Anonymous Libor Expert Explains on How the Fed has Destroyed LIBOR

As explained by an anonymous Libor ‘trader’ expert, courtesy of the Business Insider, (bold emphasis added)

LIBOR isn't really based on a tangible number; it's based on a compilation of bank responses to the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?"

Banks need to find money to settle transactions denominated in other currencies or involving transactions abroad. Therefore they use instruments like Eurodollar futures, which allows them to borrow or lend dollars at banks outside the United States for a certain period of time.

The effects of any central bank action are felt directly in these markets. When the Federal Reserve wants to lower the federal funds rate, it uses open market operations—this means it states its intention of depositing more money in banks' accounts at the Fed, making it cheaper for other financial firms to get dollars.

In the years leading up to the financial crisis, the relative stability in rates allowed algorithmic traders to take advantage of very minute changes in LIBOR at various maturities, like those mentioned by Barclays traders in documents released by European regulators. The Fed and other central banks could control that rate by adjusting interest rates, but LIBOR moved pretty much in tandem with the federal funds rate.

"My colleagues and I, we say that [LIBOR] is 14 bps over the federal funds rate...as a joke," the trader told Business Insider, pointing to the uncanny correlation between the two rates up until 2007 and since 2009. When the rate at which banks lent to each other began to jump in late 2007, however, "the system couldn't take it at all," he added.

In the lead-up to and during the financial crisis, real interbank lending for any length of time beyond overnight practically stopped. Thus, saying that banks were pushing down their reports of the prices at which they could borrow is at best misleading, because the demand for lending long-term was nonexistent.

"We submitted a hallucination," said the source.

Central banks responded to the credit stress by offering massive lending facilities, which allowed banks to to access money—in particular, dollars—through a vehicle outside the traditional private money markets. That has changed the way the markets work.

The trader explained, "Since the crisis, banks don't fund themselves [through the traditional money markets] because they don't want to. It's really now about old contracts," that were purchased ahead of the crisis.

But while markets may have exited the crisis credit crunch, markets for securities determined by LIBOR have not, the trader told us. Instead, he says there's an implicit push by the Fed to keep the lending rate low, even though it should be much higher now.

By releasing interest rate projections and jumping to non-standard measures like quantitative easing and dollar facilities, the Fed destroys the incentive to actually exchange money via Eurodollar contracts. This means the Fed is refusing to let LIBOR function as a true, independent indicator.

"If you're long the TED [you believe there will be more financial stress] in a time of trouble, you buy T-bills and take the money offered to you, so you sell a Eurodollar." Essentially, you believe you'll be profiting off of higher lending costs for banks in the future. But if the LIBOR is kept artificially low, then you lose money on a Eurodollar futures contract.

But now, the Fed has become so committed to keeping interest rates down indefinitely—and has jumped so quickly to measures that distort the market—that it has completely destroyed any faith or interest in new contracts.

The trader believed that central banks have recognized that disaster happens when the LIBOR begins to deviate from its general relationship to the federal funds rate, and therefore the Fed (and perhaps other central banks) have suppressed it to make sure rising rates don't generate fear while it develops another money market system.

"I think what they want to do is make sure the system doesn't go crazy." Otherwise, he argues, "You're not just embracing a fantasy. You're embracing a fantasy that created the great credit bubble."

The above observation has basically been congruent with my earlier thesis

Barclay’s LIBOR Scandal: Self Fulfilling Turmoil

The Barclay’s LIBOR scandal seems to be rippling across the world.

From the Bloomberg,

Regulators from Stockholm to Seoul are re-examining how benchmark borrowing costs are set amid concern they are just as vulnerable to manipulation as the London interbank offered rate.

Stibor, Sweden’s main interbank rate, and Tibor in Japan are among rates facing fresh scrutiny because, like Libor, they are based on banks’ estimated borrowing costs rather than real trades. In some cases they may be easier to rig than Libor as fewer banks contribute to their calculation, according to academics and analysts.

“Many of the ingredients which made it pretty easy to manipulate Libor and collude are common in other benchmarks,” said Rosa Abrantes-Metz, an economist with consulting firm Global Economics Group and an associate professor at New York University’s Stern School of Business. “Regulatory agencies are starting to take a look at those and there is a growing sense they need to change.”

