, each quick
recovery from a setback emboldened all involved;
industry fund inflows not only never missed a beat
- they accelerated. Yet a strong case can be made
today that this (historic) bubble has now burst -
that last year was the last gasp before succumbing
to new post-credit bubble realities. I don’t
expect performance to bounce back, while I do
foresee a flight away from the leveraged
speculating now beginning in earnest. With crowded
trades unraveling virtually across the board,
marketplace risk is now escalating significantly
for leveraged strategies in general. Systemic
liquidity issues and dislocated market conditions
have created an environment where there is
seemingly no place to hide.
Importantly, a
leveraged speculating community unraveling would
prove a death blow for myriad sophisticated
trading strategies and risk models, with enormous
ramifications for systemic stability. There are
unmistakable Ponzi dynamics involved here worthy
of a few Bulletins.
Going forward, I
expect a foundering leveraged speculating
community to be at the heart of deepening monetary
disorder. The initial victims appear the fragile
global equities market bubbles and the US
corporate credit market. Forced deleveraging of
hedge fund corporate debt and derivatives is in
the process of creating a massive overhang of
securities to sell, in the process profoundly
curtailing credit availability and marketplace
liquidity throughout. The ramifications for our
finance-based bubble economy are momentous. As an
economic and financial analyst (as opposed to
fear-monger), I feel it is imperative to highlight
that it is more technically accurate to categorize
the unfolding scenario in the historical context
of an economic depression rather than recession.
This is certainly not shaping up as a short-term
inventory-led economic adjustment or mid-cycle
slowdown. Instead, we have now entered the very
initial stages of what will likely prove a deep,
prolonged and arduous adjustment to the underlying
structure of our credit and economic systems.
WEEKLY WRAP For the week, the
Dow dropped 4.4% (down 8.2% y-t-d) and the
S&P500 fell 4.6% (down 9.3%). The Transports
declined 2% (up 3.1%), and the Morgan Stanley
Cyclical index sank 5.5% (down 7.1%). The Morgan
Stanley Consumer index declined 2.3% (down 7.6%),
and the Utilities slipped 3.1% (down 8.3%). The
small cap Russell 2000 fell 4.3% (down 8.8%), and
the S&P400 Mid-Caps declined 3.6% (down 7.5%).
The NASDAQ100 dropped 4.4% (down 14.9%), and the
Morgan Stanley High Tech index sank 5.1% (down
14.6%). The Semiconductors were hammered for 7.9%
(down 14.3%). The Street.com Internet Index fell
4.5% (down 11.4%), and the NASDAQ
Telecommunications index was hit for 4.4% (down
12.1%). The Biotechs dropped 4.5% (down 7.6%). The
rally in financials reversed abruptly. The
Broker/Dealers sank 8.1% (down 6.1%) and the Banks
8.4% (down 0.7%). Although Bullion was up $17.50,
the HUI Gold index declined 1.7% (up 8.4%).
Three-month Treasury bill rates rose 9 bps
this past week to 2.22%. Two-year government
yields sank 13 bps to 1.93%. Five-year T-note
yields declined 5.5 bps to 2.685%, while ten-year
yields rose 5 bps to 3.64%. Long-bond yields
jumped 11 bps to 4.42%. The 2yr/10yr spread ended
the week at 167 bps. The implied yield on 3-month
December ’08 Eurodollars sank 16 bps to 2.36%.
Benchmark Fannie MBS yields jumped 12 bps to
5.20%, this week under-performing Treasuries. The
spread on Fannie’s 5% 2017 note widened 3 to 56
bps and Freddie’s 5% 2017 note widened about 3 to
57 bps. The 10-year dollar swap spread increased
3.2 to 66.5., the highest level since year-end.
Corporate bond spreads were wider, with an index
of junk bonds this week 16 wider.
Investment grade issuance included Verizon
$4.0bn, Wachovia $3.5bn, United Health $3.0bn,
Kinder Morgan $1.45bn, Sysco $750 million, Ace Ina
Holdings $300 million, and Ecolab $250 million.
Junk issuance included Forbes Energy $205
million.
Convert issuance included AAR
Corp $225 million, Chiquita Brands $200 million,
and Radisys $55 million.
Foreign dollar
debt issuance included British Sky Broadcasting
$750 million.
German 10-year bund yields
declined 5 bps to 3.86%, while the DAX equities
index declined 2.9% (down 16.1% y-t-d). Japanese
"JGB" yields dipped one basis point to 1.415%. The
Nikkei 225 sank 3.6% (down 15% y-t-d and 24.7%
y-o-y). Emerging equities markets were weak, while
debt markets were weaker. Brazil’s benchmark
dollar bond yields surged 30 bps to 5.99% (high
since September). Brazil’s Bovespa equities index
fell 2.0% (down 7.5% y-t-d). The Mexican Bolsa
dropped 2.3% (down 4.8% y-t-d). Mexico’s 10-year $
yields rose 11 bps to 5.23%. Russia’s RTS equities
index sank 5.0% (down 18.3% y-t-d). India’s Sensex
equities index fell 4.3% (down 13.9% y-t-d).
China’s Shanghai Exchange rallied sharply early in
the week before the exchange closed for the
holidays (down 12.6% y-t-d).
Freddie Mac
posted 30-year fixed mortgage rates dipped one
basis point this week to 5.67% (down 61bps y-o-y).
