Price of oil for delivery in 2015 hits fresh high

(LONDON) Oil for delivery in future years is extending record highs, a sign that investors are betting that supply concerns and other factors boosting the cost of crude are unlikely to fade soon.

Oil for delivery in December 2015 set a record high of US$92.50 a barrel last Friday. When oil for immediate delivery hit US$100 for the first time on Jan 2, the 2015 price stood at US$88.33.

‘It’s telling us that the market is still looking for a long-term oil price that works,’ said Kevin Norrish, oil analyst at Barclays Capital. ‘The market believes higher prices are here to stay; the question is, how much higher do they need to be?’

The rise in long-term prices comes as a growing number of industry officials are questioning mainstream oil supply forecasts, underscoring the challenge of meeting ever-rising world demand for fuel.

‘We are experiencing a step-change in the growth rate of energy demand due to rising population and economic development,’ Royal Dutch Shell chief executive Jeroen Van der Veer said last month. ‘After 2015, easily accessible supplies of oil and gas probably will no longer keep up with demand.’

The International Energy Agency, adviser to 27 industrialised countries, warned last year that a supply crunch in the period to 2015 could not be ruled out. Among the factors driving long-term prices are falling production in some areas outside Opec as well as rising demand led by countries such as China.

‘The fundamental influences at work on the curve are strong demand growth and the poor performance of non-Opec supply,’ Mr Norrish said.

The rising price of oil for future delivery also reflects higher costs and the changing nature of production.

Oil industry costs have surged in recent years due to rising raw material prices and as oil companies tackle more complex projects in more remote locations, such as beneath deep water.

In addition, a growing portion of future supply is expected to come from so-called unconventional sources, such as by squeezing crude from tar sands in Canada, which need a higher oil price to make money.

‘The long-dated price is supposed to represent the marginal cost of extracting a barrel of oil,’ said Harry Tchilinguirian, senior market analyst at BNP Paribas. ‘Up until 2003, that long-dated price was relatively stable, around US$22 a barrel, but it is now as volatile as the prompt price.’

 

Source: Reuters (Business Times 18 Feb 08)

2008 not necessarily like 2007: UBS

(ZURICH) UBS AG does not expect 2008 to be a year like 2007, when the Swiss bank wrote down US $18 billion in bad credits and posted the first loss since its creation, its chief executive was quoted as saying yesterday.

‘I view the environment as difficult due to great uncertainties related to the US economy. Nervousness will remain high in the markets. But you cannot conclude from that that 2008 will be a year like 2007 for UBS,’ UBS chief executive Marcel Rohner told newspaper NZZ am Sonntag.

UBS, the world’s largest manager of affluent people’s money, is Europe’s biggest casualty of the credit crunch by far. Investors fear the possibility of billions of dollars in new sub-prime writedowns.

Mr Rohner said UBS’s investment banking business would concentrate in 2008 on its strengths in customer business, such as equities and mergers and acquisitions advisory business.

‘Our goal is to give the businesses that do excellent work the space to develop further, while isolating the problem portfolios in the US mortgage market, managing them separately and quickly reducing the risks,’ he said.

UBS has published details of its exposure to problem areas in US debt, totalling US$88 billion at the end of 2007, including US$27.5 billion in sub-prime debt.

But Mr Rohner said the figure could not be used to predict losses, as it comprised highly diverse positions and risks. ‘The quality of our investment in leveraged buyouts, for example, is much better than in complex securities based on mortgages with poor debtor quality,’ he noted.

Mr Rohner said it was not currently possible to sell intact structured products. But where a collateralised debt obligation structure had become insolvent, UBS had been able to reduce its risks by selling the underlying securities at prices in line with their current valuation by the bank.

UBS’s private banking business has not been affected by the blow to the bank’s reputation, Mr Rohner said. Private banking recorded net inflows of more than 30 billion Swiss francs (S$38.8 billion) in the fourth quarter of 2007, and net inflows continued in January.

Mr Rohner defended the continuing payment of bonuses amid the losses, as the losses arose from real estate loans handled by a small part of the bank. Other areas of the bank had worked well and it was important to continue to motivate staff producing these results by treating them fairly.

 

Source: Reuters (Business Times 18 Feb 08)

IMPROVING OUTLOOK: UBS expects this year to be a better one

ZURICH – UBS does not expect this year to be like the last, when the Swiss bank wrote down US$18 billion (S$25.5 billion) in bad credits and posted the first loss since its creation, its chief executive officer (CEO) was quoted as saying yesterday.

‘I view the environment as difficult due to great uncertainties related to the United States economy. Nervousness will remain high in the markets. But you cannot conclude from that that 2008 will be a year like 2007 for UBS,’ CEO Marcel Rohner told Swiss daily newspaper NZZ am Sonntag.

UBS, the world’s largest manager of affluent people’s money, is Europe’s biggest casualty of the credit crunch by far. Investors fear the possibility of billions of dollars in new sub-prime write-downs.

Mr Rohner said UBS’ investment banking business would this year concentrate on its strengths in customer business, such as equities and mergers and acquisitions advisory business.

‘Our goal is to give the businesses that do excellent work the space to develop further, while isolating the problem portfolios in the US mortgage market, managing them separately and quickly reducing the risks.’

UBS has published details of its exposure to problem areas in US debt, totalling US$88 billion at the end of last year, including US$27.5 billion in sub-prime debt. But Mr Rohner said the figure could not be used to predict losses, as it comprised highly diverse positions and risks.

Last December, the Government of Singapore Investment Corp bought a 9 per cent stake in UBS for 11 billion Swiss francs (S$14.2 billion).

On Jan 30, UBS announced a 12.5 billion Swiss franc loss for the final three months of last year and a full-year loss of 4.4 billion Swiss francs, a record for the bank. This was due to a higher-than-expected US$14 billion write-down on assets connected to sub-prime mortgages in the US.

UBS was formed in 1998 after the Union Bank of Switzerland took over local rival Swiss Banking Corp.

 

Source: REUTERS (The Straits Times 18 Feb 08)

Investors abroad don’t feel immune to US woes now

They worry how bad a US recession could get, and how badly it would hit the world

(FRANKFURT) Since late last summer, the US economy has demonstrated an enduring power to surprise. And not for the better.

Investors worldwide are pondering the prospects for a recession in the United States, their latest and furthestreaching preoccupation resulting from a succession of bad news that the US economy, the world’s largest, has delivered since the onset of global financial turmoil.

When credit markets seized up, the product of mounting losses linked to the American mortgage market, stocks dived, then recovered, as investors factored higher borrowing costs into the outlook for corporate earnings. The changes, some reasoned, were an imaginable step away from the easy money of recent years.

But as large banks in the US disclosed losses in November, equity markets plunged again to account for a lending system that, it turned out, needed to purge losses and be recapitalised.

Stocks recovered somewhat in December. Now the focus among overseas investors has jumped to recession, and a conviction that the US cannot avoid it has became embedded in many market watchers’ and investors’ psychology.

‘We have moved from a phase where an assessment was made on the credit situation, which is improving, onto the macroeconomic news flow,’ said Jacques Cailloux, chief euro-area economist at the Royal Bank of Scotland in London. ‘And if you look at the US, the data has not been very encouraging.’

On Monday, investors ignored the assurances last week from Federal Reserve chairman Ben Bernanke that the US might avoid recession; instead, they have begun to ask how bad it could become – and how bad that would make it for the rest of the world.

‘Ten days ago, only a very few people thought this would be a bad one,’ said Erik Nielsen, chief European economist at Goldman Sachs in London. ‘But now you have people debating just that.’

The latest panicky discussion – which ushered Asian and European markets on Monday and yesterday to some of their steepest losses since September 2001 – revolves around whether the normally resilient US economy will suffer a sharp, protracted downturn or a brief, shallow slowing if consumers regain their footing after the long period of free spending by borrowing against the value of their homes.

Emergency proposals with broad support from the Republican White House and many congressional Democrats to stimulate the economy, coupled with further signs that the Fed will again cut borrowing costs to cushion the blow, suggest agreement in the US that the economic downturn is a serious threat and must be addressed immediately.

That sense of urgency is also fuelling further debate among policymakers in Europe and Asia about whether their economies are truly as insulated from US woes as many would like to believe.

Investors in Asia, conditioned by the roaring economies of emerging markets like China and India, had resisted factoring the chances of a recession in the US into equity prices, stock strategists said – a stance that helped ward off losses in recent months. But now that expectation of a recession is wider, the adjustment in the markets has been jarring – a point evident in Monday’s stock losses.

The signals from the US have been strong enough that the financial markets are betting that Europe will take a much bigger hit than previously expected.

This conviction is strong enough that investors are behaving, based on signals from the bond market, as if they expect the European Central Bank (ECB) to ease interest rates later this year – even though the bank has given no such signal.

‘Overall, the market is sending a message to the ECB that the outlook is very different from what the bank has said,’ Mr Cailloux said. ‘The markets are pre-empting the ECB.’

Instead, the European bank has threatened to raise interest rates – rather than lower them, as is happening in the US – if labour unions demand compensation for food and energy price increases in new wage settlements, a move that could be expected to increase inflation, which is already 3 per cent in the euro zone.

Yet even the president of the European bank, Jean-Claude Trichet – who maintains that the euro area can continue to grow solidly despite deteriorating conditions in the US – acknowledged recently that the slowing in the US must be watched carefully.

In trying to estimate how much American consumers might curb their spending, slowing the economy further, some analysts are beginning to make comparisons to Japan’s long stagnation of the 1990s.

This view holds that consumers have overdone things to such a degree on cheap credit and loans from ever more expensive homes, that the adjustment could drag out more than a few quarters. At the least, this thinking goes, corporate earnings could be tame even after the economy stops contracting, slowing any recovery.

 

Source: NYT (Business Times 23 Jan 08)

Soros warns of worst financial crisis since WWII

(VIENNA) Billionaire investor George Soros said the world was facing the worst financial crisis since World War II and the United States was threatened with recession, according to an interview by the Austrian daily Standard.

‘The situation is much more serious than any other financial crisis since the end of World War II,’ Mr Soros was quoted as saying.

He said that, over the past few years, politics had been guided by some basic misunderstandings stemming from something which he called ‘market fundamentalism’ – the belief financial markets tended to act as a balance.

‘This is the wrong idea,’ he said. ‘We really do have a serious financial crisis now.’

Asked whether he thought the US was headed for a recession, he said: ‘Yes, this is a threat in the United States.’

He added that he was surprised how little understanding there had been on how recession was also a threat to Europe.

European shares fell nearly 6 per cent on Monday, their biggest one-day slide since the Sept 11 attacks of 2001, as fears of a US recession and more writedowns in the financial sector sparked a broad-based selloff.

In Washington, US Treasury Secretary Henry Paulson said that the US economy remained resilient and has healthy long-term fundamentals, but has slowed ‘materially’ in recent weeks.

Warning that, in the short term, risks were clearly to the downside, he said that Congress and the administration need to agree quickly on a package of tax cuts and other measures to boost the economy.

‘Time is of the essence and the president stands ready to work on a bipartisan basis to enact economic growth legislation as soon as possible,’ Mr Paulson said in remarks to the US Chamber of Commerce as House Speaker Nancy Pelosi and leaders in both parties prepared to meet President George W Bush at the White House to discuss a stimulus bill.

Such legislation presumably would involve tax rebates, business tax cuts and funding for a Democraticled call for additional food stamp and employment aid.

 

Source: AP, Reuters (Business Times 23 Jan 08)

Recession in US, Europe could shake Asia, S’pore

Region still relies heavily on world’s biggest markets, say economists

A RECESSION in the United States and Europe would badly hurt Asian economies, including Singapore’s, which still rely heavily on these two export markets for growth, according to economists.

Indeed, analysts at Lehman Brothers believe economic growth in Singapore could slump to as low as 2.5 per cent this year, if the worst-case scenario of a recession occurs. The official forecast is for growth of 4.5 per cent to 6.5 per cent.

Economists said yesterday that while the region’s economies have managed to stand on their own feet in recent years, their fortunes are still closely tied to external conditions.

Most economists are maintaining forecasts for a more benign slowdown, but they concede that risks of a severe downturn are on the rise.

‘We are probably only one shock away from the US economy tipping into a recession,’ said Lehman chief global economist Paul Sheard. ‘One thing that we will be thinking about the next week or so: Are we seeing that one shock now hitting the US economy in the form of this equity market meltdown that is unfolding this week?’

Global share prices have crashed since the start of the year and are accelerating their declines amid rising fears that a US recession may send the world economy into a tailspin.

Earlier theories that Asia’s booming economies are plotting their own destinies and escaping this plight are dissipating fast.

‘We don’t really buy the decoupling idea in its strong form,’ said Dr Sheard, adding that it is very unlikely that demand from Asia and other emerging markets can offset a slowdown in the US and Europe.

Singapore is especially vulnerable, given its small and open economy, said Mr Robert Subbaraman, who heads Lehman’s economic research for Asia, excluding Japan.

He believes overall Asian growth this year could fall by 4.5 percentage points from last year’s 8.7 per cent, if the rest of the world goes into recession. Singapore’s growth could come down to between 2.5 per cent and 3 per cent, he said.

For the moment, Mr Subbaraman is still hoping that aggressive US interest rate cuts will avert a recession to support a 5.3 per cent growth in Singapore and a 7.6 per cent expansion in the region.

This scenario, however, brings risks of an overheating economy, as foreign capital inflows drive up inflation to form possible asset bubbles in the region, he warned.

United Overseas Bank economist Ho Woei Chen said a US recession would hit Singapore’s export sector very hard.

‘Although exports to China have increased, enddemand is largely still in the US,’ he said.

Citigroup economist Chua Hak Bin said a 1-percentage-point reduction in US growth would cut Singapore growth by 1.7 percentage points.

He said a contraction in the US and Europe could lower Singapore growth from his current forecast of 5.6 per cent to between 3 per cent and 4 per cent. ‘Ultimately, manufacturing will be hit, as well as trade-related services such as wholesale and transport.’

Barclays economist Leong Wai Ho, though, is much more sanguine.

He tips Singapore growth at 6.5 per cent this year, purely on the strength of the domestic economy.

‘We already expect exports to contribute very little to growth,’ he said, pointing out that last year’s strong growth came amid a weak export performance.

Instead, private consumption, fuelled by record tourist arrivals and investments in the construction sector, should provide a buffer.

Projects, like the integrated resorts, are highly unlikely to be disrupted, while the record new manufacturing investments that Singapore won last year will provide support, Mr Leong said.

‘We have never entered a US recession from such a strong position. We are going into this with good quality, broad-based growth.’

 

Source: The Straits Times 23 Jan 08

MARKET TUMBLE: Bank stocks hit by US recession, sub-prime fears

Sell-off symptomatic of broader sell-down, slowing in S’pore’s economy: analysts

BANK stocks were clobbered yesterday on continuing concerns of a possible recession in the United States, subprime lending woes and a general slowing down of the Singapore economy.

This comes on the back of the news that Citigroup reported its biggest loss in its 196-year history due to US$18 billion worth of write-downs from the sub-prime crisis. The fall also came on a day when the broad market came under selling pressure.

Shares of DBS Bank, South-east Asia’s largest lender, were among the top losers yesterday, shedding 62 cents or 3.3 per cent to end at $18.20, the lowest in a year.

Shares of United Overseas Bank (UOB), Singapore’s second-largest bank by market capitalisation, also featured among the top losers. They ended yesterday 48 cents or 2.7 per cent lower at $17.08, their lowest price in a year.

OCBC Bank shares dropped seven cents or 0.9 per cent to end at $7.61, their lowest in 11 months.

This mirrors the fate of bank stocks in the Asian region, where Japanese bank shares fell on worries about the persisting US sub-prime crisis. Shares of Mizuho Financial Group and Mitsubishi UFJ – Japan’s largest bank – plummeted after suffering losses related to US sub-prime lending.

Shares of Bank of China, the country’s third-biggest bank, also dropped, as did those of Kookmin Bank, South Korea’s largest lender by market value.

In Australia, shares of Commonwealth Bank of Australia, Macquarie Group and National Australia Bank also declined.

Analysts said the sell-off in shares of Singapore banks was symptomatic of a broader sell-down in the markets, and a slowing in Singapore’s economy due to recession fears in the US.

‘Bank stocks are taking the lead from the US, which appears to be going into recession,’ said Matthew Wilson, a banking analyst at Morgan Stanley. ‘This will be bad for Singapore, given its small and open economy.’

David Lum, an analyst at the Daiwa Institute of Research, said a recession in the US would have a knock-on effect on Singapore bank stocks as these are the bellwether for the economy.

‘GDP growth has slowed in Singapore,’ he said. ‘If financial markets are weak, there will be a spillover effect on banks since they are closely tied to the economy.’

Mr Wilson noted that underlying pressure from sub-prime problems in the US remains and the prospect of collateralised debt obligation (CDO) write-downs still looms. ‘Financial stocks globally are under pressure.’

But Mr Lum was of the view that the prices of local bank stocks were hit by factors other than the US sub-prime lending crisis. ‘The sell-down should not be due to sub-prime problems,’ he said. ‘Singapore banks don’t need capital, and their capital ratio looks strong.’

Operationally too, banks are falling victim to low interest rates, possibly depressing their share prices. ‘The Singapore interbank offered rate (Sibor) is falling, and is likely to stay low as the US cuts its interest rates,’ Mr Wilson noted. ‘This is negative for banks’ net interest margins.’

He also said mortgage loan growth, although strong, generates low earnings for banks with narrow spreads.

The local banks are due to report full-year earnings next month. Analysts are expecting to see more write-downs relating to the CDO exposure. ‘There will be more write-downs though not as much as in the third quarter,’ said Pauline Lee, an analyst at Kim Eng Securities. ‘We won’t see as much write-downs at UOB and OCBC, compared to DBS.’

 

Source: Business Times 17 Jan 08

Markets brace for news of big losses by banks

Citigroup could write off US$24b, lay off 20,000 staff

(LONDON) Major American banks are expected to unveil substantial losses and secure more cash from abroad in what is shaping up to be a pivotal week for the global credit crisis.

Citigroup could write off as much as US$24 billion and lay off 20,000 workers in a drive to cut costs and boost capital, CNBC said on its website in a report dated Sunday.

CNBC said the plans will be unveiled today when Citi, the largest US bank by assets, reports its fourth-quarter results.

Investment bank Merrill Lynch is just as troubled.

The Financial Times said yesterday that Merrill was seeking about US$4 billion in a second capital raising, and the Kuwait Investment Authority was expected to be a significant investor. A deal could be announced as soon as midweek, the newspaper said, citing people familiar with the matter.

The New York Times on Friday said that Merrill was expected to suffer US$15 billion in losses stemming from bad mortgage investments, almost twice the company’s original estimate, when it releases its results later this week.

FT also reported on Saturday that Citigroup was putting the final touches to its second big fund-raising, seeking up to US$14 billion from Chinese, Kuwaiti and other investors.

The US$200 billion Kuwait Investment Authority had no immediate comment yesterday on the reports that it may buy into the two damaged American banks.

Banks, wrestling with huge losses stemming from mortgages lent to people ill-equipped to repay them, have been seeking cash from sovereign wealth funds.

In December, Merrill secured as much as US$7.5 billion by selling a stake to Temasek Holdings and New York based money manager Davis Selected Advisors.

