My Diary 380 --- The Bearish Uncle Ben; If The History is Right;

My Diary 380 --- The Bearish Uncle Ben; If The History is Right; U HO The EURO

February 28, 2008

Across the planet, equity markets had a very choppy session (+0.2% in DM, 0.4% in HIS and other EMs) and you can feel that caution is the dominant scene and market sentiment is sensitive to the now continuous flow of earnings reports... Indeed, it is time to see how the corporate world’s bottom lines get hit?

Overnight, news flow was largely negative, starting with a Citi analyst said that they expect JPM to write down $1.44bn and BoA with $2.5bn. These two banks were thought to be done with write downs and above the fray, which suggests that the banks/brokers that are in worse shape have more to come…… This is consistent with my cautious view as the story of structure credit blow-out has not come to an end……More data was out later…January Durable Goods was -5.3%, considerably worse than expected, and FNMA's Q4 earnings was at a net loss of $3.6bn, with an additional note of $2.0 bn increase in combined credit loss reserves in light of delinquency, default and severity trends. In other parts of newswire, housing is still the source of weakness as new home sales fell 2.8%m/m in January, extending the peak to trough sales-decline to almost 60%. The recent sales, price and starts data have not yet show a little sign of any firming in housing activity. A slight relief coming from OFHEO’s announcement that effective March 1, the portfolio growth caps for Fannie and Freddie will be removed.

Looking back, the recent days' moves suggest that when the market finally thinks the bottom in prices is near, a massive short covering rally is coming…Where to from here? Tonight will see another data potpourri with Claims, Q4 GDP, and core PCE, plus Freddie Q4 earnings …… there are a lot to digest in this week….

The Bearish Uncle Ben

Last night, Chairman Bernanke’s testimony focused on the downside risks to growth, affirming market’s expectations for a 50bp rate cut next month. His speech highlights that the negatives from the economy are 1) consumer spending, dragged down by high energy prices, falling wealth and tighter lending terms; 2) housing, dragged down by high home inventories and the credit crunch, compounded by an illiquid market for secondary trading of jumbo loans; 3) non-residential construction, which after recently booming is likely to decelerate "sharply" as a result of tighter lending standards for commercial real estate loans; 4)business fixed investment generally, due to tighter credit standards (again) and the slowing growth in final sales; and 5) the labor market, which is showing clear signs of rising unemployment.

On the other hand, some positive offsets were mentioned, including 1) the fiscal stimulus will boost growth later in the year; 2) the lagged effects of Fed easing will come through later; 3) business inventories (excluding homes) was low and unlikely to depress growth; 4) exports should continue to do well as global growth is expected to hold up despite some slowing in some parts of the world; and 5) non-financial corporate profits, liquid balance sheets and historically low leverage ratios should provide some support for the economy.

However, whatever how carefully the Fed chairman choose his wording, the ultimately scenario is1.3-2% GDP growth in 2008. Moreover, He also pointed out that inflation had become less favorable and that rising inflation risks had risen, partly due to the sharp rises in food and energy prices (as well as higher imports prices as a result of the soft dollar) feeding its way into core inflation. Bernanke warns any un-anchoring of these expectations will "complicate" policy…… A heavy reading of the “Bearish Uncle Ben’s” notes and I want to put down my digestion ……

If The History is Right

I have to acknowledge that so far, much of my understanding of the market and economy is coming from reading and knowing the history… my point is the history is correct, then what should we know …Yes, there are a few critical signs of US economy which I think still point to the North part of growth map… starting from consumer, we knew that the Conference Board survey confirmed the ongoing souring in U.S. consumer sentiment, paralleling the slide in most measures of business confidence. More worrisome piece is that the job security index is showing signs of cracking (near zero). Historically, such breakdowns persisted and coincided with recessions, underscoring that the economy is in a high risk area…. Imagine, if someone loses his or her job under current credit environment, how can average Mr or Miss US continue to spend?

The next is that, despite the fact that the Fed has been cutting 225bps since August, it is quite annoying to see the growth of monetary continuing to slowdown. In fact, after adjusting for inflation, the monetary base is actually shrinking. Historically, periods of negative growth in the real value of "high-powered" money have always coincided with economic slowdowns or recessions, plus growth in the monetary base has been quite strongly correlated with total consumer credit and spending, and has actually served as a decent leading indicator at turning points since the 1990s……. should the market be concerned this…Yes, the contraction in the real monetary base is reflective of considerable headwinds for policymakers because not all channels of monetary policy are operating as they should. The corollary to this is that the Fed will have to keep policy looser than would normally be required in the absence of a credit event. The good news is that Fed officials have acknowledged this and provided an open-ended commitment to support the economy.

Another observation is the US business sector start to refrain from taking risk due to the amounting fears of a more serious slowdown in consumption. Certainly, so fat layoffs have not noticeably accelerated, but new job creation has slowed and investment plans have been delayed ( this is why core capital goods orders have tracked sideways in the past year). Importantly, while the Fed has slashed short-term interest rates, this has not translated into lower business borrowing costs. Moreover, there is a strong fear that the availability of capital will remain constrained…… last comment is that if you see all these three points are actually close correlated with each other…you can have more to think about……

U HO, The EURO

Overnight, EURUSD's historic move above the 1.50 threshold has gathered a lot of eyeballs. Having said so, interest rate differentials were the primary driver of the EURO in recent weeks, as In ECB is in no rush to cut interest rates. In turn, the spread between EU and US short rates has surged to 125 bps.

Will this 2yr-long trend imply the end of US Dollar…of course not, but one important point of the Dollar's recent decline is its the broad-based nature. Since February 7, the range of USD r declines stems from 1% versus the JPY, to as much as 6% versus the NOK, with declines versus the AUD, EUR, NZD, CHF, CAD and GBP all falling within that range. In addition, the green paper is falling against most EM currencies as well…… well, it looks like a convincing and consistent story that USD is basically being re-rated, same as many US credit derivative securities…… So Sell the US Dollar, and go for other currencies…..

If more investors go for other currencies, there have another impact to the FX market, if carry trade is still in its function. Over the past few years, the JPY was the daring in this   scenario as low Japanese yields, increased capital outflows from Japan, and the presumed acceptance of JPY weaken among Japanese policy makers. But that has changed for several reasons --- 1) Global equity market volatility and losses since the middle of 2007 have increased substantially, as rendered JPY-funded global equity positions much less attractive and what was previously a one-way bet in the JPY (lower) now has much more two-way risk, depending largely on movements in the stock market; 2) at least equally important on the US side of the equation, the Fed's aggressive interest rate cuts since the end of last summer and particularly in  January have reduced the dollar's interest rate cushion to a point where it has become a favored "funding" currency……See the essences of globalization, you can link Japan to US so easily with dig a hole through the Earth ……

Good night, my dear friends!