My Diary 326 --- US Is Still Important, Fed Doesn’t Help Much

 

My Diary 326 --- US Is Still Important, Fed Doesn’t Help Much, Turn Gold Into Diamond and Buy Cheap Tickets

September 10, 2007

The rest of September will be overwhelming with sports events and tons of economic data to be watched. Well, I think this is a good season as you can release your stress from the financial markets by watching NFL fights, US Open Finals and Rugby Championships in Paris. But don’t forget, there is an even bigger game for financial markets -- the next FOMC meeting. 

US Is Still Important!

Over the weekend, a key dataflow in the global markets is US payroll number fell by 4k in August vs market expectations of a 100k rise.  The weakness of the report was further confirmed by an 81k downward revision to the June and July data.  As a result,

US equity fell by around 2% (DJIA -1.90% & S&P500 -1.69%), led by he retail financial and homebuilder sectors. At the meantime, US bond market rallied across the curve, with10yr @4.366 (14bp lower) and 2yr@3.88 (20bp lower).

However, there are other markets moving up. Short-term interest rates are spiking so the credit markets seemed having not fixed themselves yet. Yen I still holding onto most of its recent gains, signaling that market wise, risk aversion is there. And quickly, speaking of gold, it is soaring for a forth week, near the highest price since 1980. Spot and future gold closed at over $700 last Friday, in partial reaction to the awful employment numbers, which was not good for the dollar. But there is another interesting story going on in the background, as pointed out by South Africans’ gold bugs. There is a massive build-up of call options in the October and December Comex gold contracts, similar to a period in November 2005 prior to the gold price surging by more than 50%. Smart money? Maybe…. But gold seems to resume its decades-long “safe-heaven” status now.

Talking much about Yen and precious metals, actually I want to make a point here is that the US markets is still important to the rest of the world, even though it not the only growth engine of world economy anymore. But US still determines the global cost of capitals.

Fed Doesn’t Help Much!

Since the economy is indeed in the process of slowing down, I am now more lean to thinking the Fed should cut rates in September. But will a rate cut make difference? My answer is NO. A Fed cut is not going to solve the current credit difficulties as the real problem is not a liquidity problem but a credibility problem. There is plenty of cash around and central banks around the world are willing to add as needed.

The problem is who will buy debt if they feel complicated or confused? Or rather, how many investors are willing to buy an ABIG bond even rated AAA or CPs from another financial institution as you have started to doubt that how much sub-prime debt do they have hidden on off-balance sheet vehicles? A lower Fed funds rate might make the bonds slightly more valuable, but those who own the “contaminated” bonds need to sell and take large losses. For A-rated sub-prime paper selling @ 50 cents, a 150 bps Fed funds cut would make is only a few points in value…... So Fed does not help out very much here.

Second, a lower fed funds rate is not going to bail out the housing market. It will of course help some, but again, it is not the interest rates that are the problem. The problem is that we are talking about the 20% plus of the home buyers in the last two years that were able to buy homes because of poor lending practices on the part of mortgage companies. Those home buyers are not going to be there to support the market.

Bottom-line: It does not mean Fed should not cut. It simply means the economy is clearly slowing and the risks are now to the downside.

What Is Next?

Measured by the Merrill Lynch Global OAS Index, global corporate spread now stands at +121bps, a level which is 51bps wider for the year and this has not been seen since 2002.  Certainly, the corporate credit basis is moving noticeably wider versus both Treasuries and Swaps and part of reasons also comes form a large new-issue calendar with sizeable concessions.

Going forward, I believe that vols will persist until the release of Q3 reports, when we have more information to determine the amount of damage and where are they located. Thus far, I don't expect significant spread tightening in this environment, though some bond’s carrys are not too bad. 

September is certainly shaping up to be a challenging month (Lots of competition for athletics worldwide as well) and I think it will set the tone for the rest of 2007 and some of 2008 …… the bearish economic data, spike in short-term rates reflecting continued tight liquidity in the inter-bank market, the contracting CP and ABCP market, and equity analysts cutting their earnings forecasts for the banks and brokerage space will continues to spill over into the credit markets…… Keep alert!!!

Will Gold Turn Into Diamond?

Judging from the YTD performance, A-share markets are not doubt the most shining “Gold Medals” compared with global primary peers. However, the question now is will gold be turned into diamond? Look at SHCOMP today, it opened lower but closed up 1.48% to 5622.  Transportation sector is the top performer today, led by CEA (+10%) and COSCO (+10%). Paper & printing sector followed suit, led by Chenming Paper (+10%).  All these companies are expected to benefit from their asset restructuring scheme and upcoming industry consolidation.

To be honest, I still don’t see much of arguments to justify the continuing price move-up of China Eastern Airline. This is a money losing airline and if anybody doesn’t feel comfortable toward Air China @ 3.6XPB, why should you buy CEA @6XPB. It doesn’t make any sense to trade up A-share price by 10% every day since the announcement of SIA and Temasek taking a combined 20 % of stake ( remember, they buy at 3.3XPB). At the end of day, what involves in as the valuation benchmarks is H share issued to Singapore investors. And I believe even Temasek can not turn gold into diamond.

Broadly, I think today’s Chinese shares are worth more than its GDP has little economic significance, since the value of tradable shares is still only about 35% of GDP, compared with 150% in America or over 100% in India. I am not saying that we should not feel proud of that three of the world's biggest companies are now Chinese companies ( ICBC, PetroChina and China Mobile), but do ppl still remember that in 1989, just before its bubble burst, six of the world's ten biggest banks were Japanese……Will history repeat itself here?

The US Open Ticket is Cheap!

The Yen rose against US dollar (113.6 closed) as markets reacted badly to the worse-than-expected payroll numbers and investors are selling higher-yielding assets bought with Loans in Japanese currency. In early morning trading, the Nikkei 225 average fell nearly 3%, though part of that was a reaction to Friday’s fall on Wall Street and a sharp jump in the yen to Y112.75 over the weekend.

The strong yen comes after a government reports showed that Japan’s economy contract at almost twice the pace forecasted by analysts in the Q207. The lower than expected growth number may pull back the expectations for a BOJ rate hike and yen’s further gains would be limited.

In the other side of coins, dollar's TW Index declines to lowest on record. The Fed's broad dollar index, which includes 26 currencies, dropped to the lowest since July 1997, while the New York Board of Trade's dollar index declined to a 15-year low. It seems that we have a good bargain to buy a ticket for US Open Final! Anybody interested in……:)

Good night, my dear friends