The month before, Citi agreed to sell up to a 4.9 per cent stake to Abu Dhabi for the same amount.

As well as Merrill and Citi, other big names such as State Street and JP Morgan report results this week.

Wall Street analysts have turned increasingly wary over US financial results for the fourth quarter as well as the first two quarters of 2008, according to a weekly survey by Reuters Estimates yesterday.

The survey showed that analysts expect S&P 500 companies’ fourth-quarter earnings to fall 9.1 per cent from a year earlier.

That was gloomier than the 8.4 per cent decline forecast a week earlier, and the 11.5 per cent growth forecast in an Oct 1 survey.

The Federal Reserve was to auction US$30 billion later yesterday and the European Central Bank and Swiss National Bank will continue their unprecedented US dollar lending to banks as part of coordinated central bank efforts to help calm credit market tensions. The Bank of England will also weigh in.

Results of the latest ‘term auctions’, a plan agreed in December and one which has helped money market rates ease, will come today.

One to three-month Euribor interbank interest rates fell yesterday amid central banks’ moves to inject liquidity into markets.

Most analysts say the threat of further losses at major banks from investments tied to US sub-prime mortgages means the crisis is far from over as crucial lending between commercial banks remains patchy at best.

The Fed is forecast to use its other policy lever – interest rates – before the month is out. It is seen slashing rates by a half-point at its two-day meeting ending on Jan 30 after Fed chairman Ben Bernanke gave a downbeat assessment of the US economy last week and said the central bank was ready to take ’substantive additional action’.

Swiss banking giant UBS appealed to shareholders last week to back a capital injection by Singapore’s Temasek and a Middle East investor and warned it still could not predict how the sub-prime crisis would play out.

And shares in Northern Rock fell as much as 7 per cent early yesterday on fresh concerns that the bank is facing imminent nationalisation. Northern Rock is Britain’s biggest casualty of the credit crunch and has borrowed around 26 billion pounds (S$72.8 billion) from the Bank of England since it requested emergency funds in September.

 

Source: Reuters (Business Times 15 Jan 08)

Oil shock, recession top global risks in ‘08: report

(GENEVA) A sharp downturn in the global economy is the most likely and the most serious threat to the world in 2008, according to a report released yesterday by the World Economic Forum (WEF).

Fears of a US recession coupled with a sudden spike in oil prices replaced terrorism, pandemic disease outbreaks and short- term disasters resulting from climate change as the issues global business leaders are most worried about, said the Global Risks 2008 report.

The report, which is based on workshops involving corporate leaders, professors and risk analysts, also listed dwindling food supplies as a growing concern.

‘A recession in the United States cannot be excluded in the year ahead,’ the report said, adding that ‘economists are divided on whether domestic-led growth in Asian markets can drive the global economy.’

The report coincides with a World Bank study released yesterday that expressed concern about the faltering US housing market and its impact on global financial markets.

The WEF report said changes in the global financial system over the past years may have made it more susceptible to instability during periods of crisis.

‘The complexity and near infinite feedback loops of the modern financial system have exposed it to a small risk of very large systemic shocks,’ said the 54-page report, which was published by the Forum in collaboration with Marsh & McLennan Companies, Citigroup, Swiss Reinsurance, Zurich Financial and the Wharton School at the University of Pennsylvania.

Losses to banks in markets such as Germany and Britain as a result of the US sub-prime mortgage crisis showed how vulnerable the global financial system now is to sudden, unforeseen risks, the report said.

The world economy is also threatened by the high cost of oil, particularly if prices rise sharply as a result of political crises or natural disasters, it said.

‘Over the 10-year horizon of this report there are few reasons to believe that energy prices will fall significantly and there are several reasons to believe that energy prices may rise,’ the report said.

The third major risk – dwindling food supplies – has become an issue not just for developing nations but also for rich countries, the report said, citing steep price increases for staple foods over the past year.

‘There is considerable uncertainty as to whether food insecurity in 2007 is the result of short-term conditions . . . or whether a more fundamental change is taking place,’ the report said.

‘Policy-makers may have to return to thinking about food as a strategic asset,’ it said, adding that ‘the resilience of the world’s food system will be severely tested in the next few years’.

The report, released two weeks before the Forum’s annual gathering in the Swiss resort of Davos, also cited a slowing of economic growth in China to 6 per cent, the cost of chronic diseases in the developed world, and the uncertain political situation in the Middle East as major concerns for 2008.

 

Source: AP (Business Times 10 Jan 08)

Developing nations to lift world economy amid US slowdown

They will be the biggest drivers of global growth as pace slows to 3.3% this year: World Bank

DEVELOPING nations will be key in helping the global economy mitigate the drag from a slowing United States.

With their domestic economies coming into their own, poor countries will be the world’s biggest growth driver this year, the World Bank said in a report yesterday.

And Singapore is especially well-poised to take advantage of this as it is located amid the hottest of the world’s emerging economies.

‘I do believe that there is an impact from whatever happens in the US economy on the developing regions,’ World Bank lead economist Hans Timmer said at a press conference to present the bank’s outlook for the world economy.

‘But the result is not that the world economy will be on its knees.’

The bank is predicting global economic growth will moderate to 3.3 per cent this year, due mainly to a slowdown in the US, the world’s biggest economy.

The US, mired in a severe housing market downturn that has caused much financial turmoil worldwide, is widely expected to decelerate further this year.

While the World Bank has estimated that the US should manage a modest 1.9 per cent expansion this year, fears of a recession appear to be rising, prompted by recent economic data.

‘We can certainly smell a US recession although we can’t taste one yet,’ said United Overseas Bank economist Thomas Lam.

Against this ominous backdrop, developing economies are emerging as a bright spot for the year. They are expected to grow 7.1 per cent this year, with East Asia’s growth stars clocking in at an average of 9.7 per cent.

‘Singapore benefits from its location in Asia, which has shown the strongest dynamism in the world,’ said Mr Timmers, who cited the region’s red-hot economies of China and Vietnam. He pointed out that developing nations have become much more resilient to external demand shocks in the past few years.

The US housing slowdown, for instance, began two years ago and has been hurting US imports of goods made in poorer countries.

But that has not derailed the developing world from its growth path as its robust domestic economies – bolstered by better economic policies, open borders and stronger supply-side structures – have been picking up the slack.

Many emerging economies have also been largely unscathed by financial problems caused by the US subprime crisis as their direct exposure to the crisis has been limited.

‘With that resilience, with their strong performance, developing countries are now mitigating the slowdown that is occurring in the US,’ said Mr Timmers.

He noted that the developing economies together equal the US economy in size.

‘But they are growing more than three times as fast. That means their contribution to global demand is more than three times as important as the contribution of the United States.’

Still, a sharp and drastic slowdown in the US remains a key risk to the developing world and the global economy.

Also, an overreaction by policymakers might result in bigger problems down the road.

The World bank warned that if central banks overstimulate the economy with over-aggressive rate cuts, asset bubbles could be created.

‘Commodity markets could tighten further, inflationary pressures would mount and financial imbalances would increase rather than recede.

‘Such a scenario could sow the seeds of a much sharper downturn in the medium term.’

 

Source: The Straits Times 10 Jan 08

FOCUS: TRENDS 2008 – Trend-spotting in watershed year

World is so well connected that word of trends in one place can spread across the world in minutes

IN THE Internet era, keeping up – with the Joneses, the news or whatever else – is a lot easier than it used to be.

But staying ahead of the pack, at a time when bloggers and social networking sites can spread word of a trend in Buenos Aires to Boston or Bangkok within minutes? That is the new challenge.

‘Everything is so well connected now that it makes this job a lot more difficult,’ says Reinier Evers, founder of Trendwatching.com, an Amsterdam firm that tries to identify new directions in the consumer economy. Consumer goods companies rely on insights from Evers and other trend spotters to develop new products, while advertising agencies use them to inform the creative content of their campaigns.

Before we chalk up the demise of another media profession to the democratising power of the Internet, it is only fair to put trend spotters’ predictions to the test. This is the time of year when they look forward to the new year.

Some predictions do indeed have a familiar ring to them. Several trend-spotters, for instance, say that 2008 would be a year in which marketers rolled out more and more ‘premium’ products and services – from airline tickets to laptops to toilet paper – in order to satisfy status-hungry consumers and to take in a bit more from the transaction.

A number of trend-spotters also agree that women would continue to gain more clout in the economic, political and professional spheres. The cellphone will become ever more capable and indispensable. Consumers, not corporations, are now in the driver’s seat.

But a few nominated trends for 2008 do stand out. What follows is a short list:

• Blue is the new green. So says Ann Mack, director of trend-spotting at JWT, an ad agency owned by WPP Group. In marketing circles, as well as the broader consumer consciousness, the environment was certainly one of the defining issues of 2007. Now, ’some eco-fatigue has set in’, she says. ‘The idea of green has been so overused and misused that it has ceased to mean anything.’

  So, in 2008, marketers increasingly will link environmental messages with the colour blue rather than green, Ms Mack says. This is more than just a superficial rebranding, she insisted. The issues associated with what Ms Mack calls ‘environmentalism 2.0′ – climate change and access to clean water – are more clearly signalled by blue, the colour of the sky and water, than by green, which many people associate negatively with ‘tree huggers and sandals’.

• The data-awareness era. That is how Ben Hourahine, futures editor at Leo Burnett, part of Publicis Groupe, refers to what he sees as an emerging trend in Internet users’ approach to privacy. Until now, the disarming power of novelty on social networks like MySpace and Facebook has generally overridden concerns about the potential hazards of full disclosure.

Return to privacy

Mr Hourahine says that that could change this year. High-profile data leaks such as the British government’s recent loss of computer discs containing child benefit records have raised awareness of privacy issues. As more employers and university admissions officers troll social networks for potentially embarrassing revelations on candidates, users may decide that it is better to leave those Saturday night snapshots in their mobile phones.

• ‘If 2006 was about user-generated content and 2007 about social media, then 2008 is about the conversation.’

  So says Paul Kemp-Robertson, editor of Contagious, a magazine with headquarters in London that identifies marketing innovations. In other words, brands will have to steel themselves to the idea that marketing is a two-way street, not just a conduit for directing their messages towards pliant consumers.

  To ingratiate themselves with consumers, he says, marketers increasingly will have to provide useful services for them, rather than simply advertising wares. Mr Kemp-Robertson cites a recent initiative by STA Travel, a travel agency for students, to provide fun downloadable software such as a desktop vacation countdown clock.

  Yes, marketers have been talking about ‘engaging’ with consumers for some time. But in 2008, Mr Kemp-Robertson says, this trend might reach a critical mass, at least as far as many ad agencies – often still oriented towards creating expensive television commercials – are concerned.

  ‘From an industry perspective, this is when the agency structure really starts getting questioned by big clients,’ he says.

• ‘Status despair.’ Trend-spotters like to create buzzwords and phrases to identify the mood of a certain year. This one was coined by Trendwatching.com to describe the feeling when, say, the owner of a puny Gulfstream private jet takes in the sight of Prince Alwaleed bin Talal of Saudi Arabia barrelling down the runway in his ‘flying palace’, the customised, double-decker A380 he has ordered from Airbus.

  Because the consumption stakes have been raised so high, more people in 2008 are likely to feel status despair, Mr Evers says. Some, particularly in developed countries, will divert from the consumption-as-status pattern and seek consumer gratification in new ways – by counting the number of views of their page on the photo-sharing site Flickr, for instance. In a year when China will play host to perhaps the highest-profile marketing event of the year, the Summer Olympics, developing countries will seize the baton of conspicuous consumption, Trendwatching.com says.

  Which of these predictions will turn out to be true? In keeping with the spirit of the times, we’ll let you decide.

  After all, you may not have read them here first.

   

  Source: IHT (Business Times 8 Jan 08)

Rising population adds to climate woes

Socio-economic factors play big part in global warming

THREE-QUARTERS of the problems associated with global warming have to do with socio-economic factors like rising population, and only a quarter has to do with the climate itself, according to Andrew Watkinson, director of the Tyndall Centre for Climate Change Research in the UK.

‘The population debate has gone off the agenda,’ he said on the sidelines of a conference on climate modelling at the National University of Singapore.

‘Climate change is not the major issue. It is the socio-economic scenarios, the demographics, that are driving major changes. Its a population problem, primarily,’ he said.

Even in the UK, a developed country, demographers once thought the population would stabilise at 60 million, but the latest projections suggest that the number could hit 75 million. ‘That would make meeting the emissions obligations that much more difficult’, said Dr Watkinson.

The issue of growing populations and consumer behaviour could prove even harder for governments to deal with than straightforward climate change, because they are politically contentious, he also said.

Meanwhile, government policy must be flexible enough to accommodate the inherent uncertainty and wide range of climatic predictions.

The error term in climate forecasts can be significant, ‘because there might be something in the model that means the outcome is not as bad, or is worse than anticipated’, he said.

Government policy should be able to respond in either case.

Ideally, policy should not consist of a single solution, but a ‘road map’ or series of measures that give options down the line. For example, policy could allow for further steps to be taken after initial mitigation, if outcomes turn out worse than expected.

But neither the UK nor any other government has yet been ‘realistic’ about the efforts needed to combat global warming, said Dr Watkinson.

The UK has a target of reducing emissions by 60 per cent by 2050. Its climate change bill will get ‘nowhere near’ the target, which requires a 9 per cent drop in emissions every year. Including aviation and shipping, the bill is more in line with a scenario of a probable four-degree rise in global temperatures rather than the two-degree rise that scientists recommend, said Dr Watkinson.

He praised Singapore’s stance on climate change, as expressed by PM Lee Hsien Loong earlier this year, as ‘the most sensible from a leader that I’ve seen’.

The National Environment Agency has commissioned NUS to conduct a two-year study on the likely effects and impact of climate change on Singapore for the next 100 years, according to Rosa Daniel, deputy secretary of the Ministry of the Environment and Water Resources.

The government is also working to reduce flood prone areas on the island to less than 66 hectares by 2011, from 124 ha today.

 

Source: Business Times 18 Dec 07

Global economy facing threat of stagflation

Growth may slow to 4-year low and inflation could hit 10-year high

WASHINGTON – THE world economy is facing the risk of stagflation – the double whammy of suffering both recession and faster inflation.

Global growth this quarter and next may be the slowest in four years, while inflation might be the fastest in a decade, say economists at JPMorgan Chase.

The worst United States housing slump in 16 years, coupled with a tightening of credit by banks, have brought the world’s largest economy ‘close to stall speed’, according to former US Federal Reserve chairman Alan Greenspan.

At the same time, rapid growth in China and other emerging markets is driving energy and food prices higher worldwide.

‘What lies ahead is a period of stagflation – slow or no growth combined with rising inflation – in the advanced economies,’ says Morgan Stanley co-chief global economist Joachim Fels.

Harvard University economist Martin Feldstein is among those who say it would be just a mild case of what the world endured in the 1970s and early 1980s, when a tenfold increase in oil prices drove both unemployment and inflation above 10 per cent.

Mr Feldstein, who heads the national bureau that serves as the arbiter of when US recessions begin and end, said the combination of a stalled economy and rising inflation could be seen as a form of stagflation.

‘It depends on how you want to define it,’ he said. ‘If you say an inflation rate of 3.5 per cent and a recession is stagflation, then we could have stagflation.’

Mr David Hensley, director of global economic coordination at JPMorgan, sees global growth of 2.4 per cent this quarter and next, and inflation at 3.5 per cent.

That is a far cry from the bad old days more than a generation ago, when world growth slowed to just 0.7 per cent in 1982 while inflation ran at an annual rate of 13.7 per cent, according to data compiled by the International Monetary Fund.

Even so, no less an authority than Mr Greenspan himself expressed concerns.

Speaking on ABC’s This Week programme aired last Sunday, he said a period of ‘remarkable disinflation’ is ending.

‘We are beginning to get not stagflation, but the early symptoms of it,’ he said.

The situation poses a dilemma for the Fed and other central banks as they struggle to decide which problem they should tackle first. How they respond will go a long way in determining which danger proves to be bigger: a slumping global economy or rising prices worldwide.

For now, traders in futures markets are betting the Fed will remain focused on supporting growth, even after the latest government inflation reading last week showed consumer prices rose last month at the fastest pace in more than two years.

As of last Friday, investors put a 74 per cent probability on another quarter percentage-point cut in the Fed’s benchmark overnight rate next month, down from 100 per cent the day before.

If the global economy faced only the risk of faster inflation, the policy prescription would be clear: higher interest rates.

Yet, with growth slowing in the US and Europe, central banks remain under pressure to cut rates

 

Source: BLOOMBERG NEWS (The Straits Times 18 Dec 07)

IMF expects to lower global growth outlook

(ZURICH) The International Monetary Fund will lower its growth outlook as the continued credit crisis hurts the US and European economies, while global imbalances also weigh on growth, its top economist was quoted as saying.

‘Given this background, the numbers will indeed be weaker than in our latest World Economic Outlook,’ IMF chief economist Simon Johnson told Switzerland’s Finanz und Wirtschaft business newspaper in an interview on Saturday.

The IMF already lowered the forecasts from its July World Economic Outlook in October. But the numbers would in all likelihood have to be revised down again at the Fund’s next update in January, when it gives a preview of its April official forecasts. ‘We will not be able to stick to 1.9 per cent 2008 gross domestic product growth for the United States, nor to 2.1 per cent for Europe,’ Mr Johnson said. ‘By how much we will have to lower our GDP forecasts, we will know in January.’

The Fund already warned in November that the global economic growth outlook had dimmed, because of a troublesome mix of tighter credit terms and rising energy prices. The US dollar remained overvalued despite its continued drop since 2002, Mr Johnson said, which could be an obstacle for the US trade deficit to gradually diminish. Too high oil prices and the undervalued Chinese currency boosting exports in US trading partners formed the other side of the trade imbalance equation, he added.

The IMF did not have a foreign exchange target in mind for the greenback, but it should fall even further despite its persistent decline, to help diminish the US trade deficit and the chance of disorderly currency movements.

 

Source: Reuters (Business Times 17 Dec 07)

Credit crisis, inflation threaten world growth, says Fukui

GLOBAL economic growth is under increasing threat from two fronts – the United States sub-prime crisis and soaring commodities prices that may push up inflation.

The warning came from Bank of Japan governor Toshihiko Fukui at a function in Singapore last night. He said the sub-prime turmoil could severely disrupt financial markets, which could then have a ripple effect on economic growth. The risk of inflation is just as potent, presenting a challenge to central bankers who will need to use monetary policy to maintain price stability amid strong growth, added Mr Fukui, who spoke as part of the Monetary Authority of Singapore Lecture series.

 

Inflation expectations have been ‘generally contained’ in many markets. But rising oil prices, driven by high economic growth worldwide, especially in oil-hungry emerging markets, have increased the ‘risk of a rise in inflation expectations in the longer term’, Mr Fukui said.

 

Rising commodity prices will also ‘inevitably impair terms of trade for oil-consuming countries’, he added. Mr Fukui acknowledged that ‘downside risks for the US economy’ persisted, but the risk of stagflation – stagnant growth accompanied by high inflation – in the US and other economies was ‘muted compared to the 1990s’.

 

The credit market turmoil, linked to high-risk sub-prime home loans, was actually the result of many years of favourable growth and benign conditions in the world economy.

 

‘The crux of the problem, as I understand it, is that risk evaluation had become too lax under those benign conditions, and this has led to a correction through market forces,’ said Mr Fukui.