Barclays Plc (BARC), the U.K.’s second-largest bank, was fined a record 290 million pounds ($450 million) last month for attempting to rig Libor and Euribor, its equivalent in euros, to appear more healthy during the financial crisis and boost earnings before it. At least 12 banks including Royal Bank of Scotland Group Plc (RBS) and Deutsche Bank AG are being investigated for manipulating Libor.

Regulators and industry groups are now turning their attention to whether other benchmark rates were manipulated in the same way. Sweden’s central bank, the Japanese Bankers Association, the Monetary Authority of Singapore and South Korea’s Fair Trade Commission have all announced probes into how their domestic rates are set.

Derivatives Traders

Libor is determined by a daily poll carried out on behalf of the British Bankers’ Association that asks banks to estimate how much it would cost to borrow from each other for different periods and in different currencies.

The issue is here is that interest rates have been manipulated thereby prompting speculations that there might have been large discrepancies in the pricing of interest rates that affects much of the world financial markets.

The so-called manipulations occurred at the peak of the crisis in 2008 and has reportedly even been warned by NY Fed’s then President Timothy Geithner and so as with the BIS.

Apparently NO one took LEGAL action or that authorities simply looked the other way.

Now this has become a big issue.

But the much of the agog (impact of price manipulations) out of the LIBOR scandal has barely been a fact.

In spite of the alleged Libor shenanigans, Professor Gary North shows here in numerous charts that interest rates had been determined by the markets.

Writes Professor North, (bold original)

There is no sign that these two gigantic and interlinked credit markets were different in any significant sense over the entire decade. In other words, Barclays bank had no influence over rates. The banks that were involved rigged the system from 2005 to 2009.

Then what is the scandal all about? Ignorance of basic economics. What about the banks that manipulated the LIBOR rate? They made money on the margin, but they did not have any significant effect on these rates. You can see this in the LIBOR charts.

The scandal is a tempest in a teapot. No one lost much money. The banks did not keep rates lower than the market for more than a few hours -- maybe days, but I want to see proof.

The rates were governed by market forces.

The idea that Barclays kept rates down for years is ludicrous. No commercial bank can keep rates down if investors are willing to pay for a different allocation of capital than what the banks want. The bankers can make money at the margin, paying a little less for loans. But after 2008, none of this mattered. Bankers did not want to borrow from each other.

The appalling ignorance of basic economic theory is why we see the headlines about Barclays and the manipulation of rates. Bankers probably made many millions of pounds extra, but this had no measurable effect on the direction of interest rates. We are not talking about hundreds of billions. We are not talking about the Bank of England.

Columnists like to get attention. There is nothing like a scandal to get attention. But to say that the commercial banks manipulated inter-bank rates is saying that (1) central banks and reserve requirements don't count for much; (2) market rates can be held down by a few commercial banks, thereby overcoming the market for capital: lenders and borrowers.

The people who cry "scandal" do not think through the implications of what they are saying. Making a lot of money is one thing. It is possible. Re-structuring the derivatives market totaling about a quadrillion dollars in assets/promises is something else.

The problem has little to do with rate-tinkering by Barclays and the others. The problem, then as now, is the misguided Keynesianism that undergirds the policy decisions of the West's central bankers.

In reality, the major manipulators of the markets has been the central bankers led by the US Federal Reserve, who seem to be looking to divert the public’s attention from the real causes of the present imbalances: central banking inflationism.

With allegations that banks has been culpable for the manipulations of the interest rates the reactions will likely be a tsunami of lawsuits, of course calls for tighter regulations (which may be the real intent of the scandal-mongerers)

From another Bloomberg article,

Wall Street, grappling with mounting regulatory probes and investor claims over alleged interest-rate manipulation, may face yet another formidable foe: Itself.

Goldman Sachs Group Inc. (GS) and Morgan Stanley are among financial firms that may bring lawsuits against their biggest rivals as regulators on three continents examine whether other banks manipulated the London interbank offered rate, known as Libor, said Bradley Hintz, an analyst with Sanford C. Bernstein & Co. Even if Goldman Sachs and Morgan Stanley forgo claims on their own behalf, they oversee money-market funds that may be required to pursue restitution for injured clients, he said.

