Tightened credit standards since the last recession is making life harder for existing borrowers and with inflationary worries that are expecting to send interest rates higher again, the banks ability to be flexible is limited because of higher financing costs on the interbank market.
Troubled areas:
- Britain's untested areas of specialist lending, such as buy-to-let and self-certification mortgages, are coming under stress. Analysts expect 23% of the total stock of British mortgages by value is due to reset in 2008, against a mere 4% of stock in America last year.
- Car-loan defaults may grow as drivers decide to throw their car keys in the same dustbin as their house keys as record fuel costs are also guzzling more of consumer's disposable income.
- Untapped loan commitments to corporate customers continue to crowd out space on bank's balance-sheets, estimated $6 trillion overhang of committed lending facilities to be drawn down, most of it at more generous terms than borrowers could get now.
No surprise given the above, that some of the less well-capitalised UK banks ( AL/, BB/, HBOS) have fallen between 61-76% this year
Scenarios:
- Loan provisions increasing
- Credit cycle goes into a prolonged U-shape recovery instead of V-shape
- Flat or negative GDP growth for 2-4 quarters
- ECB and BOE raises rates due to inflationary pressures
- What more? Oil above $170? may not be impossible with summer round the corner.
Economic Update:
- The U.K. economy grew less than previously estimated in the first quarter, weighed down by the weakest services expansion in 12 years. Overall GDP rose 0.3 percent in the three months through March, the least in three years.
- Royal Bank of Scotland Group Plc, the second-biggest bank in Britain, had its credit rating lowered at Moody's Investors Service, which cited ``higher volatility'' in its securities unit and greater risk of loan defaults in the U.K.
Inflation stories:
- Spanish inflation accelerated to the fastest pace on record in June as oil and food prices surged. Consumer prices rose 5.1 percent from a year ago after increasing 4.7 percent in May
- Inflation in Germany, Europe's largest economy, rose 3.4 percent from a year ago after gaining 3.1 percent in May led by surging energy costs. (more than forecasted)
Eric Tan, London
Friday 27 June 2008
Friday 20 June 2008
Update: basis risk and credit value adjustments as potential sources of losses
Lots of assets don't have a corresponding index so banks have to mix and match several indexes for your hedges. Some work, some don't.
However when a hedge goes wrong, i.e moves in an adverse direction, you are caught in a situation where you own protection that has cost you more than what's now available in the market place.
Implications
As the value of protections (that you would assume is equivalent to an asset) gets marked to market, hedge-related losses are looking ever more conspicuous as investment banks unveil their results
- Goldman Sachs reported roughly $500 million in losses related to its leveraged-finance positions.
- Lehman Brothers, the big shift in the underlying assets and their corresponding derivative positions played a significant role in its $2.9 billion worth of losses.
- Citigroup on 19-Jun warned of further large writedowns and credit losses in the second quarter
- Morgan Stanley reported $800 million in losses from trading and leveraged loans
Comments:
There's certainly going to be a lot more uncertainty facing the financial markets in the weeks to come. Banks are going to struggle with replacing the record profits made in the yester-years from fixed income structuring with new sources of income. So far, most have jumped onto the Commodities trading bandwagon and Goldman has done particularly well. but with the commodities market fast-becoming crowded and less of an alternative bet to equities/fixed-income, no one knows when the music is going to stop.
Eric Tan, London
However when a hedge goes wrong, i.e moves in an adverse direction, you are caught in a situation where you own protection that has cost you more than what's now available in the market place.
Implications
As the value of protections (that you would assume is equivalent to an asset) gets marked to market, hedge-related losses are looking ever more conspicuous as investment banks unveil their results
- Goldman Sachs reported roughly $500 million in losses related to its leveraged-finance positions.
- Lehman Brothers, the big shift in the underlying assets and their corresponding derivative positions played a significant role in its $2.9 billion worth of losses.
- Citigroup on 19-Jun warned of further large writedowns and credit losses in the second quarter
- Morgan Stanley reported $800 million in losses from trading and leveraged loans
Comments:
There's certainly going to be a lot more uncertainty facing the financial markets in the weeks to come. Banks are going to struggle with replacing the record profits made in the yester-years from fixed income structuring with new sources of income. So far, most have jumped onto the Commodities trading bandwagon and Goldman has done particularly well. but with the commodities market fast-becoming crowded and less of an alternative bet to equities/fixed-income, no one knows when the music is going to stop.