 Financial imbalances were allowed to accumulate that, in turn, triggered corrections and posed a risk to economic stability.

Central bankers, like goalkeepers in football teams, must, therefore, defend against turbulence arising from the increasing complexity in the international flow of funds, he said. They must accurately read the risks of the global economy and financial markets to ’stabilise the market when it is under pressure’. Source: The Straits Times 16 Nov 07

High oil price demands good policies

IT would be a fallacy to imagine that the prospect of a US$100 price tag for a barrel of oil will lead to a push for renewable fuels any time soon. Simply put, there is nothing definitive yet on the horizon offering a reliable, continuous and cheap alternative in the face of mounting energy demand.

Oil prices have remained resilient in their upward trajectory. Producers remain steadfast about the adequacy of supply in the system even as large consumers clamour for more.

Traders focus on the thin inventories to push the price up. When oil was at half the current price level, it was seen as compelling enough for the big competitive initiatives. Yet there is no excited talk of renewable sources of energy or even theories that high prices would yield new oil supplies, driving prices down. Instead we have ever higher-priced oil.

Yes, consumers are in a fix, for which they should share the blame. Have they been willing to make the necessary sacrifices and use pressure to accelerate the shift? In countries that matter to oil consumption, people have not been pushy enough.

Politicians may make noises but will act only if they are convinced that a change – putting at risk trillions of dollars of infrastructure investment and millions of jobs – is politically worth their effort.

Then subsidies and legislation will follow for a meaningful change of direction. Until then, some countries will do their bit but no cohesive global policy or focus on the next big thing will emerge. Big energy companies spend scant sums on research and development on renewable fuels. Independent R&D betting on the new future have surged but their budgets are small beer.

Unless the existing big players like car, energy and power companies as well as governments line up behind a change and consumers show a determination to support the drive, we will continue to grope for good answers for years, if not decades. Not convinced? ExxonMobil has forecast energy demand will grow 1.3 per cent a year, a tad lower than at the current rate, requiring a third more energy by 2030.

It says hydrocarbons would still meet 80 per cent of demand then, though renewable energy supply will grow at a faster clip of 9 per cent a year from now.

Rich nations’ energy adviser, the International Energy Agency, is also equally bleak. Unless governments embark on low-carbon policies, it sees the unprecedented rise in energy demand accelerating climate change, threatening global energy security and possibly creating a supply crunch. By 2030, the world will have to find an additional 30 million barrels per day, equivalent to Opec’s current total daily production.

Such an enormous challenge demands good policies and determined execution. Global R&D cooperation and conservation, not bitter recrimination by rich polluters, should be the way forward.

 

Source: Business Times 15 Nov 07

HIGH OIL PRICES – A bubble that’s hard to prick

OIL prices are testing US$100 (S$144) a barrel, a key psychological threshold. Once over that hump, how much higher will the price go? Of course, given oil’s limited supply and the world’s expanding appetite, lowpriced oil will never come again.

That, however, is different from another consideration: Whether current high prices are truly reflective of supply and demand, or are prices being pushed up to a significant extent by speculation? And if the latter, is there an ‘oil bubble’?

The answer to that is wrapped up in arcane terms such as ‘backwardation’ and ‘contango’, which affect the prices of commodities, as well as in developments in the American prairie town of Cushing, Oklahoma. But more on this later.

In fact, an oil bubble may not necessarily be bad news. For if current prices reflect a bubble, there is the hope that the market will eventually readjust to equilibrium and there is the possibility of relief; it means the time for US$100 oil has not yet truly arrived. The oil bubble would be one whose pricking would benefit far more people than it would hurt.

The bad news is that if there is an oil bubble, it is unlike other bubbles – in Internet stocks, in properties and so on. An oil bubble would be more difficult to deflate.

That’s because, unlike equities, oil is a much more complex trading class. Buyers and sellers are users and producers, but also large trading houses, hedge funds and institutional investors like pension funds. Although exchange- traded funds now allow retail investors to diversify into oil, the big moves depend far more on the large players than on the collective calculations of small investors. If this is a bubble, it’s also one with more discipline.

Indeed, over the past three years, any number of analysts and economists have said that oil should be in the US$50 range, the US$60-plus level and so on. Yet it’s remained stubbornly stuck on a steeper trajectory. In fact, here we are today, knocking on US$100.

Those who say oil is priced correctly point to China’s increasing hunger for energy, India’s demand for power and the US dollar’s steep decline. Others might cite the correlation between oil and gold, which in recent periods has seen oil priced at 7.5-8 barrels to an ounce of gold. With oil just under US$100 and gold comfortably above US$800, you might well reckon that oil has legs yet.

But is Chinese and Indian demand, coupled with the weakness of the US dollar, enough to explain a more than threefold rise in oil’s price since 2001? Is this justified under the calculus of demand and value? The week before the Sept 11, 2001, attacks in New York and Washington, oil was trading at US$28.

Terrorism, wars, civil unrest and weather uncertainties – all have been kneaded into prices as well. Yet have these resulted in enough of a consistent constriction in supply to justify prices of nearly US$100?

India’s petroleum secretary, Mr M.S. Srinivasan, isn’t likely to think so. He was reported by the International Herald Tribune last Friday as saying there are ‘no supply constraints right now, and demand has not escalated out of control’. Mr Srinivasan has a suggestion for cooling the market: stop trading crude oil on commodity exchanges, which he believes contributes greatly to high prices. Do this much, and we’d see a ‘drastic reduction’ in the price of oil, Mr Srinivasan said.

His suggestion is unlikely to gain traction. For however much exchange trading contributes to speculative positions, it also provides price transparency. Without this, we’d have backroom brokering instead, which would more likely exacerbate the situation than help.

Yet Mr Srinivasan’s frustration is understandable. And this can be seen in how prices have been bubbling up lately.

Yes, demand is strong. No arguing. But the recent surge is also connected to how the premium in prices has shifted from later to earlier delivery.

Because of a complicated series of events, oil prices in the past several months are in a situation called backwardation. This means prices are higher for oil about to be delivered than for oil for later delivery. The opposite is contango, when prices are higher for future delivery than for supply sooner – reflecting the expense of storage and other carrying costs.

Until the middle of this year, conditions in the market were such that it was more profitable to buy lots of oil and hold it in storage tanks until later. But suddenly, it became more profitable to sell than to hold. The subprime mortgage crisis in the US, for one thing, has also made financing for holding oil more expensive.

So in backwardation, those who hold oil have an incentive to drain their tanks – kept in places like Cushing.

This Oklahoma prairie town is one of the biggest storage sites for oil, with capacity possibly as high as 35 million barrels. Since 1983, Cushing has been the New York Mercantile Exchange’s official delivery point for futures contracts in light, sweet crude, the global benchmark. So the market pays close attention to what happens in Cushing.

Maybe too much.

What the market has noticed is that the tanks in Cushing are down to perhaps 15 million barrels. Attention drawn to this decline in inventory is helping push up prices.

Yet, as Opec’s head of petroleum market analysis, Mr Mohammad Alipour-Jeddi, has said: ‘There is enough crude in the markets.’

Thus, it isn’t a huge mismatch between supply and demand that’s yanking up prices. Instead, backwardation is causing a draw-down of inventory, starting what’s called a ‘backwardation vortex’. By focusing on places like Cushing, the market has worked itself into a frenzy – whatever the real ability at the moment of producers to supply users.

Prices can be high in contango and oil investments profitable; but in backwardation there is an incentive to sell existing stocks, resulting in lowered inventories that spark market anxieties. As a result, some investors are reaping big profits and setting up conditions for even more gains.

Does speculation in oil amount to a bubble, then? Look again at the correlation between oil and gold.

Over a longer period of a half century, oil has been priced at 15 barrels to an ounce of gold. At gold’s current price, that means oil should be in the mid-US$50 level. Sure, there’s some wiggle room on the up side. But even then, there’s going to be enough of a gap between the implied and actual price to suspect that oil’s frothier than natural.

The question, in turn, is how do you prick this bubble?

LOGIC OF ITS OWN

If there is an oil bubble, it is unlike other bubbles – in Internet stocks, in properties and so on. An oil bubble would be more difficult to deflate.

 

Source: The Straits Times 12 Nov 07

US rate cuts won’t defuse sub-prime mess: ‘Mr Yen’

Asia, though not much affected so far, must be vigilant

(SINGAPORE) Interest rate cuts by the US Federal Reserve – which have amounted to 75 basis points since Sept 18 – are unlikely to defuse the US sub-prime mortgage crisis, according to the influential economist Eisuke Sakakibara.

Mr Sakakibara, formerly Japan’s vice-minister for finance and international affairs and now a professor at Tokyo’s Waseda University, also warned that global financial markets are likely to face further bouts of volatility. What we have seen thus far ‘is only the tip of the iceberg’, he said, adding that the problem will probably linger for 6-18 months.

Speaking at a lunchtime forum organised by newly listed Uni-Asia Finance Corporation, Mr Sakakibara pointed out that interest rate cuts by the Fed were likely to be ineffective in addressing the problems emanating from the US sub-prime mortgage sector because the cost of funding is not the key issue; rather it is the uncertainty surrounding the valuations of sub-prime assets and other structured products held by many financial institutions.

He indicated, however, that the ’superfund’ proposed by some major American banks (including Citigroup, Bank of America and JPMorgan) to buy sub-prime assets could be helpful, as might a move to provide government financial support to distressed borrowers, which is being discussed in the US Congress. But such initiatives would take time to work.

Mr Sakakibara, who was Japan’s vice-minister for finance during the Asian crisis of 1997/98, cautioned that although Asia has been relatively unaffected by the US sub-prime woes thus far, it needs to be vigilant. He recalled that during the Asian crisis, US policymakers thought that the American economy would be relatively insulated – until they were shocked by the Russian bond default of 1998 and the ensuing collapse of a large hedge fund.

The world economy is highly integrated now, he said, and it is highly possible that the US – still its primary engine – will slow down sharply or even go into recession. In such an event, Asia cannot be unaffected.

While Asian economies are doing well and will account for an increasing share of the global economy, right now, Asian asset markets are ’somewhat bubbly’, Mr Sakakibara said. ‘The situation in Asia seems too good, and usually a ‘too good’ situation doesn’t last.’

When it does turn, the decline could happen ‘very abruptly’.

Of all the Asian markets, China is ‘the biggest bubble’, Mr Sakakibara added, with both investment and GDP growth expanding at breakneck speed.

Chinese policymakers know they have to tighten monetary policies sooner or later, and a major adjustment in China’s asset markets is inevitable, perhaps in 2008, after the Olympics. If China’s economy slows down in tandem with the US, that would exacerbate the problems for the global economy, Mr Sakakibara warned.

The economist – who was known as ‘Mr Yen’ when he was a policymaker because his statements were viewed as affecting currency markets – said that as long as the Bank of Japan is unable to raise interest rates, the Japanese yen will remain undervalued. The bank actually did want to raise rates in September, he added, but refrained from doing so on account of the US sub-prime mortgage problem.

With near-zero interest rates at home, Japanese investors are continuing to seek higher-yielding investments overseas, and while this trend persists the yen will probably continue to trade within the range of 110-115 to the US dollar, he said. But if, owing to some trigger such as a dramatic US slowdown, the outflows from Japan dry up or reverse, the yen would rebound sharply from its ‘really cheap’ current level, he said.

 

Source: Business Times 2 Nov 07

An age of market resilience?

BIOLOGISTS believe that diversity increases stability and resilience in an ecosystem – a complex system where participants go about looking out for their own interest with the ultimate goal of surviving and thriving. What is true of a biological ecosystem may also hold good for the financial system, which, too, is complex. In which case, there are grounds to believe that the financial system of today is more stable and resilient than before.

The stock market crash of 1987, while its real cause is still being debated, can be said to have been exacerbated by the widespread use of portfolio insurance at that time. In theory, portfolio insurance sounded like a superb idea. Just by giving up a bit of the upside – premium for buying the insurance – a portfolio can be protected on the downside. The simplest form of insurance is to buy a put option which gives a portfolio manager the right to sell stocks or an index at a fixed price. So the floor that the portfolio value can fall to is that fixed price on its put option. Other forms of portfolio insurance involve the use of index futures or dynamic trading. A dynamic portfolio trading strategy, also called program trading, allows investors to replicate the payoff from derivatives. It basically triggers sell orders as stock prices fall, so that the portfolio value does not fall below the floor. By 1987, about US$60 billion – a significant sum at that time – in equity assets were covered by different varieties of portfolio insurance. What happened was, in the three days prior to Oct 19, Wall Street had corrected by some 10 per cent as investors became more risk averse. That fall triggered the sell programs in the numerous insured portfolios. Everybody rushed for the exit at the same time, and there was nary a buy order.

As the story goes, some professional traders who were not portfolio insurers had anticipated this pent-up selling demand and sold in advance. As the day unwound, other investors who had never heard of portfolio insurance may have misinterpreted the price changes as conveying something fundamental about the market and may have sold in a mistaken response. So, at a time when all participants were making similar kinds of bets, the market could not be trusted to provide diversification and liquidity.

How have things changed today? For one thing, there are a lot more players with more diverse views of the markets. And many have the liberty to act on those views. A hedge fund which thinks a market or a stock is overvalued has the option to short sell it, in a way keeping a check on the price. The securitisation of risks – a much vilified practice in the current sub-prime mortgage crisis – has the effect of spreading the risks to many players. This reduces the systemic risk to the global markets.

Meanwhile, the emergence of sovereign funds with typically very long investment horizons, in contrast to most commercial funds, adds another level of diversity.

The fact that markets globally have repeatedly been able to find their feet, despite numerous bouts of ‘risk aversion’ attacks in the last two years, is perhaps testament to what may be a new age of resilience – or at least greater resilience than before – that we are now entering.

 

Source: Business Times 31 Oct 07

Sub-prime rescue bid will do more harm than good

By PAUL KRUGMAN

IT pains me to say this, but this time former Federal Reserve chairman Alan Greenspan is right about US housing. Mr Greenspan was wrong in 2004, when he sang the praises of adjustable-rate mortgages. He was wrong in 2005, when he dismissed the idea that there was a national housing bubble, suggesting that at most there was some ‘froth’ in the market. He was wrong last autumn, when he suggested that the worst of the housing slump was behind us. (Housing starts have fallen 30 per cent since then.) But his latest pronouncement – that the market rescue plan being pushed by US Treasury Secretary Henry Paulson is likely to make things worse rather than better – looks all too accurate.

To understand why, we need to talk about the nature of the mess. First of all, there was indeed a huge national housing bubble. What even those of us who realised that there was a bubble didn’t appreciate, however, was how much of a threat the bursting of that bubble would pose to financial markets. Today, when a bank makes a home loan, it doesn’t hold on to it. Instead, it quickly sells the mortgage off to financial engineers, who chop up, repackage and resell home loans pretty much the way supermarkets chop up, repackage and resell meat. It’s a business model that depends on trust. You don’t know anything about the cows that contributed body parts to your package of ground beef, so you have to trust the supermarket when it assures you that the beef is USDA prime.

You don’t know anything about the sub-prime mortgage loans that were sliced, diced and pureed to produce that mortgage-backed security, so you have to trust the seller – and the rating agency – when they assure you that it’s an AAA investment. But in the case of housing-related investments, investors’ trust was betrayed. Supposedly safe investments suddenly turned into junk bonds when the housing bubble burst. High profits reported by hedge funds – profits that were reflected in huge payments to the fund managers – turn out to have been based on wishful thinking.

Thus, when two hedge funds run by Ralph Cioffi of Bear Stearns imploded last summer, it came as a huge shock to many investors, and helped trigger a market panic. But a recent BusinessWeek report shows that the funds were a disaster waiting to happen. The funds borrowed huge amounts, and invested the proceeds in questionable mortgage-backed securities. Even worse, ‘more than 60 per cent of their net worth was tied up in exotic securities whose reported value was estimated by Cioffi’s own team’. We’re profitable because we say we are – just trust us.

That hasn’t ever caused problems, has it? Stories like this have led to a crisis of confidence. The current yield on one-month US government bills is only 3.41 per cent, an amazingly low number, and a sign that people are parking their money in government debt because they don’t trust private borrowers. And the result is a shortage of liquidity that is greatly damaging the economy.

Which brings us to the rescue plan proposed by a group of large banks, with Mr Paulson’s backing. Right now, the bleeding edge of the crisis in confidence involves worries that there may be large losses hidden inside so-called ’structured investment vehicles’ – basically hedge funds that borrow from the public and invest the proceeds in mortgage-backed securities.

The new plan would create a ’super-fund’, the Master Liquidity Enhancement Conduit, which would seek to restore confidence by, um, borrowing from the public and investing the proceeds in mortgage-backed securities. The plan, in other words, looks like an attempt to solve the problem with smoke and mirrors.

That might work if there was no good reason for investors to be worried. But in this case, investors have very good reasons to worry: the bursting of the housing bubble means that someone, somewhere, has to accept several trillion dollars in losses. A significant part of these losses will fall on mortgage-backed securities. And given this reality, the ‘conduit’ looks like a really bad idea.

I’d put it like this: Investors aren’t putting their money to work because they don’t know where the bad debts are. And when investors need clarity, the last thing you want to be doing is pumping out more smoke. Mr Greenspan’s take, expressed in an interview with the magazine Emerging Markets, seems broadly similar. ‘If you believe some form of artificial non-market force is propping up the market,’ he said, ‘you don’t believe the market price has exhausted itself.’ Translated: This rescue scheme could be seen as an attempt to hide the bad debts everyone knows are out there, and as a result could delay any return of trust to the markets.

Alan Greenspan is making sense.

The writer is a professor of economics at Princeton University

 

Source: Business Times 23 Oct 07

Credit crunch puts global growth at risk: IMF chief

Champions of super fund to rescue mortgage market seen losing case

(WASHINGTON/ZURICH) World credit markets ‘have lived through an earthquake’ and the question is now whether the global economy has reached a turning point after five years of strong growth, the head of the International Monetary Fund said yesterday.

Addressing the IMF’s 185 member countries, IMF managing director Rodrigo Rato warned of aftershocks in markets, saying the full effects of the credit crunch, which began in the US sub-prime mortgage market, were still not fully understood.

‘We already know that we should not try to regulate crises out of existence: that would be like trying to ban earthquakes,’ he said. ‘But the weaknesses in our infrastructure that have been exposed need to be addressed.’ Mr Rato added: ‘The question is now whether the global economy is at an inflection point.’

The outgoing IMF chief noted that in developed countries, corporate balance sheets were strong and labour markets generally healthy.

‘For these reasons, we expect a slowdown in growth but not a recession in the United States, and a smaller slowdown in other advanced countries,’ Mr Rato said, adding that emerging economies had become a source of stability in the global economy.

Mr Rato said risks to global growth were higher than just six months ago and the market turmoil was a warning that good times may not last forever.

Further disruption in financial markets and falls in housing prices could lead to a steeper global downturn, he warned.

So far, movements in exchange rates have been orderly and in line with fundamentals, Mr Rato said, further warning that if the dollar should abruptly fall, it could provoke a loss of confidence in dollar assets.

There was also a risk that the rise of other currencies, such as the euro, could hurt those regions’ growth prospects, he added.