Because Libor is based on submissions from only some of the world’s largest banks, the probes threaten to pit firms uninvolved in setting the rate against any implicated in its manipulation, Hintz said. Libor serves as a benchmark for at least $360 trillion in securities.

“This will be a feeding frenzy of sharks,” said Hintz, who has served as treasurer of Morgan Stanley (MS) and chief financial officer of Lehman Brothers Holdings Inc. “We’re going to have Wall Street suing Wall Street.”

It’s definitely going to be a feeding frenzy especially for politicians whom are likely to use the current sentiment against Wall Street (Occupy Wall Street) and the global financial industry as fodder for electoral mudslinging or as an opportunity to acquire votes with the US national elections fast approaching.

Wall Street rending each other apart will likely exacerbate the prevailing uncertainty.

Barclay’s Libor Scandal: The US Federal Reserve as the Biggest Manipulator

Since 2008 it has been obvious that the US Federal Reserve through its manifold tools has been engaged in the manipulation of interest rates. Here is the alphabet soup of the Fed’s tools

I pointed this out earlier here

Nevertheless the Zero Hedge shows partly how the manipulation process has been done (hat tip Bob Wenzel) [bold original]

Via Peter Tchir of TF Market Advisors,

The Fed does everything it can to keep LIBOR low.

This chart says it all.

The Fed cannot affect LIBOR directly, but in general LIBOR trades in line with Fed Funds. You can see that historically as Fed Funds was changed, LIBOR responded appropriately. There was typically some small premium to reflect the "credit risk" of banks versus the Fed, but it was relatively small, and fairly stable. 3 Month LIBOR would deviate a bit as rate cuts and hikes were anticipated in the market, but in general, it was a fairly stable game.

That all started to break down in 2007. We saw the first real signs of LIBOR deviating from its normal spread to Fed Funds in the summer of 2007. The Fed responded by cutting the "penalty" rate for using the discount window, and in fact encouraged banks to use the discount window (I still can't shake the mental image of someone sitting in a dark basement with a green eye-shade doling out money to banks that request it). Then the crisis got worse. Bear needed to be rescued. Facilities such as the Term Auction Facility that had been put in earlier were increased in size. The Fed backstopped some portfolios that JPM acquired as part of the Bear Stearns deal.

As the crisis re-ignited in the late summer of 2008 and peaked after Lehman and AIG, the Fed took step after step to reduce borrowing costs. The Fed was blatantly clear that it wanted borrowing costs to go down. They had the obvious tool of reducing Fed Funds to virtually zero, but when LIBOR didn't follow, the Fed took further action. The Fed did not want bank borrowing costs to be high.

They increased dollar swap lines so foreign banks could borrow. The Fed stepped into the commercial paper market so banks wouldn't have to use money to meet drawdowns on revolvers. TALF was another creation to take pressure of bank lending.

The FDIC allowed banks to issue bonds with FDIC backing (so not quite Fed program, but who is going to quibble).

Fears that MS and GS and GE would topple the banks were alleviated by making them banks.

The list goes on. The Fed has done a lot and trying to control LIBOR as a key borrowing rate is one of the things they have worked on, both directly and indirectly.

In reality, central banks worldwide have been working round the clock to rein interest rates almost at every channel.

Bailouts are part of the umbrella mechanism of interest rate controls, as they prevent markets from revealing the real conditions of people’s time preferences over money and from the clearing of the loan markets—suppliers and demanders of loan.

And the biggest evidence is the scale of balance sheet expansions of the G-4 central banks since 2008 with the US Federal Reserve as the leader. (cumber.com)

Barclay’s LIBOR Scandal: Is the Bank of England the Culprit?

Barclays chief executive Bob Diamond recently resigned over allegations of the manipulation of the LIBOR (London Interbank Offered Rate) or the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks (Wikipedia.org)

From Reuters (bold highlights mine)

Barclays chief executive Bob Diamond suddenly quit on Tuesday over an interest rate-rigging scandal that threatens to drag in a dozen more major lenders but suggested the Bank of England had encouraged his bank to manipulate the figures.