Eric Tan, London
More Inflation stories - Markets for week ending 20-Jun-08
- India's inflation accelerated to a 13-year high and stocks and bonds fell on concern the central bank will have to raise interest rates again. Wholesale prices jumped 11.05 percent in the week to June 7, after gaining 8.75 percent in the previous week
- India increased retail prices of gasoline and diesel this month, joining China, Indonesia, Malaysia and Sri Lanka, as a near doubling of crude oil prices pushed up costs
- China, the world's second-biggest oil-consuming nation, unexpectedly raised gasoline and diesel prices by at least 17 percent and increased power tariffs to rein in energy use, potentially driving up inflation.
Implications: Chinese refiners gained, airlines fell on narrowing margins.
Crude prices tumbled more than $4 a barrel on Thursday after the unexpected announcement that China would increase petrol and diesel prices by 18%.
- German producer-price inflation, an early indicator of price pressures in the economy, accelerated to the fastest pace in almost two years in May on energy costs.
- Mexico has frozen the price of 150 basic foods to curb inflation, in the government's biggest set of price controls in more than a decade.
Next week:
Wimbledon - 23 Jun
US June Consumer confidence - 24 Jun
US FOMC meeting - 25 Jun
Eric Tan, London
- India increased retail prices of gasoline and diesel this month, joining China, Indonesia, Malaysia and Sri Lanka, as a near doubling of crude oil prices pushed up costs
- China, the world's second-biggest oil-consuming nation, unexpectedly raised gasoline and diesel prices by at least 17 percent and increased power tariffs to rein in energy use, potentially driving up inflation.
Implications: Chinese refiners gained, airlines fell on narrowing margins.
Crude prices tumbled more than $4 a barrel on Thursday after the unexpected announcement that China would increase petrol and diesel prices by 18%.
- German producer-price inflation, an early indicator of price pressures in the economy, accelerated to the fastest pace in almost two years in May on energy costs.
- Mexico has frozen the price of 150 basic foods to curb inflation, in the government's biggest set of price controls in more than a decade.
Next week:
Wimbledon - 23 Jun
US June Consumer confidence - 24 Jun
US FOMC meeting - 25 Jun
Eric Tan, London
Tuesday 17 June 2008
'Infl-animal' runs amok. Week ending 13-Jun-08
U.S. consumer prices rose 0.6 percent (more than forecasted) in May as Americans paid more for fuel, underscoring the Federal Reserve's concern that inflation will pick up.
The surge in oil and food expenses has caused inflation expectations to rise, stirring concern among Fed officials after they lowered interest rates seven times since September.
Investors expect the central bank will raise rates as soon as August, futures prices show.
Implications/analysis:
If Interest rates are raised?
- Target inflationary pressure
- Avoid wage-price crisis that may ultimately lead to endemic inflation
- Correct prices which have been caused by loose monetary policies and cheap lending. However,
There may be a large impact on Real estate values, investors, lenders and service providers and it may not actually reduce demand much further if people are already cutting back on spending. Another concern on a rapidly deteriorating economic environment means short term unemployment numbers may worsen further..
Justification:
US Retail sales for May did show surprising strength, rising 1 percent
If Interest rates were lowered?
- Provides short term support for asset prices - political agenda?
- Improve business confidence and reduce impact of recessionary pressures
- Further emphasize the effect of easy money...
- Asset prices may become uncontrollable
Justification:
Sudden surge in structural demand for commodities caused by rapidly emerging economies is just a short term blip which may stabilise soon
Jump in energy prices due to speculation
My take is that FED/ECB/MPC will watch the oil prices and the following releases very closely to gauge for an escalated need to tame the loose 'Infl-animal' (couldn't resist coining it, but you saw it here first)
Eric Tan, London
Worth noting this week:
EMU CPI data (euro zone) 16-Jun
US PPI data 17-Jun
UK May retail sales data 19-Jun
The surge in oil and food expenses has caused inflation expectations to rise, stirring concern among Fed officials after they lowered interest rates seven times since September.
Investors expect the central bank will raise rates as soon as August, futures prices show.
Implications/analysis:
If Interest rates are raised?
- Target inflationary pressure
- Avoid wage-price crisis that may ultimately lead to endemic inflation
- Correct prices which have been caused by loose monetary policies and cheap lending. However,
There may be a large impact on Real estate values, investors, lenders and service providers and it may not actually reduce demand much further if people are already cutting back on spending. Another concern on a rapidly deteriorating economic environment means short term unemployment numbers may worsen further..