Furthermore, there was a risk that emerging economies that have relied on external financing to fund large current account deficits could be tipped into crisis by a combination of reduced demand for their exports and tighter financial market conditions.

Meanwhile, whether a US$75 billion fund to rescue the battered mortgage-backed securities market takes off or not, its sponsor US Treasury Secretary Henry Paulson seems to be losing the argument over its merits, strategists and economists said.

The fund, announced recently by Citigroup, Bank of America and JP Morgan with Mr Paulson’s support, aims to prevent structured investment vehicles (SIVs) from making panic sales of bonds linked to US sub-prime mortgages.

Many of the SIVs – off-balance sheet vehicles holding some US$370 billion in assets that rely on short-term financing to make a return – are struggling to stay afloat as investors shy away from buying their commercial paper.

The plan has faced a rising tide of criticism, not least from former Federal Reserve chairman Alan Greenspan, who said last Friday the super fund may do more harm than good.

Financial strategists contacted by Reuters said time is running out for the plan’s champions to regain the initiative and the fund risks being still-born.

‘I think they are losing the intellectual argument,’ Ian Harnett, a director at financial consultancy Absolute Strategy in London said yesterday.

The fund was nevertheless more likely than not to go ahead because of the potential embarrassment for the three US banks and for Mr Paulson himself if the idea is scrapped, said Mr Harnett.

‘I would still put it at 70 to 30 that it does happen because of the reputational risk,’ he said.

A global credit crunch, originating from huge losses in US sub-prime mortgage lending, has put acute pressure on SIVs, as demand dried up among investors for the short-term paper SIVs issue to fund investments in high-yielding asset-backed securities with longer maturities.

A fire-sale of assets by the SIVs, set up mainly by banks, would force banks into a fresh round of writedowns of securities held on their balance sheets and result in them granting fewer of the loans that are the life-blood of the global economy.

 

Source: Reuters (Business Times 23 Oct 07)

Developing markets little hit by turmoil: World Bank

Central bankers see need for multilateral talks to strengthen risk management

(WASHINGTON) The impact of recent turbulence in financial markets on developing countries has been limited, and global economic growth remains strong, the World Bank said on Sunday.

Finance ministers and central bankers agreed at weekend meetings that while the global economy was on the mend after recent turbulence, they will need to pay close attention to prevent future crises from erupting.

They also said the turmoil demonstrated how interconnected economies across the world are and the need for multilateral discussions to strengthen risk management.

‘The consensus was that markets are better than in August,’ US Treasury Secretary Henry Paulson told reporters. ‘It has been slowly improving, but it is going to take awhile.’

The World Bank called on donor governments to meet their commitments to boost aid for development and said countries with fast-growing economies and mounting currency reserves could bring new resources to the effort.

In a statement, the bank’s policy-setting Development Committee said its members agreed that more support for the inclusion and empowerment of the poorest countries, especially in sub-Saharan Africa, and more engagement in conflict-afflicted countries are key.

The bank also should help developing countries deal with the causes and impacts of climate change, it said.

The committee session followed a meeting of the bank’s sister institution, the International Monetary Fund. In a lecture sponsored by the IMF, former US Federal Reserve chairman Alan Greenspan warned that rising protectionism could undermine the ability of the US to deal with large deficits.

‘If the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalisation, the current account deficit adjustment process could be quite painful for the United States and our trading partners,’ he said.

Committee members welcomed the commitment by the bank’s new president, Robert Zoellick, to develop a new strategy for the bank. Mr Zoellick, who took over on July 1, has called on the developed countries to ‘translate their words from summit declarations into serious numbers’ and contribute to the bank branch that makes low-interest loans to poor countries. He hopes to raise US$33 billion by early 2008.

He said South Africa had already set a good standard by pledging a 30 per cent boost in its contribution to the loan facility.

At a news conference, Mr Zoellick and the head of the IMF, Rodrigo de Rato, said they were exploring ways the fund could work on reducing debt for Liberia. ‘This is a country that is helping itself and deserves to be helped by the international community,’ Mr de Rato said.

In February, the US forgave US$358 million that West African country emerging from civil war owed it and pushed for further action at the IMF-World Bank meetings.

Liberia’s inherited debt to international institutions totals US$1.6 billion, including US$740 million to the IMF. Its total international debt is US$3.7 billion.

Mr Zoellick’s strategy faces a stiff challenge because in recent years, wealthier countries have preferred to channel their aid to poor countries directly through their development agencies or through foundations that specialise on issues such as malaria.

South African Finance Minister Trevor Manuel welcomed Mr Zoellick’s emphasis on helping to overcome poverty and promote sustainable growth in poor countries, particularly those in sub-Saharan Africa.

The strategy would have the bank fight poverty, especially in Africa, help countries emerging from wars and promote regional cooperation to combat disease and climate change.

Based in Washington, the 185-nation World Bank lends US$24 billion a year for projects in the developing world such as building roads, schools and health clinics. But its role as a lender has been declining as middle-income countries have access to financing from other sources.

 

Source: AP (Business Times 23 Oct 07)

Widen moves to calm markets: global finance chiefs

Steps include tighter IMF scrutiny of state investment funds

(WASHINGTON) Global finance chiefs on Saturday called for a more broad-based effort to calm financial markets, including tighter scrutiny by the International Monetary Fund and other institutions of increasingly powerful state-owned investment funds.

This year’s fall meetings of the International Monetary Fund and World Bank come amid a slowing pace of global growth and heightened risk from recent turbulence in world credit markets and soaring oil prices.

That has particularly affected Group of Seven rich nations whose finance ministers and central bankers met on Friday and concluded that their growth will suffer because of ongoing turmoil in markets.

By contrast, developing countries that are well represented among IMF members have been emboldened at these meetings by the fact that their growth rates are thriving and have used the opportunity to flex their economic muscle.

‘The irony of this situation: countries that were references of good governance, of standards and codes for the financial system, these are the very countries that are facing serious problems of financial fragility putting at risk the prosperity of the world economy,’ said Brazilian Finance Minister Guido Mantega.

After years of hearing from developed countries about the importance of prudent economic policies, developing nations felt they clearly had the upper hand, with China and India leading world growth and rich countries’ economies slowing.

Meanwhile, developed countries called on the IMF to increase its monitoring of growing state-backed wealth funds that hold surplus reserves mainly from oil exporters and China.

Those funds are investing amounts which cause some nervousness among rich members of the Group of Seven industrial nations, which want to ensure the investments are for profit-making reasons only and are not politically motivated.

US Treasury Secretary Henry Paulson said he considered the IMF ‘uniquely positioned’ to identify model behaviour for these Sovereign Wealth Funds.

His point man for international matters, Under Secretary David McCormick, told Reuters there was general agreement that some code of principles was needed to ensure the funds did not rouse such resentment that countries put up barriers to stop the funds from investing.

Belgian Finance Minister Didier Reynders said it was too early to know how the financial sector difficulties would affect economies in the end, saying central banks should stand ready to lower interest rates, or to postpone rate increases, without damaging inflation.

Developing countries also took the opportunity to push for a greater say in the voting power of institutions like the IMF.

Brazil warned bluntly that under-represented countries were likely to ‘go their own way’ unless they get a greater stake. ‘Developing countries, or many among them, would go their own way, were the perception to arise that reform will not happen or that we will be left with a purely cosmetic form,’ Brazil’s Mr Mantega said.

Some countries saw signs of progress in negotiations among IMF members on how to increase the voting powers of the developing world but others were far from optimistic.

German Finance Minister Peer Steinbrueck said no progress had been made by countries trying to agree on a formula that would rebalance the voting system to reflect the rise of countries like China or India.

Intense political sensitivities are involved in trying to divvy up voting power more frequently. Some old powers like Britain and France potentially could see China move past them in voting status if an intensely negotiated formula truly acknowledges China’s fast-growing economic might.

Also, developing countries insist any overhaul in votes must be large enough to transfer significant additional power to them and to make clear they are not simply being given a pat on the head.

 

Source: Reuters (Business Times 22 Oct 07)

A confused message from the G-7?

WHAT are we to make of it when spokesmen for the world’s most powerful economies and financial institutions begin to contradict each other in public – or make remarks which appear less than consistent with reality?

Today, the finance ministers and central bankers of the G-7 – namely the countries of the US, Britain, Canada, France, Germany, Italy and Japan – hold their semi-annual get-together in Washington, in the runup to this weekend’s International Monetary Fund and World Bank meetings.

Very public attempts to influence today’s agenda were already taking place early last week, with the leaders of France and Italy appearing to have become particularly vociferous this time. Grumbling that a too-strong euro hurts Europe’s growth and exports, they have tried to lead joint European demands for the US to reiterate its ’strong’ US dollar policy.

In short, the Europeans are getting annoyed that the euro has once again scaled fresh post-launch highs versus the US dollar over the past week, but the yen and yuan have not been contributing their fair share of upside adjustment in response to the fast-falling greenback.

They do have a point. Since the end of last year, the euro has risen some 17 per cent versus the US dollar, while the yuan has only strengthened 7 per cent, and the yen has actually weakened by 5 per cent. Yet, even within Europe, not all appear as flustered on this currency issue. North Europeans like the Germans and the Dutch, for example, have been far less vocal or upset, at least in public, on the subject.

To be sure, it does get a little surreal when the US is asked to reiterate a strong US dollar policy at a time when the US dollar is sliding across a broad front in the real world – and when economic logic suggests that more US dollar downside is needed to correct its record current account deficit with the rest of the world. Over the past fortnight, we have in fact seen the US currency slide to lows not seen in 10, 23 and 31 years versus currencies like the Singapore, Australian and Canadian dollars – on top of recording fresh post-launch lows versus the euro.

To calm jittery financial markets, US Treasury Secretary Henry Paulson has deemed it necessary to come out and help out the Europeans by reiterating – both last week and this – that a strong US dollar is indeed in his country’s interest.

Yet, even as he tried to carry that message across, the International Monetary Fund’s managing director Rodrigo Rato decided to warn this week that the US dollar is in fact still overvalued – despite trading at near record lows. And that it needs to fall even further.

The key message here is that all involved stand to lose out if the US dollar should suddenly collapse; there is a need to manage its fall. When you stop to think about it, isn’t that exactly what Asian countries like China have been trying to do in terms of the US dollar’s slide against their own currencies over the course of 2007?

 

Source: Business Times 19 Oct 07

Greenspan: No $ plunge if China offloads Treasuries

Markets are clever enough not to over- react, he says

(SEOUL) Alan Greenspan doesn’t expect a rapid decline in the dollar should China sell more of its holdings of US Treasuries, according to people attending a forum here yesterday.

‘When asked whether there will be a plunge in the dollar in case China offloads its US Treasury holdings, Mr Greenspan said it’s already-known information that won’t trigger any rapid drop in the US dollar,’ according to Kong Dong Rak, an analyst with Hana Daetoo Securities. ‘His view is that markets are clever enough not to overreact.’

The former Federal Reserve chairman was speaking via satellite from Washington and media were excluded from his presentation. The conference was hosted by Maeil Business Newspaper.

Japan, China and Taiwan sold US Treasuries at the fastest pace in at least five years in August as losses linked to US sub-prime mortgages sparked a slump in the dollar.

Japan cut its holdings by 4 per cent in August to US$586 billion, Treasury Department figures showed. China’s holdings fell by 2.2 per cent to US$400 billion and Taiwan’s slid 8.9 per cent to US$52 billion.

Kim Gyung Rok of Mirae Asset Investment Management, confirmed Mr Greenspan’s remarks on the dollar.

‘Foreign exchange markets have already priced in bit by bit’ the possibility of an unloading of US Treasuries, he said.

Mr Greenspan is ‘of the opinion that holdings of foreign exchange reserves tend not to be moved easily’, Mr Kim said.

The dollar has fallen 7.5 per cent against the euro this year after the Fed cut interest rates last month to support the housing market, reducing the yield advantage of US fixed-income assets.

The US currency slumped to a record low against the euro on speculation that the growth outlook in the US will push the Fed to make another reduction at the end of the month.

The dollar declined 0.6 per cent to US$1.4294 per euro, after earlier reaching an all-time low of US$1.4305 in early New York trading. It fell one per cent to 115.46 yen. It earlier reached 115.29, the lowest since Oct 2.

The New York Board of Trade’s dollar index touched 77.5, the weakest since the index began in 1973.

Eisuke Sakakibara, Japan’s former top currency official, said that the US currency may ‘plunge’ in 2008 should US economic growth ‘fall below one per cent’. He spoke in an interview yesterday in Tokyo.

On Wednesday, the International Monetary Fund cut its forecast for US growth next year to 1.9 per cent. IMF officials said the dollar is overvalued compared with its medium-term fundamentals. According to the Financial Times, Simon Johnson, chief economist of the Fund, said the weakening dollar was part of a normal process of economic rebalancing and was positive for the global economy provided that other currencies also adjust.

However, Mr Greenspan said the slowdown is unlikely to lead to a US recession, though it will still have a negative effect on Asia’s economies, according to Maeng Young Jae of Samsung Securities. ‘Greenspan seems more optimistic about the US economy than pessimistic.’

Mr Greenspan said China’s policy on the yuan ‘could cause long-term instability in the Chinese economy’, according to Ben Arber, head of global payments and cash management at HSBC Holdings in Seoul.

 

Source: Bloomberg (Business Times 19 Oct 07)

Possible 2008 recession in US will hit Asia: Stephen Roach

Asia needs to take events in US more seriously, he says

IN SEOUL

THE United States could face a consumer-induced recession next year, which will also hit Asian economies, said Morgan Stanley’s chairman for Asia, Stephen Roach.

Speaking at the World Knowledge Forum in Seoul, Mr Roach – well known for his bearish views – presented what he called a ‘decidedly sub-prime outlook’ for the US economy.

The so-called sub-prime mortgage crisis is ‘the tip of a much bigger iceberg’, he said. It has started to hit the American consumer.

Mr Roach, who has long predicted a US economic slowdown, pointed out that the US consumer is facing the toughest times in 30 years, and the impact on the economy could be acute.

He noted that in the first half of this year, US consumption accounted for a record 72 per cent of GDP, or about US $9.5 trillion.

‘The US consumer is about to take a long rest,’ he said, ‘and if the US consumer goes, there’s nobody on the demand side who can fill the void.’ Even China’s total consumption is only about one-ninth that of the US, he noted.

Mr Roach suggested that the US consumer is at risk because the consumption binge of the last seven years has been underpinned, not so much by rising incomes but by a wealth effect which has, in turn, been driven by ‘an extraordinary property market’.

In short, ‘the US consumer has turned his home into an ATM machine’, he added.

But now, with the US property bubble deflating, the wealth effect, based on rising home values, ‘is over, is done, is finished’.

In fact, next year, home prices for the whole of the US could decline for the first time in history, he predicted, which would severely diminish US consumers’ ability to extract equity from their homes.

In the face of this, Mr Roach said that the risk of recession ‘is quite high’.

Although sub-prime mortgage assets account for only 14 per cent of all securitised assets, the sub-prime crisis has already spread.

Moreover, ‘the big story gets written in the real economy, not in the financial markets’, he said.

And worth noting here, he added, is that US consumption is about five times the size of US capital spending, which triggered the US recession of 2001.

Mr Roach, who is based in Hong Kong, said that Asia needs to take developments in the US more seriously.

‘What’s worrying is a complacency in Asian markets, based on a belief that Asia has ‘decoupled’ from the US,’ he pointed out.

But the decoupling thesis is fanciful, he said, noting that the US absorbs 21 per cent of China’s exports, 22.5 per cent of Japan’s and about 14 per cent of Asean’s. ‘If the US consumer goes down, Asia will feel it,’ he said.

 

Source: Business Times 18 Oct 07

Foreigners sell record US financial assets in Aug

(WASHINGTON) International investors sold a record amount of US financial assets in August as tightening access to credit threatened economic growth and spurred an exodus from American equities.

Total holdings of equities, notes and bonds fell a net US$69.3 billion after an increase of US$19.2 billion in July, the Treasury Department said on Tuesday in Washington. Including short-term securities such as Treasury bills and non-market trades such as stock swaps, foreigners sold a net US$163 billion, compared with a gain of US$94.3 billion a month earlier.

Demand for US stocks overseas declined as the deepening housing recession and credit market turmoil threatened investment and hiring, slowing the economy.

‘There is acute uncertainty in the market,’ said Gabriel De Kock, chief currency economist at Citigroup Global Markets Inc in New York, before the report. ‘There are lots of people who are reducing their risk and taking money off the table.’

Economists predicted that international investors would buy a net US$60 billion of long-term securities in August, based on the median estimate in a Bloomberg News survey.

The Treasury’s reporting on long-term securities captures international purchases of US government notes and bonds, stocks, corporate debt and securities issued by US agencies such as Fannie Mae and Freddie Mac, which buy mortgages.

International holdings of US stocks fell a net US$40.6 billion, compared with net purchases of US$21.2 billion in July. The Standard & Poor’s 500 Index rose 1.3 per cent in August, while the Dow Jones Industrial Average gained 1.1 per cent.

International demand for Treasuries decreased by US$2.6 billion, compared with a loss of US$9.4 billion the previous month. The yield on the benchmark 10-year note in August averaged 4.73 per cent, compared with 5.04 per cent in July.

Holdings of agency debt increased a net US$9.6 billion after a US$8.7 billion net gain the month before.

US investors bought a net US$34.5 billion of overseas assets in August, after buying US$5.5 billion in July.

Private investors sold a net US$10.6 billion, compared with a net US$20.6 billion in purchases a month earlier. Official purchases, including those by central banks, fell by US$24.2 billion after an increase of US$4.4 billion in July.

Foreigners sold a net US$1.2 billion of corporate bonds, compared with a US$4.5 billion increase in July.

Some economists said that the difference between the US trade gap and securities purchased by foreigners is an indicator of how easily the nation can finance its external obligations. The trade deficit in August shrank 2.4 per cent to US$57.6 billion, the smallest since January, as exports climbed to a record, the Commerce Department said on Oct 11.

The US current account deficit, a broader measure of trade that includes investment income and transfers, narrowed to US$190.8 billion in the second quarter.

 

Source: Bloomberg (Business Times 18 Oct 07)

CEO survey finds 37% chance of US recession

(WASHINGTON) Leading Wall Street chief executives predicted a 37 per cent chance of a US economic recession in the next 12 months, according to a Financial Services Forum survey released yesterday.

The forum is a policy group made up of the chief executives of 20 of the world’s largest financial institutions, including Citigroup Inc, Morgan Stanley, Goldman Sachs and MetLife.

The executives said they expect slower US economic growth over the next year due to the housing slowdown, credit market turmoil and higher energy prices, according to the survey.

In predicting a 37 per cent chance of a US recession in the coming 12 months, the executives also cut their expectations of economic growth.

The forum’s US economic growth index fell from 2.03 in April, when the last bi-annual survey was taken, to 1.27 in October. The growth survey represents sentiment on a scale ranging from -5 for strongly negative growth to 0 being no growth and 5 being robust growth.

Former Federal Reserve chairman Alan Greenspan this month put the odds of a recession at less than 50 per cent. A Reuters survey of 56 private economists earlier this week found the majority saw the chance of a US recession at somewhere between 21 per cent and 30 per cent.

The Financial Services Forum executives also indicated that the credit market problems are not finished.

On a scale of 1 to 5, with 5 being significant turmoil still to come, the chief executives on average answered 2.9, according to the survey.