"The external pressure placed on Barclays has reached a level that risks damaging the franchise - I cannot let that happen," said Diamond, 60. The terms of his severance were not announced, though Sky News said the bank would ask Diamond to forfeit almost 20 million pounds ($30 million) in bonuses.

Politicians and newspapers have zeroed in on the scandal - which revealed macho e-mails of bankers congratulating each other with offers of champagne for helping to fiddle figures - as an example of a rampant culture of wrongdoing in an industry that stayed afloat with huge taxpayer bailouts.

Barclays released an internal 2008 memo from Diamond, then head of its investment bank, suggesting that the deputy governor of the Bank of England, Paul Tucker, had given Barclays implicit encouragement to massage the interest figures lower during the peak of the financial crisis in order to present a better picture of the bank's financial position.

Here is the principle, central banks are the only entities permitted to manipulate interest rates…

…but they need accomplices.

More from Zero Hedge

Wonder who was pushing Barclays to manipulate its rate? Why none other than the English Fed. From BBG:

• BARCLAYS SAYS BANK OF ENGLAND CALLED ON OCT. 29, 2008 ON LIBOR
• BARCLAYS SAYS DIAMOND MADE NOTE OF CALL
• BARCLAYS SAYS DIAMOND RECEIVED CALL FROM PAUL TUCKER
• BARCLAYS SAYS TUCKER SAID `CERTAIN' BARCLAYS DIDN'T NEED ADVICE
• BARCLAYS SAYS TUCKER SAID DIDN'T ALWAYS NEED TO BE SO HIGH (Supposedly LIBOR)
• BARCLAYS PROVIDES COPY OF DIAMOND'S CALL NOTE
• BARCLAYS SAYS DIAMOND DIDN'T BELIEVE HE HAD GOT INSTRUCTION
• BARCLAYS SAYS DEL MISSIER CONCLUDED INSTRUCTION HAD BEEN GIVEN
• BARCLAYS SAYS DEL MISSIER TOLD RATE SETTERS TO LOWER RATES

In other words, a central banks was directly and indirectly involved in manipulating interest rates. Say it isn't so. Fast forward two months when the BOE's Tucker testifies that the Chairsatan made him do it.

Hoping to take the political heat off what seems obvious, Barclay’s and Bob Diamond has served as BoE’s fall guy.

Credit Spreads: Some Improvements But Not Enough

The global banking credit crunch has triggered many liquidity problems, aside from unmasking some insolvency and balance sheet vulnerabilities across countries and companies or in both the public and private sector around the world.

Notably we see some improvements, although still far from the norm.

All charts from Bloomberg.

Euribor 3 months...

TED Spread...
Hong Kong dollar Hibor...

3 month Libor-OIS Spread...

BBA Libor USD 3 months...

First Test On Asia’s Banking System? Hong Kong’s Foiled BEA Bank Run

It was bound to happen.

The most recent spike in of LIBOR rates (courtesy of Bloomberg) in the international money markets (IHT) sparked rumors through a barrage of panicky text messages that suggested of a Hong Kong bank that had become vulnerable due to the recent losses in Lehman Brothers.

Depositors then thronged to the branches of the Bank of East Asia-founded in 1918, which makes it the oldest bank in the city-triggering a 2 day bank run.

Courtesy of BBC

But unlike the counterparts in the US or in UK, newswires reported that a combination of massive injection of funds to its system- about HK$3.9bn/$500m/£269m (BBC) by the Hong Kong Central Bank, plus domestic tycoon Li Ka-shing’s reported massive buying of the bank’s shares, which earned him the moniker of the “superman” by the local media (NYT), eased depositors’ concerns.

The overall damage, according to Timesonline, ``Total withdrawals from BEA on Wednesday were estimated at HK$2 billion by analysts at DBS Vickers Securities – a manageable 0.7 per-cent of the bank’s HK$300 billion deposit base.

