Bond and Money Markets Are Creeping Back To Normal
I'm Breathing Again
By blackhedd Posted in Bond market | Economy | federal reserve | money market | TSLF — Comments (30) / Email this page » / Leave a comment »
Noted briefly: recent aggressive actions by the Federal Reserve appear to be calming down the bond and money markets. These markets don't get nearly as much attention as the stock markets, probably because they're more arcane and harder to understand. But they're much larger than the stock markets. In general, they're the dog rather than the tail.
And they quietly went totally bananas during and after the Bear Stearns collapse, even as equity markets reacted in measured fashion. The Fed funds rate (which is usually closely correlated with a more important rate called the "general-collateral repo rate," bounced around violently from day to day. Short-term Treasury bills were in such short supply that the Treasury yield-curve steepened sharply, and for a brief period, repo interest rates on the three-month bill became negative.
In essence, the largest market participants around the world, including foreign central banks, battened down the hatches and traded as if the world were really going to end. (Their expectation was that the Fed would not be able to contain the damage and that more large firms would collapse as Bear Stearns did.) In this situation, credit was almost completely unavailable. If it had continued for any length of time, it could easily have had massive spillover effects in the real economy.
But the last three or four days have seen a significant return to near-normalcy. London LIBOR is back down to a reasonable range (indicating some revival of interbank lending). The Treasury yield curve is flattening. And the three-month Treasury rate is back to about 1.40%. The Fed's second Term-Securities Lending Facility auction last Thursday went very well. And new issues of corporate debt (Oracle, Citigroup, others) have gone quite well indeed. And retail mortgage rates are still falling.
I know this stuff is dry and technical, but I really want you all to be aware that these are extraordinary times, and that the danger to your own material well-being is real. And also that the Fed is on top of things, showing an aggressiveness that is highly unusual in central banks.
-Francis Cianfrocca ("blackhedd")
« Commodity Prices Are Falling Sharply — Comments (29)
Bond and Money Markets Are Creeping Back To Normal 30 Comments (0 topical, 30 editorial, 0 hidden) Post a comment »
...as he's better on the macro and finance side of things than I (finishing up an Econ degree with a specialization in business and regulatory economics), but, as best as I can tell from these figures, we've dodged a bullet in this credit crisis.
Scratch that. We dodged an ICBM.
"No matter how much lipstick you put on the taxation pig, it's still a pig... and it's currently snout-down in your wallet." - Michael Fisk
now I check RS every AM for "the blackhedd report" before I go to the conventional finance sites!
I started raising the alarm back in April of last year. I felt kindof stupid doing it, too.
And ironically, it was bizarre stuff that Bear Stearns was doing that gave me the creeps. I sold all my Bear stock around $150.
Sounds like it's time for you to create your own stock trader scheme to sell to the masses...LOL.
Fighting for conservatism one day at a time.
I was both complimenting you and taking a shot at Ross Jardine (sp?) who sells is Stock Investing Toolkit. He makes it sound like picking stocks is so simple that anyone can do it. That really does a disservice to most of the people who are going to buy his product as they lack the ability to interpret complex data.
Fighting for conservatism one day at a time.
In August he sounded a bit like an alarmist but on November 8 I personally found out he was prescient and if anything, understating the case. You can't get loans from banks for small businesses right now. It's impossible from where I'm standing. And for a while there, American Express for business accounts were coming across on the phone like they were about to invade with guns, pepper spray, grenades and wild dogs. Bad, bad, bad.
...speaking. The precursor was the collapse of two Bear Stearns hedge funds in late June (iirc).
The first big explosion was the BNP Paribas announcement on August 8 that they were suspending withdrawals on three large investment funds. That was the classic sign of a full-on liquidity crisis. The Fed calmed it down a week later with a big discount-rate cut, followed by a Fed-funds rate cut in mid-September.
Then the second leg hit in October, as SIVs started to bust. And that one abated. I remember around this time that third-quarter GDP came out with nearly 5% growth, and everyone outside of Wall Streeters was saying "See, I told you so."
The third one started up in late December. This one killed the stock markets and put commodity prices up sharply. It coincided with the first signs of distress in the real economy. And it's the one that's still going on, four months later.
Your commentary and analysis has been immensely appreciated here -- it has helped us understand the details on a fine-grained enough level to be applicable and it's also helped us to weather the storm. I always share your analysis with my Dad and it's helped us both because of its clarity. I really think you deserve a Blog Award for your work here in the past 9 months.
...first Fed TSLF auction, which was held on April 3. (As you know, they had been rising for most of the year, even as the Fed lowered policy interest rates.)
I'm not too close to the rest of consumer finance. (Credit cards, car loans, small-business lines of credit, etc. I assume that's what you're asking about.)
At this point, I think there's an interaction between consumer expectations for an economic slowdown and extreme risk-aversion by bankers at all levels. I don't know which is the cause and which is the effect, and I don't think anyone else knows at this point either.
Business leaders appear, by and large, to be optimistic about economic conditions in the next several quarters. But they're often overoptimistic. First-quarter earnings-reporting season just started. It'll be very interesting.
At least mine is. We're doing everything we can to keep the business going at the small end of things. We're effectively donating labor to keep the jobs moving and encourage people to do more of them.
But when you have just two people running the place, basically you can look at each other and say: "Wanna work an extra few hours for nothing?" and agree that it's OK.
One little enterprise I'm trying to get going involves me spending many, many hours with no promise of return at all, in the hopes that if I do enough, I'll grow my project to a critical mass and get some proper payback.
