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Friday, August 10, 2007

Blogging the Financial Markets

Well, quite literally I think it's true to say that I've never seen a day like today. Not since I've been blogging at any rate.

Two weeks ago I was talking about choppy water, and not being too clear where we were going. Well now we have a veritable tempest, and it certainly isn't clear when this is going to end or where it will lead. Certainly after the financial markets have quietened again there will be macroeconomic impacts and consequences.

A reasonable summary of the story so far this week can be found on Daily FX here. The Financial Times, in its end-of-week review of the situation, summed things up like this:

Global financial markets suffered their rockiest week in recent years as worries over credit markets and risk aversion began to dry up liquidity, prompting rare interventions from central banks. The temporary closure of three investment funds by BNP Paribas, the recent financial bail-out of German bank IKB and “unprecedented disruptions” for US mortgage lender Countrywide Financial all underlined the growing fallout from the turmoil in subprime lending in the US.The perception of further trouble ahead in credit markets kept investors away from risky assets. BNP cited the “complete evaporation of liquidity” in parts of the US securitisation market. As liquidity ebbed, volatility intensified. The Chicago Board Options Exchange Vix index, seen as a gauge of investors’ fear, rose to its highest since April 2003.

Despite the fact that earlier this week the Federal Reserve Board insisted it was standing firm on interest rates until inflation was beaten, bets are now on that a September cut, or even an emergency August one, may be in the offing. Such speculation is, of course, leading people to ask whether Bernanke has not, in fact, underestimated the whole sub-prime issue.

Reuters bonds is reporting that U.S. short-term interest rate futures have increased the implied probability that the Federal Reserve will step in with an emergency rate cut this month. Latest values suggest a 47 percent chance of a reduction in the Federal funds rate before the end of August, up from about 33 percent on Thursday. Futures fully price a 25 base points cut in Fed's overnight lending rate to 5 percent at the Sept 18 Federal Open Market Committee meeting, and a further cut before year-end.

To put all this in some sort of perspective, it is worth noting that it was the Fed intervening with rate cuts that calmed markets after the 1998 Russian debt crisis and after the implosion of the hedge fund Long-Term Capital Management. This time would not be an exception to that tradition, or seen as especially dramatic, just an orderly retreat.

Of course ECB head Jean Claude Trichet with his "strong vigilence on inflation is of the essence line has not come off much better than Bernanke has, and the odds that the ECB will raise in September and the BoJ in August must now have been significantly reduced, but there will be time enough to start thinking about all this, and other macro topics when we get to Monday.

It would seem to be difficult for the central bankers involved to continue their upward hike in the immediate future after the European Central Bank injected a further 61 billion euros into the banking system today following on behind the 95 billion euros they placed there yesterday, and following the Bank of Japan's decision to inject a trillion yen into money markets on their own behalf.

Earlier today the U.S. Federal Reserve announced its own three-day addition of liquidity, injecting $35 billion hard on the heels of the larger-than-normal $24 billion addition to U.S. banking system temporary reserves carried out yesterday.

According to the Federal Reserve Statement:

The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets.

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding.

This is the first time the U.S., European and Japanese central banks have acted together in this way since the aftermath of the Sept. 11 terrorist attacks. The Australian, Hong Kong and Canadian central banks have also participated.


French banking giant BNP Paribas really set the ball rolling yesterday by suspending three of its funds which were considered to be unduly exposed to US high-risk property loans. BNP Paribas Investment Partners, a unit of the French bank, said the funds -- Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia -- would accept no redemptions or subscriptions until further notice.

In Germany, insurer Allianz SE, which owns Dresdner Bank AG, has also revealed today that it has 1.7 billion euros of exposure to the U.S. subprime market — this in fact amounts to about 0.16 percent of its 1.03 trillion euro total investment portfolio. So we can see that while the magnitude of these sums is large, the implications for these huge institutions is nothing like so big. That, however, doesn't stop people worrying about what is happening, although I would say the prime concern is more in the credit retrenchment implications (the so called "credit crunch") and what might be the economic consequences of this, than in the losses per se.

WestLB Mellon Asset Management, an asset management joint venture belonging to the German state bank WestLB AG and The Bank of New York Mellon Corp., also suspended redemptions this week from its asset-backed securities ABS Fund. Other companies, including Union Investment Asset Management, a German mutual fund manager, and Frankfurt Trust, a unit of BHF-Bank, have also halted redemptions.

In the US, Countrywide, the largest mortgage lender in the US, announced, after yesterday's market close, that it faced "unprecedented disruptions" in the debt market and the secondary market for mortgages.


"Market concerns about the U.S. subprime crisis are continuing without any apparent respite," said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. "Its fallout will not be limited to financial markets," he added. "The U.S. economy and with it, the rest of the world, will feel the negative consequences for quite some time."

US Stockmarket

Debt protection costs rise:

The cost to insure the debt of U.S. brokers, including Bear Stearns Cos. rose on Friday on new concerns about spreading weakness in residential mortgages hurting corporate profits. Credit default swaps on Bear Stearns, which have been among the most volatile bank swaps, were around 15 basis points wider at 155 basis points, or $155,000 per year for five years to insure $10 million in debt, said a trader.

By mid-morning in the US, the Dow Jones industrial average was down 108.20 points, or 0.82 percent, at 13,162.48, the Standard & Poor's 500 Index was down 11.91 points, or 0.82 percent, at 1,441.18 and the Nasdaq Composite Index was down 23.97 points, or 0.94 percent, at 2,532.52.

Update - according to AP:

Wall Street pared its losses Friday to trade flat after the Federal Reserve said it would do all it can to "facilitate the orderly functioning of financial markets" and twice injected liquidity into the banking system.

In midday trading, the Dow Jones industrials rose 18.34, or 0.92 percent, to 13,148.34, after being down as much as 212 points. On Thursday, the Dow fell 387 points and extended a series of triple-digit moves that began in late July.

Friday's moves were typical of the zigzag trading and triple-digit moves in the Dow since the index closed at a record 14,000.41 on July 19. As of Thursday's close, the Dow was down about 730 points, or 5.2 percent, from its record close.