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Banking

Bond Outlook July 31st

Credit markets remain more alert to dangers of CDOs and the credit squeeze than equity markets, but if the tail strikes, too, watch out! We mean carry-trade unwind.

The dichotomy between bond and equity markets timidly reasserted itself at the beginning of this week as relative calm returned to equity markets, while credit markets worsened, except for top quality bonds. Another dichotomy is now developing: that of sources of (funds) liquidity. Banks (and credit instruments organised through them) are a much reduced source of credit, while surplus countries, many with their sovereign wealth funds, still have massive liquidity available.

Consider first the banks:

  • The securities left on their books tie up their own equity capital and reduce lending capacity

  • The pipeline of LBOs had dried up with some 40 planned LBOs pulled during the current crisis, both because the costs to the would-be borrower have gone up and also because banks have every reason to doubt that they can syndicate the loans

Then consider the sovereign wealth funds:

  • Their first forays into equity markets must have hurt them, but they are so rich that they must be metaphorically shrugging their shoulders. The one thing they cannot do is retreat to Treasuries

  • If China and Dubai are anything to go by, their strategy is to take long-term minority positions where they can influence performance and/or acquire knowledge to “take home” (example: Barclays)

These two sources of liquidity are very different and the second can scarcely make up for the first drying up.

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