Tag Archives: LIBOR

Bailout schmailout. This is it. We’re toast.

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The credit system is not operating at all. LIBOR has a bid, but no offer. The TED spread is at a new record, over 3.82. Congress and Paulson are powerless to do anything about this. Equities, always slow to catch on, are still not reflecting the severity of the situation.

Here’s the TED spread from Bloomberg:

Here are 90-day Treasuries from Yahoo! Finance:

Here’s a six-month view of the the Dow (Bigcharts.com). Not much of a move so far, given that this is a once-in-three-generations event:

The VIX is high, but not showing once-in-three-generations fear (Yahoo! Finance):

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All stocks have is hope. Hope is not enough.

Crash conditions still present: zero interbank lending.

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Last Friday, I wrote about the condition of the credit market and how it was ominous for stocks. Well, there is no relief yet. Things are worse, as banks are only willing to lend to one another at rates too high to justify borrowing. Overnight LIBOR hit 6.88% today, and 3-month LIBOR was a record 350 basis points higher than 3-month T-bill rates. Here is a graph of that difference, the TED Spread, which, in calmer times, used to stay well under 50 basis points:

Source: Bloomberg

Here’s an excerpt from a Bloomberg piece today:

“The money markets have completely broken down, with no trading taking place at all,” said Christoph Rieger, a fixed- income strategist at Dresdner Kleinwort in Frankfurt. “There is no market any more. Central banks are the only providers of cash to the market, no-one else is lending.”

Credit markets have seized up, tipping banks toward insolvency and forcing U.S. and European governments to rescue five banks in the past two days, including Dexia SA, the world’s biggest lender to local governments, and Wachovia Corp. Money- market rates climbed even after the Federal Reserve yesterday more than doubled the size of its dollar-swap line with foreign central banks to $620 billion. Banks borrowed dollars from the ECB at almost six times the Fed’s benchmark interest rate today.

Libor Rate

The two-month Libor rose to 5.13 percent today, also a record. Libor, set by 16 banks including Citigroup Inc. and UBS AG in a daily survey by the BBA, is used to calculate rates on $360 trillion of financial products worldwide, from home loans to credit derivatives.

After a massive sell-off in the equity markets, you would typically look for a powerful bounce, and while US futures are indicating an open of a couple of percentage points over yesterday’s close, I suspect that stocks won’t have much more steam than that, maybe a few percent in all.

While we dropped a lot in one day yesterday, the Dow only closed at 10,365, less than 500 points beneath its intraday July 14 low. I’m looking for another 1000 points on the downside within a few weeks before calling for a meaningful bear market rally. There is so much emotion out there that anything is possible, but that also means that whatever happens will happen soon.

Credit markets iced over. Put your head between your knees.

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This is still a Goldilocks economy?

Many standard fear gauges remain near their most elevated levels of the bust so far. From highly emotional conditions like these, we should expect a big move in equity prices. The question is whether the next emotion is relief or all-out panic.

If the fundamentals were not so horrible and stock prices not so high (with earnings falling off a cliff, real PEs are in the stratosphere and dividend yields are pathetic), this would be a promising time to go long, at least for a trade. As is, that would be Russian Roulette, because it would be hard to imagine a market more primed to absolutely crash than this one.

With open talk of a depression from the Secretary of the Treasury, and the President comparing the financial system to a “house of cards,” the Dow Jones Industrial Average registers the same opinion about the economy as it did in mid-2006, when talk of Goldilocks was in the air. Something has to give.

This is the Dow from summer 1982 to the present. We are still at the crest of the tidal wave:

Click image for larger view. Source: Yahoo! Finance.

Last week (Sept 15th-19th) a huge amount of steam was let out out of the market, first from the bears, and then from the bulls. By Friday afternoon, traders expressed physical and emotional exhaustion, and volume dried up. It was an eerie feeling.

That week started off in a fright, with new lows on the Dow, T-bills under 0.1% and a VIX over 40. In a lesser bear market, Thursday’s bailout announcement should have marked a substantial bottom (by no means the bottom, but at least the basis for a tradeable rally).

However, the 1000 point, three-hour rally from 2:30PM on Thursday to 11:00AM on Friday hardly set up the basis for a sustained rise, since where else could stocks go but down after such a move? The very violence of it showed how much fear was out there by Thursday morning. We were truly looking into the abyss, that netherworld below 10,000.

After the short-squeeze ran out of steam, prices dribbled down from Friday afternoon to this Wednesday on low volume and volatility, before a little follow-up rally Thursday and Friday relieved the very-near-term oversold condition.  The Dow rests this weekend at 11,143, awaiting what will surely be a wise edict from the philosophers in our legislature. 11,143 is a number neither too ugly sounding nor too pollyannaish, square in the middle, with plenty of room on either side (at least for the near-term).

10-day view here (double lines mark the days):

Click image for larger view. Source: Bigcharts.com

Fear is still highly elevated, no doubt stoked among the general public by the scare tactics and demeanor of Messrs. Bernanke and Paulson. Over the last week, even people who did not support Ron Paul for president have begun to acknowledge the magnitude of the problem. The question is, what are they going to to about it, and when?

To see where Mr. Market’s next move is coming from, follow his rates, not his stocks.

The credit market isn’t waiting for anyone, public nor Paulson. As far as banks are concerned, it’s already TEOTWAWKI, and that is important because changes in credit markets precede changes in equity markets. Two summers ago, while Goldilocks was still enjoying her porridge, bond traders were looking out the window and deciding to pay a premium for long-term debt over short-term (an inverted yield curve is almost always followed 12-18 months later by a recession).

Short-term Treasury yields of course are extremely compressed. 3-month T-bill yield here:

Click image for larger view. Source: Yahoo! Finance

Here is the TED spread, the difference between LIBOR (the rate that banks outside the US Fed system lend one another overnight) and 90 day Treasuries. A wide spread indicates reluctance to lend, i.e., a lack of trust between banks.

Click image for larger view. Source: Bloomberg

Here’s another scary picture from the credit markets, the discount rate spread, the difference in yield between AA and A2/P2 rated commercial paper (short-term corporate debt such as trade receivables). This is why non-Treasury money market funds are so risky (and why Paulson wants to bail them out):

Click image for larger view. Source: Federal Reserve

Fear bloodhounds should also be trained on the Chicago Board of Exchange Volatility Index, a measure of expected volatility in the S&P 500, as indicated by near-term options prices. From summer 2006 to summer 2007, the VIX dipped under 10 at times, truly the calm before the storm, registering the very apex of the decades of unfounded optimism and imprudence that brought about this mess. During the dot-com bust, it nudged over 40 on occasion, a number that was breached intraday in the pre-bailout depths of last Thursday. Two-year view here:

Click image for larger view. Source: Yahoo! Finance

This bear is scared to hell of Goldilocks. It’s too dangerous out there to even short with the confidence that you can get paid if you are right. Where will the money come from?

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