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The “Tuesday effect” has struck again, as if, every week, the mood of stock markets (but not of bond markets) turns momentarily positive, usually on the basis of some item of good news and despite the black picture overall. This week the “good news” was the USD 7.5 billion purchase of hybrid bonds in Citigroup by the Abu Dhabi Investment Authority suggesting that confidence in financial institutions may be returning. The deal is complicated, with the ADIA facing mandatory conversion, and the conversion ratio decreasing as Citigroup’s share price increases, however, does a yield of 11% suggest a return of confidence? Is there not an element of desperation (one analyst estimates the deal will reduce earnings by about 5% next year) in the world’s biggest bank accepting a Mideast sovereign wealth fund as its new largest shareholder with scarcely a murmur from US authorities? The authorities only require approval for a 5% holding -- ADIA is at 4.9%, and largest shareholder until this deal was Prince Alwaleed, not officially a sovereign wealth fund, but in Saudi there is little difference between state and ruling family).
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Thus, despite the occasional article now appearing with a positive slant (of the kind “the growth rate of US mortgage defaults is now slowing”), we stand firmly by the view that the spreading credit squeeze with its knock-on effects to the real economy has to get worse before it gets better. One of our shareholders compares the state of the credit markets to the image of Archduke Franz Ferdinand, already mortally wounded in Sarajevo, appearing in the car to be perfectly well.
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Last week we reported that bond trading had returned to the difficult, illiquid state of last August. This week it is even worse. Some two-thirds of prices quoted on trading screens (supposedly executable) do not hold to transact. This causes significant problems for many of our clients, who are told to match the best screen price, due to their compliance departments' interpretation of the new MIFID rules.
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A fresh move is underway by some banks, which might be termed a “holier than thou” pose. HSBC has always led the way in openness about its losses on sub-prime. Now it has decided to buy its SIVs and bring back all their assets and liabilities onto its own balance sheet. Other banks are likely to follow suit. A larger banking balance sheet clearly makes demands on capital adequacy ratios: to avoid breaching them bank lending has to be curtailed. Except for housing mortgages, this effect has not yet shown up, but it seems inevitable. If lending slows, so will the economy. The chances of a serious slowdown in the USA are increasing by the day, and the question outstanding is whether the rest of the world will cope with this. Our view is a cautious “yes”, but it will not be scot-free for us all.
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HSBC’s move to greater transparency could herald a positive outcome to the current crisis. There is certainly every need if investor confidence is to return. However, news is emerging (via Bloomberg) of another financial product from which investors are fleeing. Just over a year after 15 securities firms settled claims of manipulating auction-rate bonds, the $360 billion market remains opaque, with investors unable to obtain basic information about trading in their securities, such as the interest rate. The brokers determine the interest rate based on bids received (the securities’ interest rates are reset based on periodic bids (usually less than one month)). Investors are concerned because brokers can advise bidders on what they should pay, and the U.S. SEC allows dealers to use their inside information (such as the range of bids and the ratio of bids to securities) to compete with bondholders. The auction market as it is now is therefore not a level playing field because it denies investors the information they need to assess their liquidity risk; investors have to rely on non-security-specific indices based on auctions results for two days from the previous week. Consequently, investor confidence in the product is collapsing and it is estimated that $ 6 billion of securities sales have failed recently because there were insufficient bids. According to Fitch, bond Insurers accounted for $1.85 billion of failed transactions. Stories such as these are only likely to damage confidence in the markets further.
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Another type of “holier than thou” pose has been struck by Wells Fargo, a bank which seems to have escaped major write-offs (but has still taken some provisions). Its CEO observes, “It’s interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine”. Quite!
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Despite our recommendation in favour of medium-term maturities in USD and EUR, our clients currently clearly prefer short durations and cash. The continual arrival of new cash from the short maturities and, in the case of the insurance industry, from premium payments at the end of year, has created a paradoxical situation. There is a lot of cash available in EUR and CHF, but investors want to steer clear of financials, and find the yield on government bonds too low. Thus the few quality non-financial corporate bonds being issued, especially in CHF, are selling well. Trading on the secondary market is another matter, as are junk bonds!
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Focus |
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(+) ECB: additional money supply is promised to cope with the danger of end-of-year liquidity needs |
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(+) US consumer spending: USD 10.3 billion for Thanksgiving, consumers have increased spending by 8.3% over last year |
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(–) Switzerland: increasing interest rates have pushed the Cantonal Banks of Zurich and Tessin to raise mortgage rates by ¼% to 3.5% |
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(–) Gulf currencies: many of the Gulf states are questioning their dollar peg. Kuwait set an example others my follow to reduce inflation |
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(+) UK: Barclays has announced 3rd Q results, supposedly clearing the decks of sub-prime risk |
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(+) China: the slow RMB revaluation will continue and convertibility may be in sight (Chinese Premier) |
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(–) Lebanon: S&P has downgraded the sovereign debt to B- as a result of the continuing government crisis |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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