Overview
Another knock for US equity indices this week as more wake up to reality, which is: there is no money! Many are desperate to shore up balance sheets and the last thing they'll do is lend it to those who really need it (as is always the case with bankers). Meanwhile lack of confidence in the system, and in 'fiat' money itself, is causing traditional funding pipelines to dry up. This is a true 'crunch' which a) is far from over, b) could get a lot worse and c) will affect the 'real' economy. Treasury yields eased, many to their lowest in five weeks or so, while three-month US TBills yield just 1.61% and 2014 TIPS 0.75%. Credit spreads widened, iTraxx to 540 from May's 400 basis points and the TED spread to 140 from 80. European indices are still clinging to pivotal support. Currencies were quiet although the relentless rise and rise of Eastern European ones continues, so much so that the Polish economy minister said this might prevent further planned interest rate rises.
LME three-month Aluminium rallied to a new record of $3375 per tonne as China cuts production at smelters because of potential power shortages during the Olympics. LME Lead, Nickel and Zinc may have found interim lows while precious metals look bid. Grains and oilseeds eased in line with Nymex Crude which briefly dipped back to $135.14 per barrel from last week's record high at $145.85.
Political and Economic Developments
Bad news rumbles on and hopeful squeaks from the authorities are increasingly greeted with the derision they deserve. How did the head of OFHEO on Tuesday have the nerve to claim that Fannie Mae and Freddie Mac are well capitalised institutions? (When their shares trade around one tenth of their peak value and daily price swings of 20% are now the norm). Two cheers for the Fed's Bernanke who agreed to extend the Fed's borrowing window to investment banks and brokers over the year-end (closing it now would see many collapse immediately without their daily 'fix'). And Treasury secretary Paulson is dreaming up schemes using 'covered bonds' to increase the availability and lower the cost of mortgages (yet more creative bundling of debt!). The gentlemen only seem to have a vague grasp of the urgency of the situation.
Figures released by the ECB Thursday showed Q1 assets held by Eurozone investment funds dropped a record 11% from Q4, a whopping wipe-out of €630B to €5.151 trillion in total assets held. Now we get a glimpse of the scale of Europe's problem. The bulk of this was because of the drop in share prices which account for 32% of balance sheets (bonds 29%, mixed funds 28%, equity funds 26% and real estate 5%).
Underlying Themes
Much back-of-the-envelope type sums as the Halifax June House Price index drops for an eighth consecutive month, -6.1% over the year and the sharpest decline in 15 years to £180,344 (which is still almost double the 1995 trough). The current salary for a full-time UK worker is around £30,000, making the home an eye-watering six times average earnings, higher than 1989's 4.9 times. Compared with 3.5 times which is the mean since 1953, and a low of 2.8 times in 1995, these calculations must factor in more losses. Adjusting for interest rates, where three-month Libor peaked at 15.00% in 1990 and is currently 6.00%, today's interest payments on a 90% mortgage account for almost one third of gross wages. For this ratio to drop to 25%, with wages and rates unchanged, the home would cost £140,000 or another 22% down. Assuming no overshooting, of course.
What to watch for next week
Monday the Bank of Japan starts a two-day rate-setting meeting (expected unchanged at 0.50%), EZ15 May Industrial Production and UK June PPI. Early Tuesday UK June BRC Retail Sales Monitor and RICS House Prices, then June CPI, Tokyo Condominium Sales, US PPI and Retail Sales, July ZEW Surveys for Germany and the Eurozone, and Empire State Manufacturing. The Bank of Canada decides on interest rates (expected unchanged at 3.00%) and Fed chairman Bernanke presents his bi-annual report on the economy to Congress. Wednesday Japan May Tertiary Industry Index, UK Average Earnings and June Unemployment, EZ15 and US CPI, US May net TIC flows, June Industrial Production and July NAHB Housing Market Index, and finally the Minutes of the Fed's 25th June FOMC meeting. Thursday just US June Housing Starts and July Philadelphia Fed Survey. Friday Tokyo and Nationwide June Department Store Sales, German PPI, UK Public Finances and Money Supply, Eurozone May Trade Balance and Construction Output. Monday 21st July is Japan Ocean Day holiday.
Positioning and Technical Analysis
Allow for another few weeks of thrashing around key chart levels in equity indices, which should then set off more big falls later this summer. Treasury paper should be increasingly in demand, regardless of yield, as more cracks in the financial system appear - leading to further widening of credit spreads. FX and most commodities will probably be sidelined although a slight tendency to US dollar weakness appears to be taking hold. Watch the Australian dollar for signs of a sustained break above the all-time high around $0.9650 as this will lead others higher. Then we think the greenback might implode, and the short term viability of USA Inc. be questioned, as well as who is to blame and who can pick up the pieces.
Have a nice weekend!
Disclaimer
The information contained in this paper is based on or derived from information generally available to the public from sources believed to be reliable. No representation or warranty is made or implied that it is accurate or complete. Any opinions expressed in this paper are subject to change without notice. This paper has been prepared solely for information purposes and if so decided, for private circulation and does not constitute any solicitation to buy or sell any instrument, or to engage in any trading strategy.
