Another thorny Thursday

Today marked yet another sharp change of direction in markets: big falls in equities and bond yields on the back of renewed concerns about credit market conditions, a rebound in the yen as fading risk appetite undermines the attractiveness of carry trades, and a bounce in the dollar and Swiss franc against the €uro and the pound as investors sought traditional safe havens (notably shorter-dated US Treasuries, whose yields have again fallen well below levels that we think are sustainable even allowing for the prospect of Fed rate cuts).

The immediate trigger was the announcement that BNP Paribas has frozen three asset-backed funds because it is impossible to value them in increasing illiquid markets. Arguably, this is not big news. Given the well-published problems experienced by banks in other countries, notably the US and Germany, it surely cannot have been that much of surprise that at least one French bank is also having difficulties. It also seems incredibly naïve to believe that the knock-on effects of the US sub-prime crisis would not be felt elsewhere in the global financial system in time. Nonetheless, in an environment where risk premia on a wide range of assets are still relatively low by historical standards, it clearly does not take much to cause a further sell-off.

The ECB’s unusual move to inject liquidity in a one-day repo also seems to have unnerved many investors. It has even encouraged talk of emergency policy meetings to cut official interest rates – although this is extremely unlikely as long as underlying economic fundamentals remain strong. Indeed, the increases in official interest rates in both Australia and Korea in recent days show that central banks won’t necessarily change course simply because of global market volatility. The (more boring) truth is that inter-bank liquidity had temporarily dried up and the ECB was simply doing its job as lender of last resort. What’s more, its action has succeeded in pushing money market rates back down to more normal levels. Bottom line: On this occasion markets seem to be panicking for no good reason.

2007 Is Not 1998

BCA’s Global Investment Strategy service argues that the current sub-prime predicament is quite different from the 1998 debacle.

The LTCM crisis and the current market climate share similarities: they were both preceded by a sustained rise in equity prices, a period of major yen weakness and a Fed pause after a long tightening cycle.

However, BCA argues that there are several notable differences. Most importantly, the global economy was weaker in 1998 and the risk of a global recession was much higher. The U.S. economy was strong and the world was fragile while today, the U.S. economy is a soft spot in the midst of a global boom.

Moreover, in 1998 there was near simultaneous strikes from Russia’s debt default, the rapid unwinding of yen carry trades and the collapse of LTCM, provoking the risk of a full-blown credit crunch and financial disintermediation. The ongoing sub-prime crisis is serious, but is not likely to jeopardize the stability of U.S. deposit-taking institutions. Bottom line: A replay of the 1998 crisis is not in the cards.

And finally…………….

A nun walks into Mother Superior's office and plunks down into a chair.
She lets out a sigh heavy with frustration.

"What troubles you, Sister?" asks the Mother Superior.

"I thought this was the day you spent with your family."

"It was," sighed the Sister. "And I went to play golf with my brother.

We try to play golf as often as we can. You know I was quite a talented golfer before I devoted my life to Christ."

"I seem to recall that," the Mother Superior agreed.

"So I take it your day of recreation was not relaxing?"

"Far from it," snorted the Sister. "In fact, I even took the Lord's name in vain today!"

"Goodness, Sister!" gasped the Mother Superior, astonished. "You must tell me all about it!"

"Well, we were on the fifth tee...and this hole is a monster, Mother -540 yard Par 5, with a nasty dogleg left and a hidden green...and I hit the drive of my life. I creamed it. The sweetest swing I ever made. And it's flying straight and true, right along the line I wanted... and it hits a bird in mid-flight not 100 yards off the tee!"

"Oh my!" commiserated the Mother. "How unfortunate! But surely that didn't make you blaspheme, Sister!"

"No, that wasn't it," admitted Sister. "While I was still trying to fathom what had happened, this squirrel runs out of the woods, grabs my ball and runs off down the fairway!"

"Oh, that would have made me blaspheme!" sympathised Mother.

"But I didn't, Mother Superior!" sobbed the Sister. "And I was so proud of myself! And while I was pondering whether this was a sign from God, this hawk swoops out of the sky and grabs the squirrel and flies off, with my ball still clutched in his paws!"

"So that's when you cursed," said the Mother with a knowing smile.

"Nope, that wasn't it either," cried the Sister, anguished, "because as the hawk started to fly out of sight, the squirrel started struggling, and the hawk dropped him right there on the green, and the ball popped out of his paws and rolled to about 18 inches from the cup!"

Mother Superior sat back in her chair, folded her arms across her chest, fixed the Sister with a baleful stare and said...

"You missed the f***ing putt, didn't you?"

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.