Needless to say it's been a relatively slow motion project, but it's getting there :-)
HTML Help for Red Staters
"If we want to take this party back, and I think we can someday, let’s get to work." – Barry Goldwater
One good thing about this crisis is the silver lining that as an entrepreneur or microbusiness you find out exactly what your real costs are, because you have to. In fact one of the reasons I'm cautiosly optimistic about the next 9 months is that during this time we've learned a lot about shaving costs without sacrificing quality. You seriously get to a point where you have to drive the waste down as close as possible to 0, and also decide how committed you are about the venture to begin with. That's about the best thing I can say regarding this debacle. :)
Libor rates have declined by roughly 250 basis points during the past 6 months (Sept-March)
So for ever $1 billion that a corporate borrower has that is pegged to 6M Libor, the borrower saves $25 million annually.
And we are glad to get it!
Remember, the problems in the credit market now generally have been a result of liquidity deterioration, rather than credit deterioration. Although there have been credit issues in the subprime sector, the larger credit market problems- Bear Sterns, and CIT are two extreme examples- were driven by liquidity deterioration rather than credit deterioration.
The problem is- there absolutely will be credit deterioration over the next year. Everyone acknowledges we are in a recession now. Lending covenants are tested using a "trailing twelve month" Cash Income (EBITDA) number. If we are in a recession now, the impact won't work its way through the trailing twelve month covenant numbers until mid-2009. Similarly, on the mortgage side, folks like mbecker have clearly documented how much worse things will get on the mortgage side as the slew of ARMs start renewing at unaffordable levels this year and next year.
Couple these circumstances with the fact that all lenders have already seen financial performance decline due to higher cost of funds and loss of the highly lucrative syndication fee income, and we are likely in for a bad 2008 and a horrible 2009 for banks, investment banks and commercial lenders. And what's bad for those folks will be very bad for the US economy that depends on their debt capital to fuel business and consumer spending growth.
So, yes, the Fed seems to be effectively navigating through the current credit market tsunami, but however effective they are in getting the liquidity side of the equation under control, things will still get worse over the next couple of years as the credit loss side of the equation starts to unfold.
Side note- BH I know you are far more knowlable about the credit defaut swap market than I am, but I am told there are $45 TRILLION in notional CDS amounts out there (no link, anecdotal). So however bad the credit losses are on the actual loans, the impact will be magnified many times over by the wide array of CDS holders.
But the bottom line is what you wrote- "...I really want you all to be aware that these are extraordinary times, and that the danger to your own material well-being is real." I agree with you 100% and I am pretty pessimistic about the next couple of years.
when the dems get into power and raise taxes? Will this be a decade long depression instead of a one to two year bump in the road? That is what really scares me!!!!
No argument with your points about credit-quality deterioration, although I think that (as in the Depression), a lot of the real-world problems will ultimately result from financial disruptions rather than typical business-cycle issues. That's a long post in itself.
About the notional value of derivatives: credit-default swaps, and the far more widely-used plain vanilla interest-rate swaps, don't actually put at risk the notional value in the contracts. I think this is a point that many non-specialists don't grasp.
If you trade someone else the cash flows from a fixed interest rate on a notional amount of $10 billion in return for the variable-rate cash flow, that doesn't mean that $10 billion ever changed hands or is at risk. The real exposure is perhaps no more than one-hundredth of $10 billion.
You'll occasionally hear people tell you that there are $270 trillion in derivatives out there in the world. True, but that's the notional value. The entire world doesn't have any more than $90 trillion or so of real and financial assets in it!
Party A elects to receive floating rate interest on a $100 million notional, based on 6 month Libor.
Party B elects to receive fixed rate of 5%.
Six months go by; Libor declines to 3%
The settlement is:
Party A = $100MM * 3% * 180/360 = $1,500,000
Party B = $100MM * 5% * 180/360 = $2,500,000
Net cash flow is to Party B of $1,000,000.
The $100MM NEVER changes hands. The swap just allows the parties to manage their interest rate liabilities (if they are hedging; if they're speculating, see last paragraph!).
The credit angle is limited to the counterparty making good on the net settlement.
There is another risk re mark-to-market accounting, but that's another subject. If your swap portfolio goes south and you don't get hedge accounting treatment, you will have to take a huge hit to your earnings or your equity, even though the notional is not at risk.
...funkier things, in case streetwise's explanation had you wondering.
In Interest-rate Land, a year has 360 days.
;-)
the convention on floating libor loans or swaps is actual/360; the fixed side is 180/360 for the 6 month term.
On floating muni paper, the convention can be actual/actual, so in a leap year the calcs change.
...computers. My head still hurts from all that.
My favorite bond-pricing weirdness has to do with the Monroe printing calculators everyone used before personal computers got big. These devices produced a well-known and repeatable arithmetic error, that got built into innumerable fixed-income calculations.
I was running a development project once, and my supervisor told me to make sure that our newly-created computer programs reproduced the Monroe error.
I looked at her. Twice. She wasn't kidding.
HTML Help for Red Staters
"If we want to take this party back, and I think we can someday, let’s get to work." – Barry Goldwater
I did the same, and the only thing I found was some really wierd behavior on a divide by zero condition. But at one point I had to implement an application for insurance agents to take on their laptops to calculate premiums, and I remember having to do rounding very strangely in order to get my calculations to match what the mainframe did. That was back in the early 90s though.
Check out this picture sent to me by a friend.
Barack Obama thinks we can turn our backs on the idea that we operate in a global economy, LOL.
That snapshot tells us nothing about the contents, or how much would has been coming through in the past or was predicted to be coming through the future.
It's a great picture though.
HTML Help for Red Staters
"If we want to take this party back, and I think we can someday, let’s get to work." – Barry Goldwater
Does this mean that we are starting to see the light at the end of the tunnel on this one?
If so, how long until the easing of the credit markets can work their way into the consumer lending side?
Fighting for conservatism one day at a time.