My Diary 325 --- Central Banks’ Show, Next Leg Down, Doomed CPDO

 

My Diary 325 --- Central Banks’ Show, Next Leg Down, Doomed CPDOs, Stock Calming Stocks and Dancing Yen/Oil

 

 

 

September 7, 2007

 

Today is my birthday and US non-farm-payroll day. Getting older is just part of a human being’s life and I wish the market will sail through the current financial storm soon…

 

 

Central Banks on Shows!

Overnight, global central bankers were under the spotlights again. In an unanimous decision, the ECB left rates unchanged as expected citing the uncertainty about the outlook for the economy in the euro area due to the ongoing turmoil in financial markets. The ECB also didn't use the code word strong vigilance suggesting that an October rate hike is not on the agenda. However, given that GDP is expected to continue to grow at sustained rates driven by strengthening private consumption, while the bank still sees upside risk to inflation, the ECB kept its tightening bias.

 

The bigger surprise came from the BOE, which felt the need to release a statement despite leaving rates on hold as expected.  Therein they reiterated that developments in financial markets were being watched closely. Like the ECB, the MPC sees growth still solid and inflation risks to the upside.

 

Additionally, ECB pumped another 90bln into  the market via O/N tender and short rates fell from 4.60 to 3.85. Spreads are widening further and bonds get passed around among dealers on cheaper and cheaper levels as nobody wants to have any risk on his book anymore.

 

Certainly, PBOC never let their peers playing single shows. Overnight, the just announced another 50bp rise in RRR, the seventh increases this year. After this increase, the RRR has risen to 12.5%. The continuing reserve requirement hikes and the liquidity measures are further indications that Chinese policymakers are reluctant to use a faster appreciation of the CNY to slow down the economy.

 

 

Ready for next leg down?

Economy wise, the largely unchanged MOM ISM non-manufacturing index provided no evidence of deterioration in economic conditions. In addition, higher retail sales and rising productivity helped allay concern that credit market losses will cause a recession. Yesterday, two regional Fed presidents said the economy is weathering rising credit costs.  But an upward revision to 1Q07 unit labor cost nonetheless ensured an upward revision in the 2Q07 oya rate to a highly elevated 4.9% from 4.5%. As a general rule, when unit labor cost grows above inflation, there would either be margin compression or higher inflation.

 

Thus, while the growth impact of recent financial market turmoil has taken center stage, the FOMC will be alert to the upside inflation risks posed by elevated unit labor cost. Meanwhile, delinquency and foreclosure rates continued to move gradually higher in 2Q07…… I still don’t feel excited on the news flow so far.

 

Although the market has so far rejected the yield lows but I hold the view that we are close to the next leg down as stress in MMKT remains high with short dated libor climbing up to just below the discount rate. Issues are coming to the market in corporate world, but the market feels very unstable and there are still toxic bid lists doing the rounds with no takers. I also have not heard the last of big blow ups in hedge fund space. There is no end in sight to housing market woe and the consumer no longer has a rampant stockmarket to make up for the negative wealth effect coming from the decline in real estate prices. 

 

Most importantly,  there are signs that the labour market is beginning crack which makes the fundamental outlook pretty bleak andtThe Fed remain extremely reluctant to cut rates and are going to do their best to hold back from offering risky assets relief from the current crisis. 

 

 

CPDOs Are Doomed!

Liquidity at the cash end of the curve remains a mess with anyone receiving fixed feeling the pain of 3M LIBOR 80 bps higher since the end of July. According to a Fed report, the US CP market shrank for a fourth week as investors balked at buying debt backed by sub-prime mortgages. Short-term debt maturing in 270 days or less fell $54.1 billion in the week ended yesterday to a seasonally adjusted $1.93 trillion.

 

In HK, the market was very quiet before the US NFP figure tonight. The most notable thing is that the short end HIBOR going down by 6-7bps. In the bond market, I saw aggressive buying for the 1-3m bills, preparing for the coming IPOs and also because of the lower shorter end HIBOR rate.

 

A new asset class contaminated by sub-prime caught my eyeballs is CPDOs (I believe not too much ppl know what the hell it is!). Street analysts told me that Moody's and S&P assign their AAA ratings to CPDOs because of rules designed to ensure they never have to pay a debt insurance claim. CPDOs typically provide debt insurance on a basket of 250 investment-grade companies by using the benchmark CDX NA IG Index and the iTraxx index in Europe…… I start to thin Less is more now.

 

The CPDO model is being challenged as worsening perceptions of credit quality reduce the value of the credit-default swap contracts included in the securities. Those CPDOs that provided insurance on the 125 companies in the CDX index in March for a premium of 36.75 bp, or $36,750 for every $10 million debt, will have to pay nearer 70 basis points to close the contract when the index rolls on Sept. 20, based on current prices…... Hey, how many of you still believe in “AAA” structural rating as many AAAs now are turning out to be as vulnerable to default as high-risk, high-yield bonds. (Anybody knows the layers between AAA and CCC rating? Use your fingers and toes together!!)

 

 

Stock Is Calming Down!

Believe it or not, what cool down today is A-shares, CSI300 down 2.17% to 5294…Wow, it is A-share market down on the back of Premier Wen Jiabao’s talk in Davos Forum that China will maintain flying. And Chinese media already begin to tell the world that we may need to neglect a little the subprime in US and pay more attention to China’s influence to the world economy with its rapid growth. A bull market really make a difference as you can speak louder….:)

 

However, I think the downside risks on A-share market have started to accumulate. I want to be cautious on A-share due to RRR hike, high CPI, and possible another rate hike. On the monetary policy front, the PBOC’s unexpectedly RRR hike before August CPI print clearly implies that the Bank wants to do sth in advance. It actually has done so by selling 3YR T-notes on inter-bank market. 

 

For H shares, I would recommend to BUY if market over-correct due to the above news. The logic flow is that if China starts to correct, HK market may be pull down at first but that will provide a opportunity to buy as the weakness of A-shares will trigger more money flow into HK, and the government will be willing to see a correction in A market at current level and may speed up QDII as well. My top picks are consumers, infrastructure and asset injections stories, including Parkson, GOME, ICBC, CCB CBNM, Zhenhua Port Machinery, COLI, Sinotrans and Cosco Pacific.

Yen and Oil are Dancing!

The yen headed for a weekly gain (157.55 /Euro and 115.11/USD) against 14 most-active currencies this week as declines in Asian stock markets prompted investors to shun the risk of trades funded with loans in Japan. The Japanese currency rose the most against New Zealand's dollar, a favorite of so-called carry trades, after U.S. data this week showed manufacturing slowed and pending home sales fell the most on record, fueling speculation losses on mortgages to homeowners with poor credit will reduce demand for riskier investments. The Nikkei fell 0.83% today and I have some new statistics for you, that Nikkei has a correlation of 0.84 with the dollar-yen this year, while the S&P 500's is 0.61.

 

Oil markets welcome strength in terms of price. Crude oil traded near a 5W high in New York after a report showed U.S. supplies fell more than expected. Oil stockpiles dropped 3.97 million barrels, the eighth decline in nine weeks and almost twice as much as analysts had forecast. Now, traders are focusing on OPEC, which pumps about 40% of the world's oil and will discuss output quotas at its meeting in Vienna on Sept 11. No clear position has emerged so far.  It is September 11 again……

 

 

Good night, my dear friends