Justification:
US Retail sales for May did show surprising strength, rising 1 percent
If Interest rates were lowered?
- Provides short term support for asset prices - political agenda?
- Improve business confidence and reduce impact of recessionary pressures
- Further emphasize the effect of easy money...
- Asset prices may become uncontrollable
Justification:
Sudden surge in structural demand for commodities caused by rapidly emerging economies is just a short term blip which may stabilise soon
Jump in energy prices due to speculation
My take is that FED/ECB/MPC will watch the oil prices and the following releases very closely to gauge for an escalated need to tame the loose 'Infl-animal' (couldn't resist coining it, but you saw it here first)
Eric Tan, London
Worth noting this week:
EMU CPI data (euro zone) 16-Jun
US PPI data 17-Jun
UK May retail sales data 19-Jun
Peak Oil ? Markets for the week ending 6-Jun-08
U.K. producer prices increased at the quickest rate in two decades in May, double the median forecast of 32 economists in a Bloomberg News survey. From a year earlier, prices rose 8.9 percent. Core producer prices, which exclude food, beverages, tobacco and petroleum, rose an annual 5.9 percent in May, the most since 1991.
Implication:
Increases the odds the Bank of England will refrain from interest-rate cuts even as the economy edges toward a recession.
After hitting above $139, crude oil for July delivery declined as much as $3.27, or 2.4 percent, to $135.27 a barrel in after-hours electronic trading on the New York Mercantile Exchange. Friday's jump was the biggest-ever oil gain in dollar terms and the largest on a percentage basis since June 1996.
Implication:
Rising oil prices cut earnings prospects for airlines and automakers.
Inflation is now the biggest threat to the global economy as the credit crisis starts to recede
Oil will remain the focus this week.
US Payrolls fell 49,000 in May, the jobless rate increased by half a point to 5.5 percent, higher than every forecast in a Bloomberg News survey.
The U.S. lost jobs for a fifth month and the unemployment rate rose by the most in more than two decades
Implications:
European stocks fell, heightening concern the US economy won’t rebound from its slowest growth in six years.
The dollar traded near a one-week low against the yen on speculation an industry report today will show the worst housing slump in a quarter century is weighing on the U.S. economy.
The dollar was at the lowest in almost two weeks versus the euro .
The dollar traded near its weakest level in 25 years against Australia's currency as investors reduced bets the Federal Reserve will raise interest rates this year.
Eric Tan, London
Implication:
Increases the odds the Bank of England will refrain from interest-rate cuts even as the economy edges toward a recession.
After hitting above $139, crude oil for July delivery declined as much as $3.27, or 2.4 percent, to $135.27 a barrel in after-hours electronic trading on the New York Mercantile Exchange. Friday's jump was the biggest-ever oil gain in dollar terms and the largest on a percentage basis since June 1996.
Implication:
Rising oil prices cut earnings prospects for airlines and automakers.
Inflation is now the biggest threat to the global economy as the credit crisis starts to recede
Oil will remain the focus this week.
US Payrolls fell 49,000 in May, the jobless rate increased by half a point to 5.5 percent, higher than every forecast in a Bloomberg News survey.
The U.S. lost jobs for a fifth month and the unemployment rate rose by the most in more than two decades
Implications:
European stocks fell, heightening concern the US economy won’t rebound from its slowest growth in six years.
The dollar traded near a one-week low against the yen on speculation an industry report today will show the worst housing slump in a quarter century is weighing on the U.S. economy.
The dollar was at the lowest in almost two weeks versus the euro .
The dollar traded near its weakest level in 25 years against Australia's currency as investors reduced bets the Federal Reserve will raise interest rates this year.
Eric Tan, London
Market for week ending 30th May 08
Been meaning to start somewhere to share information I've collected from various sources and decided this might just be the start of my feeble blogging attempt. This is "my take on the market".
European Inflation accelerated faster than economists forecast this month as oil prices jumped to a record. The inflation rate in the euro area rose to 3.6 percent, matching a 16-year high, from 3.3 percent in April. Economists had forecast a 3.5 percent rate.
U.S. Consumer Spending Slowed: Increased 0.2 Percent in April as compared to 0.4 percent increase in March - a sign the biggest part of the economy may be faltering.