The survey found the executives expect a Federal Reserve interest rate cut of 25 basis points before the end of the year.

In September, the Fed cut benchmark rates by a hefty half-percentage point to 4.75 per cent amid concerns about increasing mortgage delinquencies and financial market disarray.

In assessing the stock market, the executives predicted the Dow Jones Industrial Average (DJIA) would finish the year at 14,137, according to the survey. On Tuesday, the DJIA closed at 13,912.9.

 

Source: Reuters (Business Times 18 Oct 07)

Investors’ short memory is worrying

Granted, the sub-prime crisis has passed. But the US economy has other major problems. So it’s advisable to be prudent

By WONG SUI JAU

WHAT a difference two months makes. In mid-August, the sub-prime loans scare had just rocked markets around the world, causing them to fall for two weeks. The air was heavy with gloom. But now, it seems as if the sub-prime problem never happened. Many markets are back to their pre-crash levels and, indeed, some – including the US market as represented by the S&P 500 index – have recently hit record highs. As the accompanying table shows, many Asian markets have done very well from the start of the year up to end-September. There is reason for much cheer among investors.

While I was one of those urging calm at the time the sub-prime issue blew up, I find the short memory of many investors worrying. Before the sub-prime issue flared in the US, there was hardly anything to worry about; Asian economies were growing strongly and the rest of the world was doing decently too.

But in the aftermath of the sub-prime crash, some things are now different. Investors need to pay close attention to these developments – not just focus on the happy reality of rising markets. The most significant thing is that the US economy has turned. As recently as the second quarter, US GDP was still accelerating in terms of growth, growing at an annualised rate of 3.8 per cent in Q2, compared with an annualised 0.6 per cent in Q1.

However, the sub-prime issue has exposed weaknesses in the US economy that are not going to go away, rising markets notwithstanding. First, the US property cycle is on a clear downward trend – and this is accelerating rather than slowing. The supply of homes has almost doubled since end-December 2005. A large number of unsold homes will put further downward pressure on prices. The sub-prime fright has also made investors much more cautious about entering an already falling market. After all, if home prices are dropping, there is no hurry to buy, because it is better to wait for prices to fall further. Thus, we may see an even steeper decline in US home prices going forward (see chart).

Second, the woes in the US property market will affect many American consumers. Americans have been consuming ever more each year, and accordingly, their debt levels have risen. The ratio of household debt to disposable income was at a high of 2.29 in March 2007, compared with 0.82 in December 1990. This means that for every dollar of income earned, the average US household has $2.30 of debt.

Previously, the rising housing market enabled Americans to take out reverse mortgages and get money from the houses they stayed in. But with prices now falling, this will dry up. Some households may even run into problems paying off their home loans. Certainly, this will affect household spending going forward. Any weakness in consumer spending – which underpins so much of what drives the US economy – will put a question mark over growth next year.

Continued volatility

Third, the US continues to do things like reduce interest rates and deflate the dollar. This may work in the short term. But over the long term, it does not solve the fundamental problem that the US economy faces – which is that it spends far more than what it generates in income, resulting in its huge twin deficits. For now, since it is the sole superpower and with the US dollar still the most important and most used currency in the world, cutting interest rates and allowing the dollar to weaken may work in the short term. But eventually the US will have to face up to its problems – and when it does, its economy is likely to be affected. A recession is quite possible.

So while the recent recovery in markets has brought much cheer and relief to investors. I would urge people not to get too greedy and overexpose themselves to risk. While we believe that, ultimately, Asian economies with their many drivers will continue to grow even amid a US recession, their growth will ultimately be affected to some extent. And certainly, markets will continue to be volatile.

As data is released in the coming months, we expect that some of it relating to the US economy will not be rosy.

Companies at the epicentre of the sub-prime loans issue have had to close down entire divisions, and many banks are expected to report large provisions for loans made, which will certainly affect their earnings. For example, just recently, Bank of America, JP Morgan Chase & Co and Wachovia Corp posted profit declines as they wrote down more than US$3.4 billion. They will not be the last to report earnings hits.

In the midst of record-breaking markets, investors may have forgotten just how bleak the situation seemed just a couple of months ago. But they must be conscious of the risks they are taking in their portfolios. Try to stay diversified and not overly exposed to any particular sector or area, no matter how attractive it seems. With many investors already sitting on profits this year, it would be advisable to be prudent at this stage. Don’t let short memories and greed lead to overly aggressive risk-taking.

 

Source: Business Times 17 Oct 07

Making that next crash insignificant

Shield your money to ensure that you won’t be devastated by what markets do in any particular time period

WHAT were you doing and feeling during the 1987 stockmarket crash, which will be 20 years ago this week?

Having married just two weeks before the crash, I was about a year into a great new job. When I saw the biggest one-day percentage loss in the Dow Jones Industrial Average on Oct 19 and near-meltdown that followed, I froze. I didn’t call my mutual-fund companies or broker. I stayed in stocks, where almost all of my meagre wealth  was invested.

It turns out my passivity was the best course. I didn’t need that money for a while and knew the economy was basically solid. Yet I’m not confusing mettle with foresight. I had no idea what was going to happen after the Dow took a 508-point free-fall and about US$1 trillion evaporated in a single day.

Various malefactors have been blamed from a ballooning trade deficit to program trading. To understand the lessons of 1987, you need to dispense with the mountains of studies that have been done over the past two decades.

What’s most important is how focusing on building personal prosperity will keep you in the eye of any market storm. To get an idea of how to survive a panic, you need to know what didn’t happen.

While the end of October 1987 was a stunning glimpse into the abyss of fear, the Standard & Poor’s 500 Index was up 2 per cent for the year.

Did a long-term bear market ensue? The following year, the S&P rose more than 16 per cent, if you include reinvested dividends. From the end of 1987 through 1993, the index more than doubled in value.

The blip of Black Monday did little to slow down the US economy. Banks didn’t close. No depression followed.

Businesses invested in new technologies that would increase productivity and create jobs. The cyber-tech age was in full bloom.

That was then

The difference between 1987 and today is that many institutional safeguards are in place that will curb market freefalls and ensure liquidity. Yet it’s never enough with little-monitored hedge funds playing a large part in trading.

There also still needs to be a single agency policing securities, futures and options markets.

No regulator will be able to prevent crashes or prolonged declines. Yet there’s much you can do to shield your money.

When noting the role of the individual investor in market sell-offs, William Brodsky, the chief executive officer of the Chicago Board Options Exchange, said individuals may think: ‘I’m in for five to 10 years and I’m not going to sell my index mutual funds or IRAs.’

Mr Brodsky described my mindset 20 years ago – and today. As president of the Chicago Mercantile Exchange at the time of the 1987 meltdown, he said the week following Black Monday was ‘analogous to a tornado. We saw it coming.’ Mr Brodsky was speaking at a symposium on Oct 9 in Chicago.

There will be more crashes and bear markets. That’s the nature of capitalism. The question is: How do you keep your cool? When do you stay in and when do you bail?

Whatever happens, the chances are good that you will time any exit or entrance poorly. What if you stayed out of the market in 1988 or the half-decade following the crash? Look at the returns you would have missed.

Personal time-horizon planning is critical. If you can afford to take a 20 per cent loss, how much time would you have to make up the shortfall?

Fear of loss is a powerful motivator in investing, although investors often focus too much on returns and don’t pay enough attention to managing risk.

Let’s say you learned well from the crash of 1987 and decided to invest across three different asset classes that typically don’t move in lockstep with each other.

When the dot-com bubble burst, for example, you would have fared better if you followed this strategy. From March 24, 2000, to Oct 9, 2002, your big-stock stake would have been down about 47 per cent in the Vanguard 500 Index Fund, which tracks the S&P index.

Had you diversified, your stock losses would have been offset by a 26 per cent return from US bonds, using the Vanguard Total Bond Market Index Fund as a proxy.

Adding icing to the cake would be a 32 per cent gain in real estate investment trusts (Reits), as represented by the Vanguard Reit Index Fund. I use these funds because they are low-cost, diversified ways of investing in these asset classes. I own the Reit and bond funds in my retirement accounts.

Even if you put all of your money on large companies – and stayed invested from the beginning of the Internet crash in March 2000 through Oct 5 this year – your holdings would have grown 12 per cent over that period in the Vanguard 500 fund.

You can torture yourself trying to explain why markets rise and fall every day. Don’t trouble yourself. It’s mostly noise.

Instead concentrate on your life plan. Are you saving for a home downpayment? Do you need money for college?

Will a parent need your financial support? Are you planning to leave the workforce part-time or permanently soon?

What if you are disabled and can’t work?

You need to weigh your own life needs to ensure that you won’t be devastated by what markets do in any particular time period. That means protecting against inflation, loss of future income and the ravages of bear markets.

Where are you now and how do you get to where you want to be? It may not matter where you were or what you did 20 years ago. The past is always prologue, yet you need to create your own portfolio insurance to make that next crash insignificant.

 

Source: Bloomberg (Business Times 17 Oct 07)

Expected volatility may hit investors: Principal Global CEO

They should diversify portfolios in this period of increased volatility, he says

JIM McCaughan, chief executive of US asset manager Principal Global, has turned cautious on the market, warning that expected volatility could cause worried investors to exit at a loss.

His broad market outlook, however, is for a number of interest rate cuts which could boost equity markets.

Still, poor economic data, pressure on US consumer spending and continued uncertainty over credit markets will dog investors.

‘The housing market in the US is in a bit of a mess,’ he says. ‘There is excess inventory quite apart from the fact that the mortgage market has seen a much tighter supply of mortgages . . . The situation is bad enough to put continued pressure on consumer spending for the next year or two.’

A weak US dollar, however, has begun to spur exports.

‘We’re in a period of increased volatility. There will be some pretty bad days that will frighten people, but I don’t expect a big setback in the US market,’ Mr McCaughan says.

He urges investors to diversify their portfolios. ‘Volatility is not necessarily a bad thing. It allows you to get in at good prices from time to time. The main strategy should be to diversify and take a long-term view.

‘Those are the ways to protect the investor against the short-term vagaries of the market. The investor who panics and sells low is the one whose return is hurt.’

Principal Global itself manages a diversified range of assets – equities, fixed income and real estate. It currently manages some US$220 billion in assets, compared to US$80 billion in 1999.

According to an article on its website, the group is gunning for US$500 billion in assets under management, and headcount is expected to rise by 25 per cent over the next few years. Singapore is its base for the Asia ex-Japan region.

The group has a partnership with China Construction Bank to market mutual funds in China. Over a period of about two years, assets have grown to between US$5 billion and US$6 billion. It also has a partnership in Malaysia.

Mr McCaughan says concern over inflation is overdone. ‘In the US, companies’ pricing power is limited; real inflation is limited. We’re not fearful of inflation . . . We think there are more rate cuts to come. That will create a fairly good backdrop for markets.

‘We think there may be 50 to 75 basis points in cuts over the next six to nine months. We think that’s probably about right. Fed funds rate at 4 per cent may well be the case in six to 12 months.’

The group sees opportunities in global real estate. It manages some US$40 billion in real estate assets, making it the fourth-largest institutional real estate manager in the United States as at 2006.

‘There are opportunities particularly in US Reits that have been held back by changes in the credit market . . . The fundamentals of commercial real estate are encouraging.’

 

Souce: Business Times 17 Oct 07

IMF cuts growth forecasts, warns of downside risks

World growth seen at 4.8% next year, driven mainly by emerging economies

ROME – THE International Monetary Fund (IMF) has slashed its forecast for growth in the United States next year and made more modest downward revisions to its outlook for the euro zone and Japan, Italian news agency Ansa reported yesterday.

Citing a draft version of the IMF’s World Economic Outlook to be issued next week, Ansa said the IMF now sees US growth next year at 1.9 per cent, compared with a 2.8 per cent projection made by the fund on July 25.

The IMF has cut its forecast for world growth next year to 4.8 per cent from 5.2 per cent, with emerging economies, rather than developed countries, being the main driver, Ansa said.

The fund only marginally trimmed its forecast for next year’s growth in China to 10 per cent from 10.5 per cent, Ansa reported, and left its forecast for the Indian economy unchanged at 8.4 per cent.

The IMF’s forecast for euro zone growth was cut to 2.1 per cent from 2.5 per cent, while the outlook for Japan was lowered to 1.7 per cent from 2 per cent, Ansa reported.

‘The risks are firmly on the downside, based on the fear that the tensions on financial markets could increase and cause an even more marked global slowdown,’ Ansa quoted the IMF as saying.

The European Central Bank ‘can keep rates on hold in the short term as a result of the downside risks to growth and inflation stemming from the turbulence on markets’, Ansa reported the IMF as saying.

‘However, when these risks subside, further monetary tightening may be necessary,’ the IMF said.

Source: REUTERS (The Straits Times 10 Oct 07)

Is the sub-prime crisis really behind us?

TOKYO CORRESPONDENT

THE fact that the world – its richer countries at least – has been living through a bubble economy period financed by junk (sub-prime) mortgages and funny money (carry trade) borrowing should be obvious enough to anyone observing events over the past few weeks.

But anyone who doubts it need only consider the startling fact that the number of millionaire families in the world grew by no less than 14 per cent to 9.6 million in the space of last year alone. These super-rich individuals now control one third of the estimated US$100 trillion in global financial wealth, according to the Boston Consulting Group in a new study on the subject this week. This is obviously a massive indictment of the failure to distribute wealth more evenly. But the way in which the stunning jump in the number of millionaire families came about is also something that should set alarm bells ringing.

Most of the new wealth came about through increases in the value of stocks, bonds and other financial instruments as global stock markets rose in value on average by 20 per cent, with the strongest wealth gains accruing in America where the equity cult is most entrenched. Not only the super-rich but also the merely ‘better off’ had a ball in 2006, as total assets held by households with US$100,000 or more leapt from US$51 trillion to near US$85 trillion.

If all this isn’t evidence of a bubble, then it is hard to know just what is. But what goes up must come down, and bubbles burst as surely as they form. Or have we discovered some new form of gravity-defying wealth creation mechanism now – an infinitely inflatable bubble?

Looking at the behaviour of markets this week, it appears that the more credulous among investors are being lulled into believing that we have. In this promised land of milk and honey there is no such thing as a financial burst or bust. Descending bubbles simply float down to earth, bounce lightly off the ground and soar skywards again like hot-air balloons being given a fresh charge from the gas jet. Only in this case, the hot air is replaced by financial liquidity supplied in abundant quantity by kindly central bankers who never want to see a hard landing.

Markets are climbing again, as though the sub- prime mortgage market crisis and all its attendant horrors – in the shape of seized- up money markets, runs on banks or other financial institutions, massive markdowns of un-tradeable financial assets and balance sheet damage all round – had suddenly become a thing of the past. Central banks have taken care of things by covering the ugly debris in a sea of fresh liquidity.

Time to party again.

Amidst this new euphoria, an odd and rather worrying thing happened the other day when no fewer that three Japanese government ministers all warned at the same time that fallout from the sub-prime mortgage market debacle might not be over yet. It was not so much what they said as the fact that they said it. Such people usually see it as their job to utter bland, confidence-boosting statements, so when they do say what others of a sane turn of mind already suspect, something clearly is afoot.

It seems likely that the trio – Finance Minister Fukushiro Nukaga, Financial Services Minister Yoshimi Watanabe and Economics Minister Hiroko Ota – were flagging concerns that there may be more nasties yet to come for Japanese banks and other financial institutions, in the shape of write-downs from the subprime fiasco.

If there is one thing more risky, or plain daft, for investors to do than to pile back into equities as if there were no yesterday and no tomorrow, it is to build fresh speculative positions by shorting the yen against other currencies (the carry trades). The yen has nowhere to go but up in the medium term, while the US dollar is already on the skids and the Australian and New Zealand dollars favoured by carry trade enthusiasts will slide again against the yen.

Meanwhile, back in the never-never land of sub-prime mortgages, things are not looking good. Sales of second-hand homes dropped by a surprisingly large (to some) 6.5 per cent in August. Morgan Stanley has announced that it will cut 600 jobs in its residential mortgage division, a quarter of the workforce. Anyone who thinks that is a detail should note that two million of the seven million new US jobs created in recent years were connected with real estate.

As the housing sector turns down, along with consumption-financing equity withdrawal by US home owners, the danger of a US recession will grow and with it a slowdown in the world economy and in global capital flows. Irrational exuberance will evaporate in stock markets around the world and liquidity will drain away like so much milk and honey. The only consolation is that a lot of those new paper millionaires will find themselves joining the world or ordinary mortals once more at the new dawn of reality.

 

Source: Business Times 4 Oct 07

US spending slowdown won’t hit Asia hard

But risk from China equity correction is a threat: economist

THE threat to Asian economic growth from a slowdown in US consumer spending may not be as great as widely feared, said a senior HSBC economist last week.

Economic growth in Asia is increasingly driven by domestic demand, while the historical relationship between US consumer spending and Asian export growth is quite weak, said Robert Prior-Wandesforde, senior Asian economist at HSBC.

‘We think generally growth in Asia will hold up very well,’ he said. He was speaking to members of the British Chamber of Commerce at the Raffles Hotel.

Overall US economic growth has already been slowing in recent months, but Asian economies have survived this ‘incredibly well’, he said.

And in the last two years, consensus forecasts of Asian economic growth a year ahead have shown an ‘unprecedented divergence’ from similar forecasts for US growth, as economists downgraded their outlook for the US while simultaneously becoming more optimistic about Asia.

He noted that in Malaysia, overall exports have not slowed as much as exports to the US alone, which suggested its exports were increasingly fuelled by demand from Europe, China, India, and other Asian countries.

In Singapore, overall economic growth accelerated in the first six months of the year even as export growth has been slowing, he noted. ‘The domestic economy has managed to shake off the downturn in exports.’

‘There are good chances that it will continue.’ HSBC now predicts 8.5 per cent growth for Singapore this year, higher than the 7 to 8 per cent official growth forecast.

The other main fear – that a slowdown in US consumer spending triggered by falling house prices there would hobble Asian growth – may not be fully justified either, he said.

An analysis of nine major Asian economies including Singapore suggested that total export growth since 1995 was more closely linked to the amount of investment on equipment and software in the US than with American consumer spending.

‘The point is that US tech spending has already slowed pretty dramatically. I think the worst is either close at hand or we may even be past the worst in the US tech cycle, and that is the more important driver of what happens to Asian exports.’

But there remained other risks to his relatively rosy outlook for Asia, including the risk of a correction in the Chinese equity market, where share indices have soared to five times what they were two years ago, he said.

‘The danger is we focus too much on the US and forget about the bigger picture.’

‘There are vulnerabilities in a lot of housing markets around the world, not just in Europe or the US,’ he said.

 

Source: Business Times 3 Oct 07

Is the worst over?

Investors and analysts clash over whether the global sub-prime mortgage crisis has turned the corner

Yes, say investors

POSITIVE OUTLOOK

• Banking giants disclose sub-prime related losses on Monday but investors take the disclosures as a sign that the worst may be over.

DOW’S RECORD CLOSE

• Investors push US stocks to its highest-ever close on optimism that the sub-prime crisis is nearing its end.

• Key index ends Monday up 1.4 per cent at 14,087.55.

• Stocks recover all of the nearly US$2 trillion (S$2.98 trillion) lost in July-August rout.