``Some of those queueing to withdraw their money cited fears that BEA had not properly assessed its exposure to the unwinding of Lehman Brothers’ huge positions, which the bank puts at about $54 million. Many savers took to the streets in protest after discovering that HK$13 billion of minibonds guaranteed by Lehman Brothers that they had bought were rendered worthless after the bank’s collapse. Some pointed to the suddenness of Lehman’s demise, saying that in the days before the Wall Street giant went bankrupt it was issuing assurances of its stability, in similar terms to those used on Wednesday by BEA.”

From our understanding, the strongest possible reason why BEA survived the ordeal was PROBABLY because it wasn’t insolvent unlike its contemporaries in the US (IndyMac) or UK (Northern Rock). Liquidity injections can do some temporal patch up work, but can’t hide the company’s structural infirmities. The equity support provided by tycoon Li Ka-Shing signified as a vote of confidence or opportunity to profit than from altruism.

Second, in a world where people are anxious about the stability of the world’s financial system, the flow of information has been real time and powerful enough to trigger an unwarranted stress or panic.

Lastly, while this will NOT be the last of the systemic tests for Asian banks, they are likely to be better conditioned to weather the storm of panics.

The differences in the outcome of how an Asian bank and US banks reacted to Bank Runs clearly demonstrates signs of brewing divergences.

Phisix: Domestic Participants Panic! Bottom Ahoy?!

``Time is what matters most. Just as time is the friend of the great business and the enemy of the not-so great business, so to time, like volatility, makes friends with the long-term investor and antagonizes the short-term one.” –Josh Wolfe Timeless Space & the Mismeasure of Risk

Post Holy week of 2008, we noted of an article by a high profile domestic analyst in a business broadsheet satirically provoking local stock market participants to “panic” so as to “end” the anguish of the present bear market.

The article appeared to be a “reverse psychology”, as we wrote in In A Crisis, Be Aware Of The Danger But Recognize The Opportunity, ``which was meant to do otherwise, it signifies pretty much of a deeply entrenched state of denial-the inability to accept the persistence of the present conditions. This seems to reflect signs of impatience and deepening frustration from a supposed market expert. As German-Swiss author poet Hermann Hesse in his novel Steppenwolf wrote, ``All interpretation, all psychology, all attempts to make things comprehensible, require the medium of theories, mythologies and lies."

Instead we suggested that prudent investors ought to understand the global credit-equity cycle, which appears to be of more impact to our equity market more than simply reading too much of sentiment as a potential indicator of the direction of our market.

Let us see why…

Figure 1: stockcharts.com: World Equity Markets Have Basically Tracked US Financials

Figure 1 courtesy of stockcharts.com depicts of the Dow Jones World Index (main window), whose peak seems to resemble the local Phisix (not shown), has been winding down since the US General Financial Services (lowest pane) has broken down in July of 2007. In short, global equity markets have been heavily correlated with the performance of US financial stocks and apparently have signified as a drag.

However, in contrast to the Dow Jones World index, which remains above its recent low, the local benchmark the Phisix has severely underperformed by successively carving out new lows despite this week’s technical rally.

Will Global Financial Markets Survive High Oil Prices?

In addition, we hear many of today’s pains pinned on oil prices. However, such causality seems specious. The same chart shows oil prices (pane below main window-$WTIC) and global equities have not been strongly associated. On the contrary, the recent rally of oil prices coincided with the rebound of global equity markets.

When oil prices pinnacled at nearly $140, global equity markets were already rolling over concomitantly alongside with the US financials. Thus, the pain from high oil prices is clearly a subordinate source of concern relative to the headwinds from the US financials.

On a positive note, $135 oil today also translates to strong demand from emerging countries, which is a peculiarity or an unprecedented characteristic given today's environment see Figure 2.

Figure 2: British Petroleum: World Oil Consumption: Signs of Decoupling?

British Petroleum notes that ``world consumption rose by about 1 million barrels in 2007, just below the 10 year average. OECD consumption declined nearly 400,000 barrels per day. China accounted fro the largest increment to consumption even though growth rate was below average. Consumption in oil exporting regions was robust.” (BP)

Essentially with oil at $135, the outperformance of emerging markets relative to advanced economies in terms of oil consumption could also be seen as another sign of "decoupling".

