FYI | Aug 10 2007
By Greg Peel
In the mid seventies, a movie called Jaws so terrified the world that many an ardent beach goer irrationally declared they would never go back in the water again. It didn’t matter that the movie depicted the unusual circumstance of one rogue shark.
Last night the European Central Bank startled the world by injecting 95 billion euros into the European banking system. The move came as France’s biggest bank – BNP Paribas – announced it was freezing three hedge funds worth some E3bn. The funds were invested in US subprime mortgage securities. BNP made the move for the simple reason that no one, absolutely no one, is prepared to make a bid for credit securities. Even if BNP’s funds wanted to sell their loss-making positions they cannot. There is no liquidity. No one will go in the water.
It doesn’t matter how long and hard one argues that subprime mortgages represent a small part of the market, and that prime credit securities should be strong while the global economy is strong. Nobody knows right now what price should be put on credit, and no one is going to be the first to find out. The bulls have been forced to concede that despite any good signs, despite any attractive valuations, until this fear has abated sufficiently there is going to be more pain to come.
The ECB injection was the first since, and bigger than, the injection it made after 9/11. Last night the CEO of the US Federal National Mortgage Association – a government-sponsored, publicly-listed and regulation-controlled lender know as Fannie Mae – suggested that we won’t see the bottom of the credit crunch until mid-2008.
The Dow fell 387 points or 2.8%. The S&P fell 3% and the Nasdaq 2%. The BNP Paribas news hit the market before the open prompting a sharp sell-off. Much ground was recovered however, as once again the bulls isolated the impact of simply another hedge fund or two freezing. This is to be expected. But when the ECB acted, it was game over. The Dow closed bang on its lows as the NYSE recorded the highest trading volume in its history. This was the biggest day’s fall since February 27 – the day that the subprime crisis officially came to light after a fall in the Chinese stock market.
The Dow is now down 5.2% from its high. It had been down 5.8% before the mid-correction rally began this week. Conventional wisdom suggests a correction must reach 10% before it can truly be called a correction. And even from that point the next move will not necessarily be up.
It is almost ironic that last night’s developments in Europe sparked a shift back into the US dollar – the currency of the economy that is behind the rot. But the ECB’s move suggested European monetary policy tightening is over, and an easing could well come at the next meeting. As the Fed had indicated two days ago that it would not be cutting interest rates, the logical place for cash to go was back into the greenback. The US ten-year bond yield fell 7bps to 4.79%. In a hastily arranged press conference, President Bush declared there was plenty of liquidity in the system. But the flight to the dollar occurred irrespective of renewed belief that the Fed would also have to drop the cash rate some time soon.
However, the US dollar fell heavily against the yen. Carry trade unwinding was back in full swing. After clawing back to over US$0.86 yesterday, the Aussie fell to just below US$0.85.
US-denominated oil, precious metals and base metals were all hit. In the case of gold, days of quiet graft were dashed as investors once again looked to cash in from whatever they could. Gold fell US$13.00 to US$660.90/oz, crashing through various technical support barriers along the way. Gold traders fear the safe haven metal will suffer further such pressure until the world decides it is the only safe currency available. Oil dropped US56c while nickel led the carnage in the base metals, falling close to 7% in New York. Lead was down 3.5%, zinc 2.5% and copper 1%.
The VIX volatility index jumped a whopping 23% in Chicago. This implies severe panic as traders rush to buy insurance against any further shocks.
It was the US financial sector that had led the market back from the brink this week, and the same sector that was once again rapidly abandoned last night. There is little doubt the Australian financial sector will suffer a similar fate today. The SPI Overnight fell 157 points.