CITIGROUP AND UBS DISCLOSURES BRING RELIEF

• Bad news from two banking giants but investors choose to focus on the positives.

• Citigroup to write off US$5.9 billion (S$8.8 billion) in third quarter. Profit to drop 60 per cent. Citi chief executive Charles Prince says profits will return to normal in fourth quarter. Investors choose to focus on this healthy forecast.

• UBS to write off US$3.4 billion and suffer a loss in the same quarter. But it indicated that the current period might see a return to normal earnings levels.

GREENSPAN UPBEAT

• ‘Is this August-September credit crisis about to be over? Possibly,’ says former US Federal Reserve chairman Alan Greenspan. He cites signs that lenders are seeking to buy longer-term assets of lower quality.

ANOTHER RATE CUT

• Investors still expect another rate cut from the Fed to boost the US economy.

Maybe not, say analysts

NOT ENOUGH ASSURANCE

• Conditions in the credit market are still fragile. Many problems remain for the United States economy, especially in the housing sector.

• ‘The question really is, ‘Is this the end of it or not?” Mr Axel Merk, portfolio manager of the Merk Hard Currency Fund told the Washington Post. ‘For whatever reason, the market wants to see the glass as half full. I just think we need to see more,’ he said.

MORE PAIN FOR BANKS

• Banks cleaning up their balance sheets only solves half the problem. Going ahead, they are likely to generate less income as the buyout boom slows.

• Banks must find ways to replace the income from sub-prime mortgages, a market that could take years to recover.

HOUSING RECESSION NOT OVER

• The US consumer spending is being hit by falling home prices, higher mortgage rates and foreclosures. Thus lower spending will adversely affect the economy in the long run.

• Most US adjustable-rate home loans will reset over the next several years at higher rates. This could lead to more foreclosures and a fall in home prices.

FALSE RALLY?

• Analysts caution: Do not read too much into the Dow’s rally.

• This is because the rally was achieved on low trading volumes.

• Shares of large companies recovered because of investments in strong economies overseas and a weak US dollar.

• Many mortgage companies, banks and home builders are still trading far below their highs.

 

Source: The Straits Times 3 Oct 07

Why the financial world wobbled and what it means for funds

2 recent papers pick over the causes and conclusions of the recent market turmoil

(NEW YORK) Smart investors love crises. People panic, everything gets out of whack, securities get cheaper, and the world gets more interesting.

Academic types also love crises because they produce data, which prompt questions and every once in a while produce some answers.

August, the month in which everything went awry on Wall Street, offered up fascinating data.

The financial world trembled, which it does every so often, and even though everyone seemed to know it was coming, everyone seemed surprised.

Two recent papers, one academic and one written for investors, examine the August unwind.

They reach similar conclusions about risk (there is more of it) and the cause of the collapse (an unknown multibillion-dollar fund unwinding), but they differ slightly on what it means for the types of hedge funds that were most affected.

In separate papers, Andrew Lo, a professor of finance at the Massachusetts Institute of Technology who just sold his hedge fund, AlphaSimplex, and Clifford Asness, the founder of AQR, a US$37 billion hedge fund, concluded that the market craziness started when a large multi-strategy fund or a proprietary desk suddenly started to dump its positions in early August.

That set off a wave of de-leveraging, or selling, that in turn caused stocks to do strange things.

Specifically, cheap stocks, or value stocks, got pummelled, and expensive stocks, or popularly shorted stocks, rose.

This caused a lot of pain on the street, especially among quantitative hedge funds, or quants.

Prof Lo’s research, which builds a very basic quantitative model and then tests what would happen to it during the August unwind, concludes that the proliferation of hedge funds using similar investment strategies has led to more risk in the system.

If this seems obvious, be mindful that a lot of people have argued otherwise, and Prof Lo is trying to prove it, not grandstand about it, which is unusual when it comes to any topic related to hedge funds.

According to his analysis, assets in certain strategies – quantitative and long/short equity, both of which generally try to buy cheap stocks and sell expensive ones – have soared and returns have plummeted (these are data points, not conclusions).

From 1995 to 2007, assets in two strategies – equity market neutral (a quantitative model) and long/short equity – skyrocketed to US$160 billion from about US$10 billion. Over the same period, yearly average daily returns of Prof Lo’s portfolio fell to 0.13 per cent from 1.3 per cent.

So to achieve the returns that investors expected, his fund had to increase leverage to about nine times from about two times.

When the unwind came, all those funds with all that leverage resulted in a lot of panic.

‘Now that we have so many boats in the harbour, you can’t whiz by at 50 knots without rocking a few boats,’ Prof Lo said in an interview.

‘In the middle of the ocean, your wake has no impact, but in a crowded harbour, a fast exit can cause quite a disruption.’

In his paper, Mr Asness reached a similar conclusion. ‘I have said before that ‘there is a new risk factor in our world’, but it would have been more accurate if I had said ‘there is a new risk factor in our world and it is us’,’ he wrote in his Q&A letter to investors.

However, he drew a slightly different analogy than Prof Lo. Mr Asness conceded that the harbour is more crowded, but he argued that the problem was not that there were too many boats but that all the boats raced for the same exit. The upshot: There is still room for sailing, which in this analogy means there is still room to make money.

Asness argued that the spread between expensive and cheap stocks, what he called the ‘value spread’, was not that tight before the August unwind and is now wider than the historical norm.That suggests there is room to make money.

‘If too much capital had been attracted to these strategies, then that spread should have been tighter,’ he wrote.

‘Since it hasn’t, it is reasonable to believe that the growth in these strategies has at least been matched by the growth in the behaviour that makes them work.’

Put another way: ‘The growth in the quants seems to be reasonably balanced by those who want to take the other side of the quants,’ Mr Asness said. In other words, there is always someone on the other side, willing to sell cheap stocks and buy expensive ones.

So is the harbour half-empty or half-full? Since hedge funds are not particularly transparent, and no one has particularly useful data on them, no one really knows.

One thing is clear: The harbour, after the August unwind, is less full than it was – a lot of boats have been wiped out.

‘I agree with Andy that these strategies will make less money going forward,’ Mr Asness said.

‘But as of now they are cheap strategies.’ In other words, smooth sailing until the next storm.

 

Source: NYT (Business Times 29 Sept 07)

Fed’s aggressive rate cut sparks global markets

A BIGGER-THAN-EXPECTED interest rate cut by the United States central bank sent global bourses sprinting ahead yesterday.

The half-percentage point cut by the US Federal Reserve was double the quarter-percentage point cut that most analysts expected – and immediately caused a surge in US stocks.

Last night, the optimism continued on Wall Street, with the Dow Jones Industrial Average up 97.30 points, or 0.71 per cent, to 13,836.69 at press time.

Asian markets were equally thrilled at the Fed’s move to restore confidence in global financial markets and head off the risk of a US recession after weeks of market volatility.

It was the Fed’s first cut of the benchmark Fed Funds rate in four years, and is set to relieve a credit crunch in the global financial system, sparked by a US mortgage market crisis, by flooding it with cheaper funds.

In a statement, the Fed said the ‘action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time’.

At home, the benchmark Straits Times Index registered its second biggest one-day gain in history when it soared 116.61 points to 3,594.36 yesterday – just 70.77 points shy of the record high of 3,665.13 hit on July 24.

Tokyo’s Nikkei-225 Index shot up 3.67 per cent, and Hong Kong’s Hang Seng Index soared 3.98 per cent to a record high.

Across Asia, lower interest rates are expected to give a fillip to the housing market and stimulate spending in big-ticket items such as cars.

This gave a big boost to real estate developers and banks, which were among the biggest gainers in the various regional bourses yesterday.

Analysts said the Fed’s move should also help to restore confidence in the troubled global credit markets, where international banks have been hoarding cash and refusing to lend to each other.

But they warned that the surge on Wall Street and other global bourses was fuelled by hopes of further interest rates cuts later on.

These cuts would, how- ever, depend on US economic data to be released over the next month, they said.

They warn that, going by the wording in the statement issued, the Fed might have been uneasy cutting interest rates with crude oil prices hitting record highs, fuelling fresh inflation fears.

The cut in the widely watched Fed Funds rate – which sets the pace for US interest rates – to 4.75 per cent came early yesterday morning Singapore time.

Wall Street immediately notched up its best one-day gain in four years as the Dow Jones shot up 335.97 points, or 2.51 per cent.

The size of the cut was a major surprise. It was correctly forecast by only 23 of 134 economists surveyed by Bloomberg News, while 105 predicted a quarter-percentage point cut; six forecast no change.

 

Source: The Straits Times 20 Sept 07

Caution still needed despite market rebound

It may take more than rate cuts by central banks to sustain the recovery

IT IS almost certain the United States Federal Reserve will answer the prayers of stock market traders across the globe and cut rates when it meets tomorrow.

A lower benchmark interest rate would mean more cash flowing into corporate coffers, which would have positive knock-on effects on markets globally, at least over the short term.

From the way international equity markets have regained their poise, one might be tempted to believe the problems that have beset the global financial system in recent months are over.

At home, the Straits Times Index (STI) closed at 3,536.4 points last Friday, after regaining lost ground, up 19.4 per cent from its Aug 17 intra-day low of 2,962.01. On Wall Street, the Dow Jones Industrial Average rose to within 4 per cent of its all-time highs.

Still, the situation might not be quite that simple.

The STI rebounded strongly after a boost from stocks linked to the booming offshore marine sector, as crude oil prices hit record highs. This more than made up for the pallid performance of the three local bank stocks, which make up about a third of the STI. These banks are still assessing the impact of the credit crunch plaguing global financial markets.

Despite the overall rally, DBS Group Holdings is trading 21.6 per cent off its year’s high, while OCBC Bank and United Overseas Bank are both about 10 per cent below their 12-month highs.

Risk of stagflation

INVESTORS could well be placing too much faith in a few rate cuts by major central banks such as the Fed.

The provision of this form of cheap credit by central banks in recent years was what caused the massive mispricing of risky loans to borrowers with poor credit histories.

The picture is further muddied by soaring crude prices, which hit US$80 a barrel last Wednesday, and by a falling greenback. It is hard to gauge how the global economy will react to the heady brew of a US Fed rate cut and high oil prices.

The conventional wisdom is that in times of rising prices – caused perhaps by higher oil prices – monetary policy should be tighter, not looser.

Such a scenario has not been seen for nearly 30 years. Those with long memories will recall that this mix pushed the US and the rest of the world into a long period of stagflation, characterised by a deep recession and high jobless rates with rampaging levels of inflation.

This vicious cycle was finally broken only when then Fed chairman Paul Volcker ignored the shrill screams of politicians and Wall Street, and relentlessly drove up interest rates to break the back of the inflationary cycle.

Wall Street’s sway factor

WHAT about the argument, increasingly peddled, that Asia has finally unhooked itself from Wall Street – so the credit crunch is a problem for the West, but not Asia?

It is an attractive notion, after years of Asian markets slavishly following the US lead, but it might be wishful thinking, for now at least.

True, China’s decisive intervention last month – it announced that it would allow its citizens to invest in Hong Kong equities – curbed the plunges on Asian bourses and sent the Hang Seng Index to record highs.

But the sheer size of Wall Street means Asia simply cannot ignore any wild US swings as investors sort out the mess surrounding sub-prime loans and agonise over a possible recession in the US economy.

With a market value of US$16 trillion (S$24.2 trillion), US bourses are still bigger than their Tokyo and European counterparts combined, and eight times larger than China’s, even after the giddy run-up there this year.

Therefore, it might be better to remain cautious, as all of the signs point to further trouble over the next 12 to 18 months.

Over the short term, central banks could literally paper over the problems caused by the credit crunch, flooding the markets with billions in fresh cash.

Seeds of trouble

HOWEVER, one big immediate problem remains unresolved: International banks are still struggling to borrow, either from each other or from external sources.

Last Wednesday, for instance, the European Central Bank had to pump another 75 billion euros (S$157.4 billion) into the region’s banking system to reduce the interest rate gap between overnight funding and lending over longer maturities.

And the cost of funds in the hard-hit interbank money markets – where banks borrow from each other – has surged to peaks last seen two decades ago, as the scramble for cash by financial institutions shows little sign of easing.

Observers say investors could be neglecting one key warning sign as they celebrate any easing by the Fed: the gridlock now experienced by the US$2 trillion market for short-term commercial bonds.

Most of these short-term bonds are sold to rich investors and cash-rich firms by special investment vehicles owned by banks. As such bonds mature within 30 or 40 days, this could intensify the credit crunch over the next few weeks, if investors refuse to extend the credit by rolling over their purchases.

In many cases, the sponsoring banks will have to take the risky assets back onto their balance sheets, which will force them to hoard their cash. This, in turn, will cause liquidity to dry up in the money market, whether central banks cut rates or not.

Some market experts have also argued that the current rebound has shaky foundations, as share prices are gaining ground on lacklustre volumes.

Over the past two weeks, average daily volumes on the STI have only reached 2.33 billion shares worth $2.03 billion, a far cry from the 4.4 billion shares worth $2.95 billion that changed hands daily in July when the STI was at a similar level.

More sober-minded observers with good memories suggest that 1998 offers a likely guide to the future direction of the stock market. Back then, panic selling in January was followed by an almost miraculous recovery, but that was snuffed out by a fresh round of bad news.

As the old maxim goes: One swallow does not make a summer. Investors might have to realise that a Fed rate cut is hardly likely to spur a renewed global bull-run that is sustainable.

 

Source: The Straits Times 17 Sept 07

Dreaded R-word heard again amid credit crunch

THE dreaded R-word is now becoming commonplace as the complex sub-prime and credit crisis takes hold in the US and Europe.

The International Monetary Fund (IMF) and the Organisation For Economic Development (OECD) have cut their US and global growth forecasts. Blue Chip Economic Indicators surveyed 50 economists who believe that there is a one in three chance that there will be a recession in the US. A tiny minority predict that it will spread to Europe and parts of Asia.

The global economy’s prospects can no longer be divorced from the banks’ credit crunch. The crisis is the result of excessive lending, not only in the US but in Europe, China and other parts of Asia.

American, British, French, Spanish and Italian consumers, comfortable with the rising value of their homes, borrowed as much money as possible to finance spending on a variety of goods and holidays.

Huge flows of money poured into stocks, real estate and commodities. Hedge and private equity funds and other speculators leveraged themselves to the hilt. They borrowed excessive amounts to trade and purchase a variety of inflated assets.

The Bank of International Settlements and economists such as Brendan Brown of Mitsubishi UFJ Securities International and Stephen Roach of Morgan Stanley warned of the excesses.

So did Yale’s behavioural finance professor Robert Shiller. But in the heady final phases of bull markets, participants are only too happy to cast derision at their views.

As so often happens during rampant speculation, a single, relatively unimportant event, has changed the course of the market. The June collapse of two Bear Stearns hedge funds precipitated the current credit crunch.

Compared with the trillions that wash around the financial markets and much bigger recent hedge fund collapses, the US$1.6 billion bankruptcy seemed ’small potatoes’ as the Guys & Dolls humorist Damon Runyon put it.

But those funds had borrowed US$10 billion to US$20 billion and punted on sub-prime debt and other junk. Their failure made the market stop and think. How many others were caught? The result was a vicious circle.

Banks began to scrutinise their credit lines to hedge funds, forcing them to dump assets, causing price declines, losses, investor withdrawals, loan reductions, more sales and hedge fund closures.

The jittery state of the markets indicates that the circle is still turning, although bargain hunters are precipitating rallies from time to time.

The big question for the global economy is to what extent will banks rein in credit and put the screws on consumers and businesses.

Goldman Sachs, Morgan Stanley and several other investment banks are taking a sanguine view. They believe that there will be a downturn in the US economy, but interest rates and the US dollar will fall.

A recession is unlikely and Europe and Asia could well decouple from the US. The proverbial American sneeze will not be contagious.

Tighter credit and higher interest rates have already brought about a slide in American real estate prices.

Mr Brown of Mitsubishi UFJ Securities International contends that the decline is already dampening business and consumer spending and a recession has already begun.

Most economists and the financial press are examining dated statistics, so they wrongly believe that the US economy is yet to turn downwards, contends Mr Brown.

Prof Shiller of Yale, who predicted the current American property slump, the worst in 16 years, agrees with Mr Brown that Europe cannot be isolated from American economic trauma.

He believes that there is a ’substantial probability’ that the housing slump in the US could well spread to the UK. There are ‘remarkable’ similarities between the property markets in cities such as Boston and Los Angeles and British cities, he says.

‘People are so accustomed to rising house prices, they do not believe it when someone tells them it will come to an end . . . What we have may be the makings of an economic crisis,’ maintains Prof Shiller.

‘Other countries that are vulnerable to a property slide are Spain and France,’ fears Mr Brown. Banks there are exposed.

Other economists fear that high European exchange rates and tighter credit are already denting the German economy. Saudi officials are worried that high oil and gasoline prices could be pushing some countries toward recession. Since Asia is dependent on exports to the US and Europe, any downturn there would have an impact. It seems the day of economic reckoning is at hand.

 

Source: Business Times 12 Sept 07

The Fed likely to cut, but cautiously

TO many observers, it appears a foregone conclusion that when the US Federal Reserve meets on Sept 18, it will cut short-term interest rates, possibly by as much as 50 basis points. Some have even called for a 100 basis point cut. It is hoped the subsequent easing of pressure in credit markets will spill over into equities.

While this happy scenario is plausible, it would be wise for investors not to expect too much. While it is likely that the Fed will indeed cut rates, it might not do so as aggressively as many market players predict or hope.

First, too-high rates are not the cause of the problem: much of the blame for the sub-prime mess can be apportioned to outright fraud by the real estate and finance industries and poor risk assessment. Cutting rates will be of limited use in resolving the problem.

Second, at Monday’s G-10 meeting of central bankers, one message was stressed above all others – that although central banks have an interest in securing market stability, it would be a huge mistake to bail out bad investors. Third, Fed chief Ben Bernanke, who was present at that meeting, is well aware that one of the culprits behind the sub-prime crisis was his very own organisation.

In December 2000 following Nasdaq’s crash, the Fed, then under previous chairman Alan Greenspan, began an unprecedented year-long series of rate cuts, reducing the federal funds rate from over 6 per cent to just 1.75 per cent – a level last seen in the 1950s. By mid-2003, two further cuts had reduced the rate to just one per cent. History has shown that when rates fall this low, what typically ensues is a real estate boom or worse, a real estate bubble. This is exactly what occurred in the US, where lax banking and credit industry practices helped fuel speculative demand for housing between 2003-2006, thus sowing the seeds for the present sub-prime crisis.

However, when inflation became a problem and the Fed was forced to raise rates to cope, the resulting pressure on mortgages then triggered the present collapse. Mr Bernanke, well aware of recent economic history, may be keen to impose his own personal stamp on US monetary policy and hold off on a rate cut for the time being.

In fact, there is actually very little reason to bail out Wall Street. Despite all the doom-laden headlines of the past seven weeks, the Dow Jones Industrial Average is still 5 per cent up for the year while Nasdaq’s gain is 6 per cent. From its all-time high, the Dow has only lost 6 per cent, hardly a catastrophic fall that cries out for Fed intervention.

The main reasons markets believe rates will be lowered are last Friday’s weak jobs report and comments earlier this month by Mr Bernanke that the Fed is ready to take action to provide liquidity and promote the orderly functioning of markets.