Higher fuel costs, smaller wage gains and lower home values have shaken Americans' confidence, raising the odds that spending will keep slowing. Government tax rebates may only provide a temporary boost to economic growth in coming months. Incomes grew 0.2 percent, bolstered in part by the government's tax rebates
U.K. consumer confidence dropped in May to the lowest level since Margaret Thatcher was ousted from office in 1990, as people became more pessimistic that the economy will slip into a recession
Retail sales in Germany, Europe's largest economy, unexpectedly dropped for a second consecutive month in April as faster inflation left consumers with less money.
Commodities-wise
- Slump in oil spurred declines in other raw materials. Crude oil lost 3.6 percent this week on signs record prices will slow economic growth.
- Gold headed for its first weekly drop in four in London as oil fell and the dollar rose, curbing the metal's appeal as a hedge against inflation and declines in the U.S. currency.
- Corn heading for the first monthly drop since August, on speculation a stronger dollar and lower energy costs will reduce demand.
- Tin headed for its steepest weekly drop since August in London after stockpiles expanded and investors judged that a record reached this month didn't reflect the outlook for demand.
- Copper rose 0.8 percent, to $7,950 a ton, rebounding from two-month low. Market expectation for softness in copper prices has been realized and view dips below $8,000 a ton as a buying opportunity given tightening concentrate supply
Overall: The dollar's rally has dampened market sentiment for grains and other commodities
Hot off the press:
Billionaire investor George Soros is to tell US lawmakers that "a bubble in the making" is under way in oil and other commodities.
Recent ability of investment institutions to invest in the futures market through index funds is exaggerating price rises and creating an oil market bubble.
Commodity index buying is eerily reminiscent of a similar craze for portfolio insurance which led to the stock market crash of 1987.
Implications
With financial institutions piling in on one side of the market, they have sufficient weight to unbalance it. So, if the trend was reversed and the institutions as a group headed for the exit as they did in 1987 there would be an unwelcomed crash.
Eric Tan, London
European Inflation accelerated faster than economists forecast this month as oil prices jumped to a record. The inflation rate in the euro area rose to 3.6 percent, matching a 16-year high, from 3.3 percent in April. Economists had forecast a 3.5 percent rate.
U.S. Consumer Spending Slowed: Increased 0.2 Percent in April as compared to 0.4 percent increase in March - a sign the biggest part of the economy may be faltering.
Higher fuel costs, smaller wage gains and lower home values have shaken Americans' confidence, raising the odds that spending will keep slowing. Government tax rebates may only provide a temporary boost to economic growth in coming months. Incomes grew 0.2 percent, bolstered in part by the government's tax rebates
U.K. consumer confidence dropped in May to the lowest level since Margaret Thatcher was ousted from office in 1990, as people became more pessimistic that the economy will slip into a recession
Retail sales in Germany, Europe's largest economy, unexpectedly dropped for a second consecutive month in April as faster inflation left consumers with less money.
Commodities-wise
- Slump in oil spurred declines in other raw materials. Crude oil lost 3.6 percent this week on signs record prices will slow economic growth.
- Gold headed for its first weekly drop in four in London as oil fell and the dollar rose, curbing the metal's appeal as a hedge against inflation and declines in the U.S. currency.
- Corn heading for the first monthly drop since August, on speculation a stronger dollar and lower energy costs will reduce demand.
- Tin headed for its steepest weekly drop since August in London after stockpiles expanded and investors judged that a record reached this month didn't reflect the outlook for demand.
- Copper rose 0.8 percent, to $7,950 a ton, rebounding from two-month low. Market expectation for softness in copper prices has been realized and view dips below $8,000 a ton as a buying opportunity given tightening concentrate supply
Overall: The dollar's rally has dampened market sentiment for grains and other commodities
Hot off the press:
Billionaire investor George Soros is to tell US lawmakers that "a bubble in the making" is under way in oil and other commodities.
Recent ability of investment institutions to invest in the futures market through index funds is exaggerating price rises and creating an oil market bubble.
Commodity index buying is eerily reminiscent of a similar craze for portfolio insurance which led to the stock market crash of 1987.
Implications
With financial institutions piling in on one side of the market, they have sufficient weight to unbalance it. So, if the trend was reversed and the institutions as a group headed for the exit as they did in 1987 there would be an unwelcomed crash.
Eric Tan, London
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