My Diary 336 --- Grandpa’s Talk, Inflation Risk, Short-Squeezing China and Can Euro Hold on?
October 3, 2007
Higher, Higher and Higher…over the past few days, except for the USD reaching new lows and the housing market showing no signs of a bottom, every other thing went up --- Oil almost touches $84 before backing off, interest rates go up after the Fed cuts and the stock market keeps climbing. In particualr, global stock markets are trying to picturing a story that the US subprime problems and the knock-on impact on credit markets were a distant memory.
I however remain sceptical that the worst is over. Why? 1) The spread of 3M rates over target rates has declined in the US, UK and EU in recent sessions, but remain relative high suggesting continued reluctance to assume counterparty risk. Swap spreads have followed a similar pattern. 2) Volumes of resetting mortgage rates in the subprime mortgage sector in the US over the next 6-12 months are going to be much higher than the last 6 months. 3) Listen to what the Former Fed Chair Greenspan’s warnings against the US recession risks and further concerns on the inflation risk.
Well, there are enough to open up today’s market notes….
Listen to the Grandpa’s Talk
Here we have an grandpa who was the “living god” of Wall Street and partially contributed to the current housing bubble. Former Chairman Alan Greenspan made comments on the US and global economy in London last night. I quote some of his key points for the reference.
Credit crisis --- We're not by any means out of the woods. Continental Europe is still facing significant problems.
US Housing --- House prices are already declining. We can't say how far they will fall before they stabilize. We've had no experience in all the postwar period of anything like this. We're flying blind here.
US Economy --- We may be looking at a decline in overall household wealth in the fourth quarter, but also in the third quarter. This is a significant threat to the economic outlook. We are already experiencing a slowing rate of growth.
Stock Markets --- The fact that the market hit a recent high is utterly irrelevant. Markets are essentially discounting the fact that the credit crunch is over.
Money Supply --- Milton Friedman was right when he said that in the end inflation is a monetary issue. The problem is that the money data the Fed had was subject to major distortions.
On Housing Bubbles ---The bubbles that exist now in housing are in more than two dozen countries. They're all caused by the same thing: a decline in mortgage rates and a decline in long-term rates.
Even by eyescanning his comments, I believe ppl can easily pick up his concerns over the biggger than expected housing bubbles and the hanging-over impact of recent credit crunch... Maybe the stock market shouldn’t feel so high....
Inflation: A Problem or Not
After the 50 bps Fed cut, the stock market has rejoiced, but the bonds came out in different story. Looking back to the histroy, the last 3 times when the Fed initiated a new easing cycle, 10yr yields typically dropped 20bps or more in the next 5 days, while this time they rose by 20 bps. Clearly, the bond market is worried about inflation, or worse – stagflation.
But, will 70s replay? I think the answer is largely NO and the reason is simple --- inflation should not be a problem in a recession, and certainly one caused by the bursting of the largest housing bubble in US history. Be definition, those are deflationary events. In fact, what we saw over the week is anything related to housing is weak. New home sales, pending home sales, home prices are all falling and showing no signs of settling down anytime soon.
In addition, the core PCE (the Fed's preferred measure of inflation) dropped below 2% for the first time in a long time, down to 1.8%. The Dallas Fed uses its own version of the PCE, called the trimmed PCE (which includes food and energy), which shows inflation is now edging down below 2%. That being said, the bond market must be worrying about something else and I think part of the answer lies in the energy and commodities prices, inluding oils, metals, graind and softs, which have been sitting on their heights for quiet a long time. That being said, inflation maynot be a problem now, but you can't rule it out, and granted we were seeing a slowing in productivity growth as data outside the housing sector is generaly OK.
Short-Squeezing China
Without the A-shares, H-shares definitely have caught all the spotlights this week. After adding more than 1000 ppt yesterday, the HSI index was up 500pts in this morning, however, it did not last longer. Just after I digested my lunch, the HSI Index slid 720, or 2.55% to 27479 from its record close of 28199.75 yesterday.
HK stocks fell on concern a surge to a record had overvalued company earnings prospects. Including China Mobile and HKEx, most of the HSI’s best performers in the past month lost their steams and SHK Properties, Hong Kong's biggest developer by market CAP, slumped the most in six years on speculation the company will sell shares in itself. HSCEI Index, which measures 43 Chinese companies, slumped 3.2% too.
A piece of market comment made by JPMorgan’s Chinese Strategist Frank Gong has several points I want to highlight here regarding the so-called “short-squeeze China” --- 1) The re-rating anticipated for the next 9 months has been quickly accomplished in just ONE month time; 2) mainly driven by the hedge fund community, especially global macro funds in particular, in anticipation of the big QDII and DII inflows into the H-shares/Red-chips and HK/China (The "Short-squeezing China" mentelity); 3) Real money has been mostly seating on the hands and has not been chasing the market.
Now. an interesting question being raised is can global investors and hedge funds really be able to short-squeeze China? Certainly, Frank says NO and reminds us -- “remember China has the policy control, if they want to see a correction in HK, a correction can happen if something in China forced the A-shares to correct sharply...with the party congress coming and then the NPC leadership changes in March 08, global investors should not ignore the event & A-shares risks in China.” ... So in short, we maynot see another George Solos in the next 6 -12 months defeating the Chinese Government....:)
Can Euro Hold on?
The Euro was introduced January 1, 1999 and had a value of $1.19. It promptly started falling and reached a low of around $.82 shortly before the end of 1999. In fact, if you view it from the introduction in 1999, that is only about a 20% move in almost nine years for the currency to close at 1.4179 USD today.
It is quite interestinglt to think about -- can Euro hold on at this level as the speed in the slowdown in European growth has been surprising considering the weaker survey data seen of late. Although one could argue the data was coming down from very high levels. Certainly European growth looks set to slow further and the decoupling story could really be an exaggeration as European rates have never not followed US rates in such a slowdown. Will it really be different this time? With nothing priced into Europe and the US rates having nearly 100bp through the peak in yields, there is a weighty presumption European growth will hold up well. Moreover, inflation and oil though make lower ECB rates an impossibility for the ECB at present
However, more weak Eurozone data are coming. Today, German PMI had its sharpest drop in 10yrs during September, implying the credit crunch appears to have affected Germany the worst, unsurprising as this was a focal point for credit casualties. While the employment component held up well though, but the trend in the data is looking more convincing.
Bottom-line: whilst I don’t think Eurozone growth is about to fall off a cliff, this does give some concern for EURUSD, although the USD side is arguably the bigger driver of the currency cross at present.
Good night, my dear friends
