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Recently in our Weekly we alluded to the UK showing many of the same basic defects as the USA in terms of inflated house prices and sub-prime mortgages. There has been relatively little mention of UK sub-prime from mainstream commentators (exceptions: “Money Week” and “Market Oracle”), but this week the hard-hitting BBC TV programme “Panorama” brought the issue to the broader attention of both the public and politicians. |
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Panorama showed how high-pressure salesmen have sold mortgages at high interest rates (9+ %) to people that even a layman could see were totally unable to afford them. The programme also uncovered massive fraud in the Docklands area in London. There are some 1 million sub-prime mortgages in the UK, repossessions in 2006 were 22,500 and they were 14,000 for the first half of 2007. These figures are likely to increase if mortgage rates rise further. The likely result would then be a loss of confidence in all mortgage-backed securities, much as in the USA.. |
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Obviously the scale of the problem is much smaller than in the USA and the BoE is unlikely to raise rates, so the “general collapse” scenario should be avoided. Nevertheless, house price growth is moderating and may even turn negative this year. |
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The main concerns raised by this programme were, however, with regard to supervision and due diligence: |
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- The Financial Services Authority, which declined to be interviewed by Panorama, has shown a lackadaisical attitude to mortgage supervision, but has yet to admit that publicly (as it has regarding the Northern Rock affair). The FT refers to the tri-partite supervision of the financial markets as “the Bermuda triangle of the British financial system”
- Just as in the USA, the ease with which mortgage lenders can lay off their loans as mortgage-backed securities has led to appallingly lax lending, which has allowed the lenders to take the margin but pass on the risk
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We can only suppose that financial market supervision in the UK is due for another major revision to address unscrupulous mortgage selling, fraud and the moral hazard of easy loan lay-off. In addition, the markets themselves are likely to question more and more the underlying strength of mortgage-related securities. |
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The outlook for interest rates in the UK has turned from moving higher to moving lower, so yield curve steepening at the short end is in view. This suggests short maturities for GBP bonds, but since our recommendation for several months has been for average maturities of three years, we see little need to shorten further. |
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Various authorities are announcing an improvement in bank liquidity, but it has yet to show up in the bond market, with the exception of floating rate notes (mainly issued by major banks). Faith has returned that the major banks are no longer in danger after their ”confessions” and absorption of credit-related losses. Unfortunately, that does not mean that they are fulfilling properly their responsibility as market makers; bond trading remains heavy-going. |
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The 100 + points climb in the DJIA when the FOMC released its minutes showing unanimity in the decision suggests that stock markets believe the Fed will lower rates further. Probably, but it is odd that the Fed itself denies a near-term drop in the overnight rate. With the EUR rates on hold and the US and UK expected to lower rates, the likely impact on the exchange rates is all in favour of the EUR. |
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The performance of local currency bonds (e.g. BRL, TRY, RBB, ZAR) – a basic recommendation of ours for many months – has been so good that partial profit taking should be considered. We would judge the alleged crisis in Kazakhstan to be a possible opportunity. |
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Focus |
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(+) Switzerland: the unemployment rate has declined to 2.6%, its lowest since 2002 |
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(+) USA: with the IMF forecasting GDP growth declining to 1.9% in 2008 (from 2.8% 2007), optimism reigns on future Fed policy. UBS expects two 25 bps cuts this year (October 31 and December 11) |
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(–) Ecuador: the government wishes to levy a 99% tax on the extraordinary profits of the oil companies, but has rejoined OPEC |
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(+) ECB: Trichet has indicated that monetary tightening will not be pursued in the euro zone for the moment because of uncertainties about economic growth |
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( ! ) Carry trade: the JPY versus AUD and NZD has picked up again |
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(+) positive for bonds (-) negative for bonds (!) watch out (?) begs a question |
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