While the balance of the evidence suggests the Fed will indeed lower rates, it will probably do so in cautious calibrated fashion. Expectations of a hefty rate cut are likely to be misplaced.

 

Source: Business Times 12 Sept 07

A quick guide to sub-prime issues

How individual loan defaults in a faraway land can have a domino effect all over the world – including here

PAUSE for a moment to consider these facts: HSBC, the world’s third-largest bank, announced that 50 per cent of its earnings in 2006 were wiped out by sub-prime losses from its US subsidiary. Since the beginning of that year, over 50 US mortgage companies have put themselves up for sale, closed or been declared bankrupt. In July this year, Bear Stearns closed two of its ailing hedge funds, while in June, BNP Paribas announced the suspension of three of its funds due to exposure to US mortgages.

With news like this making waves in financial markets lately, it is hardly surprising to see the proliferation of doomsday headlines like ‘Market falls parallel previous collapses’, and ‘Anxiety attack knocks markets down’. No longer confined to the US real estate or financial markets, the topic of America’s sub-prime mortgage market has taken centre-stage, as fears of a spillover spread to financial markets in Europe and Asia – even Singapore.

How did it all begin?

Before the US real estate bubble burst, sub-prime lending was a rapidly growing segment of the mortgage market.

It worked by banks extending credit to borrowers who, for a number of reasons, would otherwise be unable to qualify for credit. According to the US Department of Treasury guidelines issued in 2001, ’sub-prime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments and bankruptcies’.

Most US sub-prime mortgages have an attractive initial fixed-rate mortgage payment for a few years, followed by a higher adjustable rate for the remaining life of the mortgage. The sub-prime mortgage industry began to proliferate earlier this century and estimates say that about 21 per cent of all mortgage originations from 2004 to 2006 were sub-prime – a sharp increase from 9 per cent in 1996-2004. At its height in 2005, sub-prime mortgages were worth US$805 billion.

Although not all sub-prime loans are necessarily high-risk, many of them were made to homebuyers with poor credit or little income. As the US housing market boomed, thousands of lenders greedily sought greater profits by aggressively touting loans to individuals with poorer credit ratings and making greater exceptions to guidelines. In certain cases, individuals were not even required to produce any proof of their income.

These sub-prime loans were bought mainly by big banks which bundled the debt and sold them to Wall Street firms. To sell these ticking time bombs, Wall Street packaged these risky loans with supposedly safer loans to create instruments known as collateralised debt obligations (CDOs) – making them more attractive to risk-averse investors. In 2006, an estimated US$100 billion of sub-prime debt went into US$375 billion worth of CDOs.

In pursuit of higher yields, investors stretching from Europe to Asia invested in these instruments for their potentially higher returns, as compared to bonds with the same ratings.

What went wrong?

Trouble started brewing when the US economy began showing signs of slowing down. Interest rates crept up, house prices tumbled and sub-prime mortgage defaults began climbing at an alarming rate, reaching 12.6 per cent at one point.

As default rates soared, creating losses on the underlying mortgages of CDOs, investors began to question the reliability of the models and ratings which valued these CDOs; indeed, credit rating agencies like Moody’s have come under fire for misjudging default rates in sub-prime mortgages. With the uncertainty surrounding the current analysis and valuation of credit risk, many investors have decided to pull back on investments in CDOs and hedge funds with stakes in such securities.

Explained Jeremy Goh, an associate professor of finance at the Singapore Management University (SMU): ‘When investors heard all these negative things about default rates in the news, they started withdrawing their money from hedge funds and parked them in safer money market instruments like treasury bills.’

The result was a triggered chain of reactions which affected markets worldwide. Hedge funds were forced to unload their assets in order to raise cash.

The scattered ownership of CDOs has in turn created widespread loss of confidence in financial markets. Besides affecting all holders of sub-prime-related assets, the greater and more serious implication of the sub-prime crisis is a squeeze on liquidity. Due to the uncertainty over other financial institutions’ exposure to sub-prime losses, they became unwilling to lend to each other.

A tsunami or ripple effect?

However, central banks around the world have responded by injecting liquidity into the markets to ease fears of a liquidity crunch. The US Federal Reserve has also cut its discount rate (which it charges for emergency lending to banks) from 6.25 per cent to 5.75 per cent.

Asian equity funds have also been hit hard, and among those affected the most are funds from Singapore and Malaysia. Data from Morningstar Asia showed that funds from both countries sank an average of 10 per cent.

Asian stock markets has also been tumultuous, spreading fears that a slowdown in the US economy will extend to the rest of the world.

Although the sub-prime crisis in the US may be a cause for concern, investors here should not be overly worried as Asian fundamentals remain strong. Many industry watchers agree that Asia’s economies are no longer as reliant on the US as in the past. As intra-regional trade grows, Asian giants like China and India have become increasingly important trade partners for other Asian countries instead of the US.

Fundamentals of Singapore’s economy remain firm as well, analysts agree. With the introduction of Formula One and the integrated resorts in the coming years, demand and consumption is likely to continue to propel Singapore’s growth.

Prof Goh concurs: ‘I think the jittery stock market in Singapore is only temporary, and I believe that highly-rated CDOs are still safe. Even if the US economy is heading for a recession, it will be a mild one, so the problem could be due to panic selling in the markets or hedge funds unloading some illiquid assets.

‘ As a result, it triggers fear in the lending market. Lenders are more reluctant to lend, which might have some effect on the economy – but nothing major, in my opinion.’

 

Source: Business Times 10 Sept 07

Rate cut not always needed: Fed official

Market disruptions can be addressed using tools available

(NEW YORK) Federal Reserve Bank of Philadelphia president Charles Plosser said there is an ‘underlying stability’ in the US economy and officials need not always cut interest rates in response to turmoil in financial markets.

‘Disruptions in financial markets can be addressed using the tools available to the Federal Reserve without necessarily having to make a shift in the overall direction of monetary policy,’ Mr Plosser said on Saturday at a conference in Waikoloa, Hawaii.

Mr Plosser said while the housing slump has lowered forecasts for the expansion and there is ‘considerable uncertainty’ about the outlook, he expects economic growth to return ‘toward trend later in 2008.’ The drag from housing will ‘gradually’ ease, concluding sometime next year.

The comments suggest that Mr Plosser has yet to conclude a reduction in the Fed’s benchmark rate is critical to safeguard the economy, which lost jobs for the first time in four years in August. The Philadelphia Fed chief doesn’t vote on the rate-setting Federal Open Market Committee until next year.

Lowering the benchmark rate is an ‘option if financial sector problems spill over to significantly harm the outlook for the broader economy,’ said Mr Plosser, 58, who took office a year ago. And, when shocks threaten market stability, a central bank ‘must be prepared to act promptly,’ he said.

Mr Plosser said that the US has coped with blows in the past, such as the devastation of Hurricane Katrina in 2005 and oil-price shocks, and that a decline in one industry ‘does not always imply major problems in the economy as a whole.’

‘It is important to understand and appreciate this underlying stability of the economy in the face of temporary disturbances as we seek to assess monetary policy,’ Mr Plosser told the Pennsylvania Association of Community Bankers convention.

Investors and economists said on Friday there’s little doubt Fed policy makers will lower the main rate after a government report that day showed employers unexpectedly cut 4,000 from payrolls in August.

‘The committee usually does not base its decision to change monetary policy on any one number,’ Mr Plosser said, without referring specifically to the August jobs report.

Answering questions following his speech, Mr Plosser said the outlook for inflation is ’still up in the air,’ and it’s not clear that the moderation in prices of recent months will be sustained.

 

Source: Bloomberg (Business Times 10 Sept 07)

Fed has effectively cut funds rate: analysts

They say unusually large spread between fed funds target and effective rates signals Fed’s next move

(NEW YORK) Here’s a secret: The Federal Reserve has already cut the fed funds rate.

Yes, the Fed’s target rate is still the same 5.25 per cent it has been since June 2006, and the US central bank has only formally cut the less-used discount rate on loans it makes directly to banks.

But going back to Aug 9, when global central banks started flooding financial systems with cash to prevent a complete shutdown of credit markets, the actual rate at which US banks are providing each other overnight funds, the fed funds effective rate, has averaged just under 5 per cent, according to Federal Reserve data.

That’s equivalent to the 25-basis-point reduction in the fed funds target rate that many investors expect US monetary policy-makers to announce at their next meeting on Sept 18.

‘The Fed already eased,’ said Jim Bianco, president of Bianco Research in Chicago, a member of the bond market camp that says a de facto rate cut happened a month ago and a formal announcement of one on the 18th would be little more than a rubber stamp.

‘This is really hard for many market participants. They are so locked into the target rate that they cannot see the game has changed. The target rate is meaningless,’ Mr Bianco said.

Mr Bianco’s view is not universal, however. Others counter that the Fed’s out-sized liquidity injections are strictly temporary measures to ease credit conditions and are not the equal of a formal policy change by the Federal Open Market Committee.

This group does agree, though, that rubber stamp or not, the unusually large spread between the fed funds target rate and the effective rate is a clear signal of the Fed’s next move.

Typically the effective rate rarely sways beyond a few basis points on either side of the target rate. But through last Thursday, the 21-day moving average on the effective rate has been 4.99 per cent – a 26-basis point spread.

In fact, the last time such a significant deviation between the two occurred for a persistent period was after the Sept 11 attacks. The Fed kept the banking system flush with cash and followed through with two rate cuts by the first week of October, including a rare inter-meeting cut on Sept 17, 2001.

The effective fed funds rate – a weighted average of where federal funds trade over one session – was 4.98 per cent last Thursday, well below the 5.25 per cent target rate.

‘Federal funds typically would move only 5 basis points around the target,’ said Kenneth Kim, economist with Stone & McCarthy Research Associates, in Princeton, New Jersey.

Normally, ‘maybe not until a day or two before the meeting you could see some slippage.’ ‘But these are extraordinary circumstances,’ he said.

Since Aug 9, the Federal Reserve has added US$199 billion of temporary reserves to the banking system. These operations have eased the pain for banks struggling with the US subprime mortgage debt crisis and have also contributed to striking volatility in the overnight money market.

And, despite the sudden gap between the target and effective rates, some analysts say the recent moves in federal funds simply reflect those upheavals and fast-changing credit conditions.

‘While the Fed may very well cut the funds target on the 18th, I don’t think you can make the leap of faith that the effective fed funds rate being below target was the signal,’ said Kevin Flanagan, fixed income strategist for global wealth management with Morgan Stanley in Purchase, New York.

In fact, the daily trading in the fed funds rate has been the most volatile since at least 1994, careening from effectively zero to as high as 6.05 per cent in just one session on Aug 10.

Before 1994, federal funds traded rates were a main tool for tracking Federal Reserve policy, and big swings then were a signal of a policy change. In 1994, though, the Fed adopted the current system of targeting a specific rate and announcing changes to its target the same day, as part of an effort to increase transparency to markets.

Since then, the effective rate has lost some of its predictive power, and for clues to pending rate moves investors have turned instead to rate futures markets.

Still, the current gap probably cannot continue for much longer. Either the Fed has to cut the target rate, as most now expect, or it has to ease up on the liquidity injections to allow the effective rate to float back up to a more typical spread.

 

Source: Reuters (Business Times 10 Sept 07)

ECB, Britain’s central bank leave rates unchanged

This comes as US Fed pumps $48b into banking system to bring down lending rate LONDON – THE European Central Bank (ECB) and Bank of England (BOE) held interest rates steady yesterday, saying it was too soon to gauge the damage wrought by a global credit crisis.

The ECB also pumped 42.2 billion euros (S$87.6 billion) into money markets to lower borrowing costs and said there was more to come.

Across the Atlantic, the United States Federal Reserve added US$31.25 billion (S$47.8 billion) to the banking system, the most in almost a month, pushing down the overnight lending rate to the central bank’s target of 5.25 per cent.

The cash infusion was the largest since the Fed added US$38 billion in reserves on Aug 10.

After leaving euro zone rates at 4 per cent, ECB president Jean-Claude Trichet cast doubt on further increases, dropping his key phrase ’strong vigilance’ that he has consistently used to signal a looming hike and pledging to watch developments in turbulent financial markets closely.

‘Given the high level of uncertainty, additional information is needed before further conclusions for monetary policy can be drawn,’ he told a news conference.

The BOE left its rate at 5.75 per cent and issued a statement saying it was too soon to fathom the crisis’ impact on the British economy.

Before the liquidity crisis, stemming from mass defaults on US sub-prime mortgages, both central banks had been expected to tighten policy again.

‘Heightened concerns about a variety of asset-backed securities have led to disruption around the world, not only in markets for those financial instruments but also in money markets more generally,’ the BOE said.

‘It is too soon to tell how far the disruption in financial markets will impair the availability of credit to companies and households.’

On Wednesday, the BOE acted for the first time to temper sky-high money market rates, something which other central banks have been attempting for a month with limited success.

Mr Trichet said the ECB would hold an extra tender to allot three-month refinancing for euro zone banks on Wednesday to ease money market conditions, which have seen rates soar to a near six-year high above 4.5 per cent.

‘This operation aims to support a normalisation of the functioning of the euro money market,’ the ECB said in a statement.

The global credit squeeze remained as tight as ever.

Banks have shied away from lending over the past month, as they scrambled to calculate exposure to the US sub-prime mortgage sector.

Source: REUTERS, BLOOMBERG NEWS (The Straits Times 7 Sept 07)

Property bubble may burst: Daiwa House

A concerned CEO of Japan homebuilder aims to cut costs and expand in China

(TOKYO) Daiwa House Industry Co, Japan’s second biggest homebuilder by market value, wants to cut local costs and expand in China as the developer is concerned a property ‘bubble’ may burst, slashing land prices.

‘The property market has become dangerous,’ Takeo Higuchi, chairman of the Osaka-based homebuilder, said in an interview. ‘I wouldn’t be surprised if the real estate bubble goes bust.’

Land prices are key for Japanese homebuilders like Daiwa House because declines in population are shrinking the residential construction market. Housing starts in the first half of this year averaged about 23,000 a month fewer than they did 20 years ago.

Daiwa House wants to build condominiums in China and Vietnam and is increasing sales of cheaper steel-frame homes in Japan. The company is also investing in energy and research into rechargeable batteries.

The Ministry of Health, Labour and Welfare in December predicted Japan’s population would drop to 95.2 million by 2050 from 127.8 million in 2005 because people are marrying later in life and having fewer children. That compares with a January 2002 forecast for a 21 per cent decline in the population to 100.6 million by 2050.

The homebuilder’s overseas expansion plan is a positive move, considering the shrinking market at home, said Yoji Otani, an analyst at Credit Suisse Group. Even so, it may be difficult for Daiwa House to meet the needs of consumers in foreign markets, he said.

‘Homes are a highly local product,’ Mr Otani said. ‘It may be risky for a foreign builder to expand broadly into another country’s market.’

Annualised housing starts fell 23 per cent in July from a year earlier to 947,088, after surging 6 per cent to 1.35 million in June after changes to construction laws prompted companies to apply for building permits the previous month. Under the new rules, approvals can take as many as 70 days, compared with 21 days before the change.

Daiwa House, whose shares have dropped 27 per cent this year, plans to spin off a real estate investment trust (Reit) within a year as Japan’s real estate market rebounds from a 15-year slump.

The Reit will contain 100 billion yen (S$1.32 billion) worth of properties, including warehouses, rental apartments and commercial buildings, Mr Higuchi said. The properties will be mainly located in Tokyo, Osaka and Nagoya.

Japan’s land price growth quickened last year to 8.6 per cent from 0.9 per cent in 2005. The gain was the fastest since the National Tax Agency started to compile national land figures. The rapid gain in land prices has become worrisome for Daiwa House, Mr Higuchi said.

Osaka’s Midousuji, one of the city’s main streets for office centres, experienced the most rapid growth, with prices soaring 40 per cent to 6.96 million yen per square metre, the tax agency said on Aug 1.

Daiwa House forecasts profit will surge 25 per cent to 58 billion yen for the year ending March 2008, as sales are expected to advance about 5 per cent to 1.7 trillion yen.

The company is cutting costs by increasing sales if its ‘xevo’ line of two-story, steel-framed houses.

The company plans to sell 1,200-1,300 xevo houses a month this year, exceeding an earlier goal for 1,000 a month.

From next year, Daiwa House expects all of the new homes it sells to be based on xevo frames, up from about 85 per cent now, Mr Higuchi said.

Daiwa House will next month start selling 830 apartments in the seaport of Dalian, north-east China. The developer also plans to build 10 condominiums with 1,200 units in Suzhou, near Shanghai, seeking to meet its two trillion yen sales goal by 2010.

In Vietnam, Daiwa House plans to build 200 units of rental apartments near Japanese schools in Hanoi by 2010.

‘In the long run, it is impossible to achieve such growth if we only focus on the Japanese market,’ Mr Higuchi said.

The company is also looking to expand into energy. Daiwa House bought 52 per cent of Eneserve Corp, which makes electricity generators, for 2.51 billion yen in April.

In addition, it has invested an undisclosed sum in research on lithium-ion batteries, a type of rechargeable battery commonly used in consumer electronics, for residential usage to combat carbon emissions contributing global warming.

The homebuilder plans factories in the Tokyo and Osaka regions and may start producing rechargeable batteries for properties by 2009.

Daiwa House also plans to start producing power- assisted walking devices for the disabled from next year, Mr Higuchi said.

 

Source: Bloomberg (Business Times 6 Sept 07)

Hedge fund investors withdrew US$32b in July

Outflows may increase in August, industry survey finds

(NEW YORK) Investors withdrew a net US$32 billion from hedge funds in July, the most in any month since at least 2000, helping to spark global stock and bond sell-offs, according to a new industry survey.

Funds of hedge funds, which invest clients’ money with other managers, pulled US$55 billion, according to the TrimTabs BarclayHedge Flow Report. That was partially offset by US$23 billion in direct investments into hedge funds. Outflows may increase in August, the report said.

Withdrawals by funds of funds represented almost 5 per cent of their estimated US$1.2 trillion in assets, according to the report, which was prepared by Santa Rosa, California-based TrimTabs Investment Research and Barclay Hedge Ltd of Fairfield, Iowa.

Hedge funds and funds of funds oversee a combined US$1.9 trillion, according to the survey.

‘We believe deleveraging and risk reduction by funds of hedge funds was a major cause of the turbulence in the credit markets and the equity markets in July and August,’ Charles Biderman, chief executive officer of TrimTabs, said on Monday in a statement.

Most hedge funds require clients to give at least 30 days’ notice before they can redeem money, meaning that fund managers started seeing requests for July withdrawals in May and June.

The report was the first by TrimTabs, which tracks fund flows, and Barclay Hedge, which compiles data on more than 5,400 hedge funds and managed futures funds.

Meanwhile, a study found that hedge funds in the US might leave the country if subjected to burdensome regulation.

‘With a heavy regulatory hand, there is a risk of hedge funds moving totally offshore,’ said a Federal Reserve Bank of New York study.

New York Fed vice-president John Kambhu, assistant vice-president Til Schuermann and vice-president Kevin Stiroh wrote the paper released on Tuesday.

‘Outright regulation of hedge funds such as through activity restrictions, required capital or leverage restrictions has not received much attention and could have substantial costs,’ the authors wrote in the report.

