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For those of us who view the recent stock market rally with bemusement, there are two very real issues threatening the US economy for the rest of the year: the liquidity crisis and the underlying economy. Let us consider each in turn. |
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There are signs of a modest return in bank liquidity. The spread of 3 month USD Libor over T bills is still at about 120 bps (compared with 40 earlier this year), but it is settling down. The banks are apparently lending to each other, but learning to live with significantly higher interest costs. Some of the pipeline of underwritten loans has now been emptied (notable KKR), but there is still a lot left on the banks’ books. Our own business of finding willing counterparties is still “heavy going”, but a little less so. |
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It is certainly to the good that the major banks are “revealing” their write-downs on CDOs. The numbers are gigantic, rarely under USD 1 billion and up to four times that amount depending on the bank. Yet the same banks are so big that the write-downs are in the order of one quarter’s profits, highly embarrassing but survivable. By “coming clean” the banks have helped free up financial markets, and have even protected their own share values with the help of the odd buy back! |
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From this we may conclude that the liquidity crisis is being resolved, but that it cannot yet be declared to be over. It may well be that Libor remains significantly above T bills for a while, and that fixed-income securities trading remains difficult for many months into the future. The commercial paper market may not recover for many months, with the inevitable impact that banks need to bring loans back onto their own books ( = less money to lend). |
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The moderate optimism we express over the credit markets is far from being repeated for the US economy as a whole. For once we find ourselves agreeing with Greenspan: there is a serious risk of a US recession and the certainty of at least a significant slowdown. As we have said many times, the immediate cause of this is the decline in house prices and construction activity, while the underlying cause is US overspending. |
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For us the question is not so much whether the USA will slow, but whether the rest of the world can maintain growth despite partially losing such a prolific consumer. It is impossible to be sure. We lean to optimism as the domestic demand of the BRIC countries and even of the “new frontier” emerging nations (mainly in Africa and Asia) should pick up much of the slack (not just in consumer products, but also in infrastructure investment). Everything now depends on the US economy moderating slowly enough, the USD declining gently, and for the replacement demand to compensate in a timely way. We cannot but remind our readers that the fate of the USD, the US economy and global rebalancing is largely in the hands of a faceless committee in Beijing. |
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Generally accepted wisdom is that the Fed will cut the overnight rate still further and rates will not be raised in Europe. If so, the USD has further to fall (despite Trichet’s attempts to talk it back up against the EUR). We imagine that the Chinese and OPEC central banks will continue to support the USD (they really have no choice), but we would expect Sovereign Wealth Funds (SWF) to be much more interested in other currencies, see Qatar below in Focus The Chinese SWF has opened for business this week. How interesting it will be to see how and where they invest. |
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Focus |
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(–) Switzerland: UBS has announced CHF 4 billion in sub-prime write-downs, equivalent to slightly more than one quarter’s earnings |
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(–) Other sub-prime: Citi has warned of a 3rd quarter drop in profits of 60% and losses of USD 6 billion relating to loans and mortgage-backed securities |
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(+) US housing: foreclosures were up in August by 36% over July and more than double last year’s. Nevada, California and Florida are the most affected |
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(?) UK: the BoE is under pressure to lower the bank rate by ½ % to avoid a possible recession |
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(!) Qatar: the Sovereign Wealth Fund (USD 50 billion) has reduced its exposure to the USD by 50% over two years (currently 40% EUR and 20% in a currency basket) |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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