Yes, China surprisingly raised energy prices this week-18% diesel, 16% gasoline (NYT) and electricity prices nearly 5%-which means easing of subsidies to alleviate the growing incidences of crippling shortages arising from losses of petrol refineries, whom have been curbing production, aside from the prospects of power failure (as the Olympic season nears), as power companies have become reluctant to operate oil fired power stations for the lack of revenues to cover oil costs. Anyway, despite such increases, refined crude oil prices are still about 30% BELOW world market prices!

Of course while we may expect price increases to somewhat dampen demand for energy usage (it is expected to hurt mostly countries that don’t use subsidies), this won’t be enough to curtail overall demand as evidenced by some countries who recently undertook measures to lift subsidies as Indonesia-recently hiked oil prices last May (Reuters), saw vehicle sales 24.4% year on year but 1.8% down from April (automotive world).

Besides, the market have learned how to adjust to the recent high oil price landscape by introducing fuel efficient yet affordable motor vehicles, as shown in Figure3.

Figure 3: Economist: Where low-cost car sales are set to grow

From the Economist, ``WITH one eye on emerging markets and another on fuel restrictions more carmakers are entering the low-cost car market. Renault, which already manufactures the €7,600 ($12,000) Logan, recently announced a venture with Nissan and an Indian carmaker, Bajaj Auto, to develop a car that will compete with Tata's Nano, which goes on sale in India in October for a tiny $2,400. Sales of basic and small low-cost cars are predicted to leap by nearly 4m cars a year to 17.7m by 2012, according to Roland Berger, a consultancy. Growth is set to be highest in the emerging economies of Asia and Eastern Europe, but sales in America, home of the big gas-guzzler, will also grow by an average of 8.7% a year.”

Figure 4: Economist: Falling US Light Truck Sales

So yes, while SUVs and Hummers (figure 4) are on the decline in the US, we don’t see the same with China which has a black market for Hummers and some growing variants-Beijing Auto’s Trojan and Dongfeng Auto’s HanMa (Financial Times).

The world has survived high oil prices. And is likely to get over high oil prices provided the world can adapt to the changes brought forth in time.

In fact, as seen in above, it is not high oil prices per se that has been contributing to the angst of the financial markets and the real economy, but the rate of change of oil prices, given that oil has doubled year on year. But then again the world markets seem to be finding ways and means to adjust to a given environment.

The point is that high oil prices reflect the reality of distortive government policies on one hand, and the seismic shift in the sphere of global economic progress on the other.

Short Credit-Short Equity In The Face of Global Monetary Inflation

Next, as we further commented, the pang of the recent bear market here and abroad looks likely one which tracks the cyclical credit-equity cycle. As we earlier quoted Citibank’s Mark King’s credit-equity cycle, it looks likely that we have segued into the fourth phase, where…

``Phase 4: Short credit, Short equity

``This is the classic bear market, when equity and credit prices re-couple and fall together. It is usually associated with falling profits and worsening balance sheets. Concerns about insolvency plague the credit market, while broad profit concerns plague the equity market. A defensive strategy is most appropriate - cash and government bonds are the best performing asset classes.”

Going back to figure 1 shows that LIBOR rates have remained high signifying continuing stress in the credit markets.

The London Interbank Offered Rate (wikipedia.org) is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market (or interbank market). To quote David Kotok of Cumberland Advisors, ``LIBOR is perhaps the most important interest rate in the world, in US dollar terms. It’s the pricing reference for probably $150 trillion. Trillion with a T. That number includes lots of derivatives.”

While falling credit and falling equities seem to be the classic bear market which we envisage today, we are faced with an environment where rising goods and services inflation makes the classic defensive strategy (cash and bonds) as an unlikely viable option.

Why? Because the inflation phenomenon has been transformed into a global affair. To aptly quote Doug Noland, in his Credit Bubble Bulletin (emphasis mine),

``First, there is the massive flow of dollar liquidity inundating the world. Despite huge dollar devaluation, a major Credit crisis, and economic downturn, our system is on track for yet another year of $700bn plus Current Account Deficits (and this doesn’t include the massive speculative outflows to participate in the global inflation). Global economies, especially booming Asia, are awash in dollar liquidity to use to bid up the prices of oil and other strategic resources.

