Wednesday, 24 August 2011

Markets update - Credit - Rates - Equities - The Jackson Hole leap of faith.

The Jackson Hole leap of faith: is Ben Bernanke the new messiah?
"Markets bet on Fed miracle" is the title of the WSJ.

Looks like the recent disconnect between credit and equity is unlikely to persist and I am not the only one to think that.
In JP Morgan's daily Credit Strategy & CDS/CDX update here is what they had to say:
"Yesterday the S&P 500 was up 3.4% while CDX IG was flat and HG bond spreads actually widened by 8bp (to 218bp) which is a large negative move. The relationship between IG and HG bond spreads is in line with historical trade pattern, so both the cash as derivative markets in HG credit markets are in line with each other. Both have significantly underperformed stocks, however. The historical regression between IG and S&P is almost 4 standard deviations away the 3m and 6m trading patterns (both have a strong Rsq of 89%). Based on this trading pattern IG should be at 114bp, 8bp tighter than yesterday's 126bp close.

What is driving HG credit to underperform so significantly? One possible explanation is low summer liquidity in the bond market. IG remains quite liquid, however, and IG and JULI are in line, so the liquidity argument doesn't seem to really explain the situation. A second possible explanation for the underperformance of credit is that credit is more heavily weighted to Financials which are underperforming. CDX.IG does not include the large banks, however. A more logical explanation is that lower UST yields are contributing to bond underperformance as over the past week UST yields are 10bp lower."

And JP Morgan to add in their report on the current disconnect between the credit guys and their equity friends:
"The WSJ has a headline this morning "Markets bet on Fed miracle" to explain yesterday's strong stock market performance. No HG investors with whom we have spoken expect the Fed on Friday to offer much that would actually help the economy. Equity investors, mindful of the huge stock rally sparked by the QE2 announcement at last August's Jackson Hole conference seem unwilling to be so dismissive of the Fed's options and power. It seems the difference in recent equity and credit market performance is perhaps explained by a greater faith in Fed 'miracles' from the equity side."

Well, on Friday don't expect miracles.

As pointed out by a recent report from CreditSights (From Jackson Hole to Japan - 17th of August 2011), the last time you had three dissenting votes at any FOMC meeting was November 1992. You had Charles Plosser, President of the Philadelphia FED, an inflation hawk, Richard Fisher, President of the Dallas FED, who was opposed to QE2, and he is against QE3, and moderate Minneapolis President Narayana Kocherlakota, who is against additional accomodation. According to the same report, Ben has four options on the table:
1. Additional purchases of longer term securities;
2. Modifying the committee's communications;
3. Reducing the interest rate paid on excess reserves;
4. Increasing the FOMC's inflation goals.

Fourth option has already been dismissed. So what is left is re-investing the proceeds of the MBS holdings into longer maturity treasuries to extend the duration of the FED's portfolio.
Probably the reason why David Rosenberg is seeing much lower 10 year Treasuries yield, and I agree with this view as well.

CreditSights in their report, thinks that the FED would need to see bigger deflation threat before engaging into a new round of QE.

On the market front today the big story was the Gold sell-off.
Could it be profit taking or forced liquidation? One thing for sure the movement was fast and furious as per the attached intraday Gold chart snapped earlier:
Truth is, the recent rise of Gold was too steep to continue at that rate. A positive pullback to some extent.

In bonds and CDS here was the picture:

And two year Greek bonds making a new record:
More than 40% yield on the two year notes.

And the consequences of the Japan downgrade by Moodys to Aa3:
Japanese Financials CDS spreads widening:
[Graph Name]

Stay Tuned!

No comments:

Post a Comment

View My Stats