Fifteen-year fixed rates declined 2 bps to 5.15%
(down 87bps y-o-y). One-year adjustable rates fell
2 bps to 5.03% (down 46bps y-o-y).
Bank
Credit declined $42.1bn during the most recent
data week (1/30) to $9.291 TN, reversing a
majority of the previous week's $74.2bn increase.
Bank Credit has posted a 28-week surge of $647bn
(13.9% annualized) and a 52-week rise of $961bn,
or 11.5%. For the week, Securities Credit sank
$52.9bn. Loans & Leases rose $10.9bn to a
record $6.879 TN (28-wk gain of $554bn). C&I
loans gained $5.5bn, with one-year growth of 22%.
Real Estate loans rose $8.4bn (up 7.4% y-o-y).
Consumer loans declined $3.8bn. Securities loans
fell $6.3bn, while Other loans added $7.1bn.
Examining the liability side, Deposits declined
$27.9bn.
M2 (narrow) "money" supply jumped
$37.6bn to a record $7.529TN (week of 1/28).
Narrow "money" expanded $66.7bn over the past four
weeks, with a y-o-y rise of $432bn, or 6.1%. For
the week, Currency slipped $0.7bn and Demand &
Checkable Deposits declined $9.0bn. Savings
Deposits jumped $29.1bn, and Small Denominated
Deposits gained $3.9bn. Retail Money Fund assets
rose $14.3bn.
Total Money Market Fund
assets (from Invest. Co Inst) surged another
$46.3bn last week (5-wk gain $248bn) to a record
$3.315 TN. Money Fund assets have posted a 28-week
rise of $777bn (56% annualized) and a one-year
increase of $978bn (41%).
Asset-Backed
Securities (ABS) issuance slowed to about nothing
this week. Year-to-date total US ABS issuance of
$25bn (tallied by JPMorgan) is down 60% from
comparable 2007. No Home Equity ABS deals have
been sold thus far, compared to $38bn in
comparable 2007. There has been less than $1bn of
CDO issuance year-to-date, compared to $17bn this
time last year.
Total Commercial Paper
declined $8.6bn to $1.848 TN. CP has declined
$375bn over the past 26 weeks. Asset-backed CP
fell $9.9bn (26-wk drop of $393bn) to $802bn. Over
the past year, total CP has contracted $163bn, or
8.1%, with ABCP down $252bn (23.9%).
Fed
Foreign Holdings of Treasury, Agency Debt last
week (ended 2/6) increased $7.3bn to a record
$2.118 TN. "Custody holdings" were up $61.2bn
y-t-d, or 25.8% annualized, and $320bn
year-over-year (17.8%). Federal Reserve Credit
declined $2.9bn last week to $861.7bn. Fed Credit
has contracted $6.1bn y-t-d, or 11.7% annualized,
while expanding $20.2bn y-o-y (2.4%).
International reserve assets (excluding
gold) - as accumulated by Bloomberg’s Alex Tanzi –
were up $1.355 TN y-o-y, or 27.2%, to a record
$6.331 TN.
Global Credit Market
Dislocation Watch February 8 – Financial
Times (Michael Mackenzie and Henny Sender): "Fears
about corporate and commercial property debt
reached new heights in the US and Europe on Friday
as investors liquidated holdings in a sign of
spreading credit turmoil. The markets were gripped
by worries that economic weakness would affect
corporate profits, leveraged buy-outs and
commercial property. This represents an escalation
of the crisis that began with concerns about US
subprime mortgages. The trading was particularly
heavy in leveraged loans – used by private equity
firms to finance deals. Mutual funds that invest
in these loans have been hit with redemptions,
forcing them to dump some of their holdings. Hedge
funds that bet on the likelihood of buy-out deals
happening have been among the casualties. The
turmoil has also put pressure on banks and other
investors who are holding $200bn of leveraged
loans that they had been hoping to sell. Kevin
Cronin, portfolio manager at Putnam Investments,
said: ‘The overhang of bank debt from last year’s
leveraged buy-out activity is becoming more
problematic. ‘Loans are being liquidated at
distressed prices and banks are looking to reduce
risk.’"
February 8 – Bloomberg (Abigail
Moses): "The risk of companies defaulting soared
to a record on speculation collateralized debt
obligations packaging credit derivatives are being
unwound, according to traders of credit-default
swaps. Contracts on the benchmark Markit CDX North
America Investment Grade Index jumped 4.25 bps to
128.5…the highest since the index started in 2004,
according to Deutsche Bank AG. The Markit iTraxx
Europe index rose 5.5 bps to a record 97.75,
according to JPMorgan Chase & Co. ‘There is
speculation structured products are being
unwound,’ said Jim Reid, head of fundamental
credit strategy at Deutsche Bank…"
February 5 – Financial Times (Stacy-Marie
Ishmael and Henny Sender): "The leveraged loan
market begins the week in ‘disarray’ following the
collapse of efforts to syndicate $14bn of the debt
used to finance the $27.8bn buy-out of Harrah’s
Entertainment, bankers say. The group of banks
backing buyers Apollo Management and Texas Pacific
Group are having trouble selling on the leveraged
buy-out debt to third parties. With the bulk of
the debt remaining on their books, the banks are
sitting on a sizeable loss. The freeze in the debt
market means they now face larger potential losses
on other big buy-outs…and will be more desperate
to get out of the financing commitments on those
deals. Banks are already saddled with more than
$150bn of unsyndicated debt, most of it LBO
related, according to S&P…
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