``Second, today’s massive dollar flows have increasingly gravitating to speculative endeavors (hedge funds, sovereign wealth funds, commodities speculation, etc.) – each year ballooning the “global pool of speculative finance” that by its very nature chases rising prices (“liquidity loves inflation”).

``Third, the confluence of the flood of global liquidity and unfettered domestic Credit systems has exerted its greatest stimulatory effect upon the highly populated countries of China, India, and Asia generally. This, then, has created a historic inflationary bias throughout the energy, food and commodities complexes.-Doug Noland Good Inflation?

Figure 5: Brad Setser: US Exports More Financial Assets

Proof? Figure 5 courtesy of the Brad Setser of the Council of Foreign Relations shows that the US exports TWICE more Financial Assets than its exports of goods and services.

To quote the meticulous Brad Setser, ``No one has argued that the main benefit of globalization is that it allows America’s bankers to sell US debt – and increasingly shares of American companies – to governments in the emerging world. But that is a fairly accurate description of current trade and financial flows.”

This is the epitome of the US dollar standard- the US sells promises to pay (sovereign debt or treasuries/agencies) in exchange for goods and services, aside from selling equity ownership in the US to foreigners (mostly emerging markets).

Thus, the ongoing wealth transfer and inflationary pass through from the US to world which has begun to boomerang back to the US.

Local Investors Gripped By Panic! Bottom Ahoy?

Well going back to the local analyst who called for the domestic participants to panic, the Philippine stock market appears to be accommodating his wishes.

Market internals suggests, despite the rally in the Phisix last week, of panic stricken activities led by local mostly retail investors.

Let us look at some of the evidences:

Figure 6: PSE: Net Foreign Trade

Figure 6 accounts for the year to date representation of net foreign trade. The chart shows that despite the most recent burst of foreign selling largely brought upon by the intense politicking amidst a drab global equity market sentiment, the intensity of foreign selling seems to have been thawing (red arrow) compared to the earlier bouts of liquidation.

In fact, for this week, foreign trade accounted for a marginal net buying of Php 152 million. But, this came amidst a negative net foreign trade breadth or the number of companies with positive foreign trade minus number of companies with negative foreign trade.

For the Phisix to bottom, foreign trade needs to revert to both a positive net Peso value and positive market breadth. We anticipate improvements on the said variables as the BSP raises interest rates in the face of high goods and services inflation, provided the politicking will abate.

However, market breadth persisted to decline despite the modest rally posted by the Phisix this week.

Figure 7: PSE data: Deteriorating Advance-Decline Spread

As can be seen in Figure 7, market breadth has turned deeply negative, but this has been smaller compared again to the earlier bouts of selling seen last January or March.

A bottoming phase would likely show lesser degree (smaller incidences of declining companies) and intensity (smaller number of declining companies during down days) of negative market breadth coupled with stability or improvement in the technical picture.

Figure 8: PSE: Collapsing Average Peso Trade Amidst Rising No. of Trades

And the kicker, as shown in Figure 8, is the surging number of trades (violet) amidst a materially diminishing Peso volume per trade (maroon).

During the earlier bouts of selling (since the second round of credit driven fears emerged in October 2007), the number of trades had been declining as the Phisix headed lower. This basically reflected a retreat of buyers.

However during the past two months we can see a reversal of this pattern, the Phisix persisted towards its downdraft but the number of trades amplified. This apparently reflects FEAR.

In addition, the latest episode of selling shows that the average Peso volume per trade has dramatically weakened. Again the lower volume plus heightened trading activity could possibly indicate fear among small accounts or retail investors!

Usually, the inflection point of any cycle is marked by a shift in ownership. In a bullmarket cycle, the strong hands give way to the weak hands who pushes the market to its maturity or until the pivotal turning point. On the other hand, we should expect the same but an antipodal ownership shift in a bearmarket, where weak hands are expected to give way to the strong hands.

So for our analyst whose wishes appear to have come in full circle, perhaps this could be indicative of the nearing culmination of the bearmarket.