Creaky credit markets
It’s not a snap or even a pop – but there’s definitely a crackle. Rumblings emerging from key credit markets bare a frightening resemblance to the early days of the 2008 credit crunch.
Take commercial paper, a widely used instrument for short-term funding in the corporate world. Financial sector issuance of commercial paper fell steadily in the second half of last year, from around $556.5 billion in July to $434.4 brillion in December. The final month of the year saw the downward trend spilling over into other industries.
Paul Ashworth at Capital Economics:
The contraction in commercial paper issued by the financial sector is now being compounded by a dramatic drop off in commercial paper loans to the non-financial sector.
Despite the European Central Bank’s renewed effort to keep bank liquidity ample, money markets have shown some signs of strain. The London Interbank Offer Rate or LIBOR, used for loans between banks, more than doubled in the last six months of the year to its current 0.55 percent as worries mounted about the health of European institutions.
Anthony Crescenzi, portfolio manager at PIMCO:
Liquidity risks by no means have been eliminated because liquidity provisions are no substitute for private capital nor the transference of risk to either the private-sector or the central bank.
For inter-bank rates, this means that while rates might be capped by the cost of borrowing from the Fed and the ECB, no substantial decline in rates is yet likely either until an external balance sheet is drawn into the mix or there is a miraculous endogenous recovery in the wholesale funding market and Europe’s banks therefore regain market access.
Please take my money: The zero-yield bill
Wall Street firms are begging the U.S. Treasury to take their cash, at least judging by the latest auction of short-term Treasury bills. Treasury sold $30 billion of four-week bills at a “high rate” (pause for laugther) of 0.000% on Wednesday, a mix of strong demand for year-end portfolio shuffling but also a reflection of ongoing fears of a credit crunch emanating from Europe.
It was the fourth straight sale in as many weeks that brought a high rate of zero. The zero percent rate means buyers of the debt will receive no interest at all, sacrificing any return simply to hold cash in the safest of investments.
A rise in repo financing costs is “a sign the year-end demand for short, safe assets has begun,” said Roseanne Briggen, our New York-based colleage at IFR Markets, a unit of ThomsonReuters.
The expensive repo financing also reflects the other typical year-end event – lots of accounts unwilling to lend securities. This scenario worsens into the turn of the year, but then is offset by dealers scrambling to finance what’s left on their books over the turn.
Which strengthens the case of those who think the Treasury market will increasingly behave like the notoriously low-yielding market for Japanese government bonds or JGBs.
While demand for short-term U.S. debt remained strong, key euro zone bank-to-bank lending rates fell for the fifth session running on Wednesday, pushed down by a funding glut after banks took almost half a trillion euros at the European Central Bank’s first-ever injection of 3-year cut-price loans.
Trust me, I’m a banker
The market for U.S. commercial paper, a key source of short-term funding for firms, is signaling fresh distrust of the banking sector. Investors continue to favor commercial paper issued by non-financial companies over those issued by banks, the latest Fed data show. On a non-seasonally adjusted basis, non-financial CP outstanding increased $5.1 billion to $187.1 billion in the week ended Sept. 21, while financial CP rose $3.2 billion to $503.5 billion. Since the end of 2010, the amount of industrial CP outstanding has grown by 65 percent, while the amount of bank CP has contracted by 10 percent.
Dramatic ending to Greek tragedy
Greece is in the danger zone. Even as the country’s finance minister sought to reassure his euro zone counterparts at a meeting in Poland, Greek credit default swaps were pricing in a more than 90 percent chance of default, according to Reuters calculations of Markit data. Economists in a Reuters poll see a 65 percent chance of that happening, probably within a year.
Such fears recently sent jitters across financial markets, prompting some words of comfort from German Chancellor Angela Merkel and French President Nicolas Sarkozy that they are determined to keep Greece in the euro zone. But speculation is growing that Greece will default, and that it will be a messy ordeal. Here are some of the potential dangers if it occurs:
* Greece may be seen as setting a precedent for Portugal and Ireland, analysts said. Yields on peripheral euro zone debt could surge rapidly, making funding costs increasingly unsustainable as yields on Italian and Spanish 10-year bonds surge back towards 7 percent. The ECB could have to intervene more aggressively in the secondary bond market to the detriment of its balance sheet.
* European banks may have to make more significant write-downs of their Greek holdings than they already have. This would hit French banks especially hard, since they are the most heavily exposed to Greek debt, with $56.9 billion in their portfolio — more than double as much as Germany’s equivalent holdings. French banks are also the most vulnerable to Italian debt, with a hefty $410.2 billion.
* Fears of more contagion and further write-downs could make banks even more reluctant to lend to each other. A key measure of financial stress — the three-month spread between euro Libor and overnight index swap rates – hovered near its highest in over two years. Said Gary Jenkins, head of fixed income research at Evolution Securities:
You would get the loss on the Greek debt of course but I think much more important is the funding situation. Who is going to be lending the banks money if you have got euro zone sovereigns defaulting and you are unsure about what is going to happen next?
* Banking sector problems could hurt equity markets at large: stock valuations could fall significantly, raising concerns over the ability of corporations to raise capital. That would hurt business and consumer sentiment and further diminish the likelihood of a meaningful global recovery, says Richard McGuire of Rabobank.
It is in the interest of Germany to pay one time all the debts of European governments and set fresh guidelines for future borrowings.
In case of failure by Germany , the markets will shift to China products making German economy to collapse to third of today’s size.
The logic of life is rich have to pay for establishing the security which benefits poor also. No escape from this law of life.