Hedge funds are largely unregulated pools of private capital that are linked to the broader economy as their gains and losses affect banks, the paper said. In the event of big declines, a bank’s ‘greater exposure to risk may reduce its ability or willingness to extend credit to worthy borrowers’, the paper said.

Hedge fund assets worldwide increased almost threefold in the past five years to US$1.75 trillion as at June, according to Chicago-based Hedge Fund Research Inc.

As they grow in size relative to the US economy, disclosures that do not impede the business interests of the hedge funds would ‘help’ investors and regulators better understand the risks, the authors wrote.

Otherwise, under ‘more forceful’ oversight, ‘regulators might go from seeing little to seeing nothing’, the paper said.

 

Source: Bloomberg (Business Times 6 Sept 07)

ECB hints it may cut rate today if volatility persists

FRANKFURT – THE European Central Bank (ECB) said yesterday it is prepared to ‘act accordingly’ in the light of renewed market volatility, a sign that instead of keeping its benchmark interest rate unchanged at 4 per cent, it could actually lower it.

It did not explain why it issued the statement, a surprise that caught markets off-guard and produced mounting speculation about what path it could take.

Instead, the ECB, which sets monetary policy for the 13 countries that use the euro, said it may take action at a meeting of its Governing Council today to ‘contribute to orderly conditions’.

‘Volatility in the euro money market has increased and the ECB is closely monitoring the situation,’ the bank said in an unexpected announcement.

‘Should this persist tomorrow, the ECB stands ready to contribute to orderly conditions in the euro money market.’

The message had some market observers conjecturing that the ECB may be poised to mirror a move by the United States Federal Reserve and lower its own lending rate for overnight funds, its marginal lending facility.

That facility has stood at 100 basis points more than the main refinancing minimum bid rate for years.

Within minutes of the ECB announcement, the overnight interbank lending rates dropped to between 3.99 per cent and 4.11 per cent, from between 4.64 per cent and 4.76 per cent.

In London, the Bank of England offered to provide extra cash to reduce ‘unusually high’ overnight lending rates in its monthly market operations, reflecting concern about dwindling credit levels spurred by the collapse of the US sub-prime mortgage market.

In its first statement since the fear of shrinking credit gripped global markets, Britain’s central bank said it had raised its aggregate reserves target for next month by 6 per cent to relieve pressure on overnight rates, and it was ready to add 25 per cent more if overnight rates remain high.

However, it added that it should not be expected to take additional action to reduce banks’ three-month borrowing costs, which have jumped to their highest rate in almost nine years, as banks become increasingly reluctant to lend to rivals until the extent of the crisis is known.

The key three-month interbank lending rate, or Libor, is now 6.8 per cent, more than a full percentage point above the 5.75 per cent base rate and just above the Bank of England’s emergency lending rate of 6.75 per cent.

The central bank is expected to keep its benchmark interest rate unchanged at 5.75 per cent today.

Separately, a senior US Treasury Department official warned yesterday that turmoil in credit and mortgage markets was ‘far from over’ and policymakers must remain vigilant to the need to protect the broader economy.

‘I do want to caution policymakers that this process is far from over,’ Treasury Undersecretary Robert Steel said in prepared testimony for delivery to the US House of Representatives Financial Services Committee.

As expected, the Bank of Canada and Reserve Bank of Australia left their rates unchanged yesterday.

ASSOCIATED PRESS, REUTERS

 

Source: The Straits Times 6 Sept 07

Sub-prime rout less severe than in ‘98: BIS

Swiss body’s view contrasts with grim outlook of S&P

(BASEL, Switzerland) The market fallout from the sub-prime mortgage slump is less severe than in 1998 after Russia’s default and the collapse of Long-Term Capital Management (LTCM), the Bank for International Settlements said.

The assessment from the BIS, which monitors financial markets for central banks and regulates lenders, contrasts with analysis from Standard & Poor’s, which last week said that the outlook for securities firms is worse than in 1998.

‘Some investors began to draw parallels with the autumn of 1998, when the collapse of LTCM had triggered fears of instability in the banking system as a whole,’ the BIS in Basel, Switzerland, said in a report published yesterday.

‘However, the recent rise in US 10-year swap spreads was less sharp than at the time of the LTCM crisis.’

Investors are demanding a yield premium over 10-year Treasury notes of 70 basis points to swap floating-rate interest payments for fixed rates, up from 54 basis points in May. The premium, which increases as the perception of risk deteriorates, had more than doubled in 1998 to 97 basis points.

Bank stocks dropped as much 17 per cent this year, half the 35 per cent decline in 1998, according to the Standard & Poor’s Banks Index.

Declines in stock markets ‘largely reflected investors’ anticipation of losses related to speculation in the sub-prime market and other credit products, as well as expected declines in bank profits due to lower M&A-generated fees’, the BIS said.

‘Despite such losses, the overall decline amongst US banks had not by late August been as severe as in 1998.’ Bank Revenue S&P, based in New York, last week said that revenue from investment banking and trading may fall 47 percent in the final six months of this year, compared with a 31 per cent decline nine years ago. Moody’s Investors Service on Aug 16 said that a hedge fund collapse on the same scale as LTCM was possible.

LTCM, the Greenwich, Connecticut-based fund run by John Meriwether, failed after Russia defaulted on US$40 billion of debt in August 1998 and investors sought the safest securities, including US Treasury notes.

LTCM had been betting on financial markets becoming less risky, borrowing from Wall Street banks to make wagers of about US$125 billion that global bond prices would converge, according to accounts of the debacle including When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein.

The BIS, formed in 1930, polled 62 institutions for its semi-annual report.

Separately, China said yesterday that none of its massive foreign exchange stockpile was invested in the teetering US sub-prime mortgage sector, while a top EU official predicted the crisis would not choke off economic recovery.

European Union Economic and Monetary Affairs Commissioner Joaquin Almunia told newspaper El Pais that lower credit growth and tighter credit conditions were ‘very possible’ but that Europe’s economic recovery would continue.

‘There is no reason that financial turbulence … will put an end to a phase of economic recovery which is solidly based,’ he said.

A senior Chinese foreign exchange agency official helped sentiment by saying none of Beijing’s US$1.33 trillion stash of foreign exchange reserves – the world’s largest – was in US sub-prime mortgage-backed securities, underscoring China’s earlier assertions that it had only limited exposure.

 

Source: Bloomberg (Business Times 4 Sept 07)

Sub-prime will hit global economy: bank CEO

(FRANKFURT) Global economic growth will take a hit as a result of the US sub-prime mortgage crisis, says the chief executive of Deutsche Bank, Germany’s biggest bank.

‘Growth, especially of private consumption in the United States, will suffer because of the housing crisis and that can naturally not go without negatively affecting the world economy overall,’ Josef Ackermann said in a guest column to be published in the German business daily Handelsblatt today. The daily made a summary of the column available to other media at the weekend.

Mr Ackermann said that many banks and investors affected by the credit market turmoil that arose in the wake of the sub-prime crisis had apparently taken risks that exceeded their size and risk-bearing capacity.

‘This is, to say it clearly, above all negligence on the part of the managements of these houses,’ he said. The distribution of credit risks in the international financial system had not been transparent to supervisory authorities and market participants, Mr Ackermann said.

Deutsche Bank has shut down its proprietary credit trading desk in London and is laying off some of the 14-strong team, a source familiar with the matter said on Friday.

Earlier last month a source close to Deutsche Bank told Reuters the bank was set to ditch its credit relative value trading strategy used by the London proprietary trading desk after losses of about US$135 million.

Deutsche Bank has declined to comment.

Two German banks, SachsenLB and IKB, have been bailed out after running into trouble due to their exposure to US sub-prime mortgages.

 

Source: Reuters (Business Times 3 Sept 07)

Harvard economist warns of recession, urges rate cut

FED CONFERENCE

Key rate slash to shield US economy from sub-prime fallout: Feldstein

(JACKSON HOLE, WYOMING) Harvard University economist Martin Feldstein said that the United States housing slump threatens a broader recession, and the Federal Reserve should lower interest rates.

‘The economy could suffer a very serious downturn,’ Mr Feldstein, head of the group that charts America’s business cycles, told a Fed conference here on Saturday. ‘A sharp reduction in the interest rate, in addition to a vigorous lender-of-last-resort policy, would attenuate that very bad outcome.’ Mr Feldstein made a case for lowering the overnight lending rate between banks to 4.25 per cent from 5.25 per cent to cushion the economy from the fallout of defaults on sub-prime mortgages.

Chairman Ben Bernanke told the same gathering on Friday that the Fed will do what’s needed to stop this month’s credit-market rout from ending the six-year expansion.

Lowering interest rates may result in a ’stronger economy with higher inflation than the Fed desires’, a situation that Mr Feldstein described as the ‘lesser of two evils’.

‘If that happens, the Fed would have to engineer a longer period of slow growth to bring the inflation rate back to the desired level,’ said Mr Feldstein, 67, president of the National Bureau of Economic Research (NBER).

Some investors speculated that Mr Feldstein was a candidate for Fed chairman before Mr Bernanke was picked to succeed Alan Greenspan. Mr Bernanke wasn’t in the room for Mr Feldstein’s speech, though most other Fed officials were, along with central bankers and economists from around the world who travelled to the annual mountainside conference hosted by the Kansas City Fed bank.

‘Marty is a guy of good judgment,’ said former Fed governor Lyle Gramley, who attended the event. ‘Everybody in the room recognises that. Everybody, including the people at the Fed, will think carefully about what he said.’

The US economy expanded at a 4 per cent annual rate in the second quarter, the fastest pace in more than a year, before turmoil in the credit markets forced the Fed to warn in an Aug 17 statement that risks of slower growth had increased ‘appreciably’.

Already, some indicators are suggesting a weakening economy. First-time applications for jobless benefits rose to the highest level since April in the week ended Aug 25. Property values in 20 metropolitan areas fell 3.5 per cent in June from a year earlier, according to an Aug 28 report by S&P/Case-Shiller.

The economy was last in recession from March to November 2001, according to NBER. Mr Feldstein outlined a ‘triple threat’ from housing: a ’sharp decline’ in home prices and construction; higher borrowing costs and a ‘freeze’ in credit markets stemming from sub-prime-mortgage losses; and fewer home-equity loans and refinanced mortgages, leading to less consumer spending.

Investors expect the Fed to cut the federal funds rate on overnight loans between banks to 5 per cent on Sept 18 and at least another quarter-point by year’s end. The central bank has left the rate at 5.25 per cent since June 2006 after raising it from one per cent over a two-year period.

Mr Gramley, a senior economic adviser at Stanford Group Co in Washington, said he was surprised by the gloominess of Mr Feldstein’s 25-minute speech, which capped a conference where many participants were pessimistic.

Kansas City Fed President Thomas Hoenig, speaking briefly after Mr Feldstein, said that the symposium gave him and probably his colleagues ‘a lot of useful information to use as we deal with some difficult issues that confront us all’.

Earlier in the day, Fed Governor Frederic Mishkin presented a paper in which he said that US banks can cope with ’stressful’ conditions and that the financial system is in ‘good health’ even with the disruptions of the mortgage market.

Mr Feldstein had said in an interview on Friday that there is a ’significant risk’ of a downturn and urged the Fed to cut borrowing costs.

 

Source: Bloomberg (Business Times 3 Sept 07)

Wild ride for investors ahead: analysts

WALL STREET INSIGHT

But they expect rally once sub-prime uncertainty clears

IN NEW YORK

ON Wall Street, stock market analysts and money managers see stocks ready to register gains once the considerable cloud of dust kicked up by the turmoil in the world’s credit markets sparked by the sub-prime mortgage market settles in the weeks ahead.

But stock traders warned that investors should prepare themselves for potentially huge short-term dips and advances as the market reacts to a steady stream of data leading up to the all-important meeting of the Federal Reserve’s interest rate policymaking committee on Sept 18, which will coincide with the beginning of a pivotal third quarter earnings reporting season.

‘The only thing I’m ready to predict for this month is a wild ride for investors,’ said Hugh Johnson, chief investment strategist of Johnston Illington Investors.

The US stock market’s performance last week could have been a microcosm for the entire summer. Huge ups and treacherous downs leaving the major stock indexes, in the end, pretty much at the same point at which they started the week off.

‘There’s an old saying on Wall Street: go away in May, don’t buy until Labour Day,’ observed Joe Battipaglia, the chief investment strategist at Ryan & Beck, who has seen more than his share of stock market gyrations, volatile markets, bull runs and short term meltdowns over more than 30 years of stock market forecasting.

‘And if investors had followed that rule, they’d have made themselves some very nice returns from the beginning of the year, and be in a situation to enjoy what I think will be a strong run sometime this fall, once the uncertainty over the credit market meltdown, how it’s affecting the economy, and what the Fed will do in response, calms down,’ he said.

Mr Battipaglia’s prognosis sounds simple enough, but investors probably will have several more weeks of the kind of volatility witnessed throughout the summer months and typified in last week’s often frantic trading action, before answers to those three key questions become clear.

The market remains on the edge, poised to either jump in with both feet and start a buying frenzy like the one witnessed following the late February plunge, which eventually sent the Dow to new record highs in July; or to cut and run, pull money out of the market at the dizzying pace seen in August’s sell-off, which brought the stock indexes to the brink of a full-blown bear market.

‘It’s going to be a wild and crazy September,’ echoed Joe Kalinowski, chief investment strategist at Grace Financial.

‘You’re going to see a lot of speculative buying and selling until the dust clears on the economy.’

September is known as the worst month of the year for stocks, with the Dow losing an average of 1.2 per cent for the first month of fall since 1929, and it could happen again if the Fed does not act to cut rates, as the investment community is clearly expecting at this point. The Federal Open Market Committee convenes on Sept 19.

Speculation over the likelihood of the first cut in the Federal funds rate has been running hot and heavy since the Fed took the unusual action of raising the discount rate target by 50 basis points two weeks ago in order to keep liquidity from drying up in the credit markets and to reassure the world that it would not allow the financial system to be plunged into chaos by the greed and speculative behaviour that led to the sub-prime mortgage crisis, which has spread to all financial markets.

On Friday, Fed chairman Ben Bernanke’s much-anticipated comments at a conference in Jackson Hole only stoked those expectation to a higher degree. ‘Everybody thinks they heard what they wanted to hear from Bernanke,’ said Mr Kalinowski. ‘Bernanke said the Fed would not let the credit crisis spread to the economy. The market took that to mean he’s more than likely to cut rates at the Sept 18 meeting,’ he said.

Indeed, investors responded strongly to Mr Bernanke’s speech, sending the Dow Jones Industrial Average soaring 119 points, or up 0.9 per cent to 13,357.74. It was a broad-based rally, too: of the Dow’s 30 components, 27 finished higher. The S&P 500 rose 16.35 points, or 1.1 per cent, to close at 1,473.99. The Nasdaq closed up 31.06 points or 1.2 per cent, at 2,596.36.

For the week, the blue chip index advanced nearly 1.2 per cent while the S&P 500 finished with a loss of 0.4 per cent, and the Nasdaq gained 0.7 per cent.

All three indexes registered gains of more than one per cent for the month of August, with the S&P 500 leading the way with a 1.28 per cent gain. The Dow and the Nasdaq posted 1.1 per cent advances.

The coming holiday-shortened week will get off to a fast start for traders coming off their Labour Day break, concerns over the credit crunch and its effects on the economy remaining front and centre.

Tomorrow, the Institute for Supply Management’s August manufacturing index will be released. That will be followed two days later by the ISM services index, which gives a similar snapshot of the non-factory sector. ‘These are both important and timely indicators and are some of the earliest readings on economic activity for August and do include the period of market turmoil,’ said Joel Naroff, president of Naroff Economics.

Exactly how much the real economy has been affected will have a direct bearing on the Fed’s interest rate decision at its Sept 18 meeting. The Fed funds futures market is pricing in a 100 per cent chance of a quarter-point cut, with another quarter-point cut expected by year-end.

The credit markets will also face a big test starting tomorrow, when investment bankers will be looking to finance several major buyouts, including the US$26 billion buyout of First Data Corp by Kohlberg, Kravis, Roberts.

‘If that deal goes smoothly, it could give a big boost to the credit market and would be a step in the right direction of reassuring investors that liquidity is not still in crisis,’ said Mr Johnson.

 

Source: Business Times 3 Sept 07

Outsourcing firms on edge as sub-prime crisis buffet US clients

Fallout for now limited to those that process mortgages

(BANGALORE) Indian outsourcing firms nervously hope the US loan crisis does not deteriorate as the business of processing mortgages in their biggest market dries up and some clients keel over.

Firms such as iGate Global Solutions and WNS that serviced American mortgage lenders are already feeling the impact of the crisis, which a US survey this week called the biggest short-term threat to the world’s largest economy.

India’s outsourcing industry is now worrying about the crisis impact and a possible slowdown in the US economy on technology budgets of banking, financial services and insurance clients that farm out work to India to cut costs.

‘The impact is now limited to individual companies that had a reasonable amount of mortgage servicing business,’ said Kiran Karnik, president of the National Association of Software and Services Companies.

‘We are hoping that it will blow over soon, but if the ripples travel to other areas of the US economy, it could be bad for the industry,’ Mr Karnik said on Wednesday.

Processing loan mortgages during the US housing boom was a profitable line of business for pure-play outsourcing firms that logged 47 per cent growth to 209 billion rupees (S$7.8 billion) in revenue during the year to March.

The mortgage business has virtually dried up as US financial firms try to weather the sub-prime crisis, caused by defaults on loans made to home buyers with patchy credit histories, by staunching credit.

‘In the US, sub-prime loan originations have almost ceased and, consequentially, the demand for origination services has dropped,’ said N Ramachandran, chief financial officer at iGate Global Solutions.

The company’s revenue from mortgage servicing fell to 7 per cent of sales for the three months ended June 30 from a peak of 10 per cent for the previous quarter, he said.

‘That said, these revenues continue to be at risk due to the ongoing sub-prime market turmoil,’ Mr Ramachandran said, adding that iGate had assigned other duties to about 100 employees that used to process mortgages.

The outsourcing arm of Infosys Technologies, India’s second-biggest software maker, and iGate Global Solutions, both based in Bangalore, lost a major client when GreenPoint Mortgage was shut down by parent Capital One Financial Corp.

Mumbai-based outsourcer WNS said last month that it expected to lose business from US mortgage firm First Magnus Financial, which had been expected to contribute 5 per cent of its revenue for the nine months ending next March.

First Magnus has filed for bankruptcy, forcing WNS to assign other duties to about 500 staff, a press report said on Wednesday.

Software firms such as Infosys are better protected from the US loan market turmoil than companies that earn revenue from back-office services such as transaction processing and risk management.

Still, any US slowdown would hit the entire information technology industry, which earns two-thirds of its US$50 billion annual revenue from the US.

‘We have been speaking to our clients, economists and financial analysts every 15 days,’ said Infosys chief executive officer Kris Gopalakrishnan.

‘There have been concerns of a slowdown in the US economy for two quarters . . . but our clients do not anticipate an actual slowdown,’ he said.

Clients concerned about declining profits tend to initially cut costs, including on outsourcing, but will farm out more work over the ‘medium term’ as they try to increase revenue, Mr Gopalakrishnan said.

Some outsourcing companies scent an opportunity in the crisis.

Quatrro BPO Solutions last month paid an undisclosed amount to acquire the mortgage processing business of USbased Preferred Financial Group.

 

Source: AFP (Business Times 1 Sept 07)