Relentless. That’s what this bear market in credit is. It won’t quit.
First it was subprime loans. Then Alt-A. It will probably include securitized credit card receivables before it’s over. Now, we have trouble in the European junk bond market and rumblings in the corporate bond market. And at long last, cdo liquidation.
“The European high-yield bond market remains frozen, as spreads at the widest levels in nearly five years fail to draw investors worried that prices may fall further due to the global credit turmoil,” reports Natalie Harrison for Reuters. The great unwinding of leverage may be about to hit another gear.
“Unwinding of synthetic CDOs – which reference CDS contracts – is thought to be behind some of the rapid spread-widening on credit indices on Friday,” reports Sam Jones at the Financial Times.
It gets tricky here. But the basic explanation for Friday’s action is that to shut down a CDO you have to buy protection in the credit default swap market. Like any market, higher demand usually leads to higher prices. The unwinding of CDOs will mean higher prices for credit default risk, and big losses on CDOs.
DABDA. Denial, anger, bargaining, acceptance, depression, acceptance.
Those are the stages of grief according to Elizabeth Kubler-Ross in her book, “On Death and Dying.” This bull market in financial engineering and credit is either dead or dying. But you can see that various market participants are at different stages in the grieving process.
Ben Bernanke is somewhere between denial and bargaining. He knows there’s a problem, but he would like to bargain with the Bear Market. “Let me cut rates to help home owners. You can have your pound of flesh from savers if you’d like. But please Bear Market, be reasonable.”
The Bear Market is not reasonable, but he is thoughtful. He wants you to believe he can be reasoned with. That way he can swipe you one paw at a time at his own leisurely pace. If you run, it makes his job harder. He wants you to sit and be still. It’s easier to eat a stationary target.
Jean Claude Trichet is also bargaining. Until recently, the European Central Bank has been a rock in the fight against inflation. It has not cut rates to “stimulate” or promote growth. But the credit Bear market even has Trichet spooked. He has sat down to offer the Bear some easy-money honey.
“Uncertainty about the prospects for economic growth is unusually high,” Trichet told reporters last week. “We have had a reappraisal of risk in financial markets which triggered unusually high uncertainty, so the risks are on the downside from that standpoint.”
Trichet used the word “growth” and not “inflation” suggesting every so subtly that the bias at his bank is to cut European interest rates to ignite “growth.” This prompted a bout of U.S. dollar strength last week which could continue.
How very strange. Just last week, the U.S. Treasury had trouble auctioning $9 billion in thirty-year bonds. The market seemed to tell Uncle Sam, we do not want to lend you money for 30-years at a mediocre interest rate of 4.45%. Yet relatively speaking, the dollar could rally. Why?
We have no idea. In a world of relative currency movements, it’s a constant battle between growth and yield over which determines the market value of a currency. Sometimes investors value higher yields on government debt, believing that makes a government’s money strong. Other times, high growth economies are valued.
Our prediction is that gold and silver will to better than paper money for the next few years, both relatively and absolutely. As Bill Bonner says, all paper money eventually finds its intrinsic value.
Psychologically, precious metals accept the Bear market in credit. Indeed, they hug him as safely as one can hug an angry, furry, be-clawed 300-kilo animal. The more he mauls financial assets, the better it ought to be for real assets.
And be prepared for more mauling of financial assets this week. “There were reports that several large German banks will need capital infusions to complete some upcoming mergers,” reports Leslie Wines at the Associated Press. As you can see from the figures below compiled by BNP Paribas, the losses in the global banking sector have already been substantial.
Source: BNP Paribas
Markets and Money