Daily Market Reports | Oct 15 2010
By Greg Peel
The Dow fell one point while the S&P fell 0.4% to 1173 and the Nasdaq lost 0.2%.
It is now a matter of history that when the demand for AAA-rated subprime CDOs revved up in the period 2005-07 there were not enough mortgages available. The most disturbing aspect is that when a small few cottoned on to the potential disaster that may lay ahead and began buying CDSs on the CDOs (ie going short subprime), investment banks did whatever they could to create new CDOs to set against CDS demand.
So was born the NINJA mortgage – no income, no job or assets. Mortgage brokers were fraudulently filling in applications for dumbstruck home buyers which included fictitious employment that was never verified. It was a house of cards that had to eventually crumble, and so it did, but it is now coming to light there was another (allegedly) fraudulent step in the whole CDO creation process.
A CDO was made up of three tranches of mortgages – prime, medium-prime and subprime. A typical CDO may be proportioned at 80%, 15% and 5% respectively. Despite the fact default of the 5% proved enough to bring down the 100% in many cases under the CDO structure, it is alleged the banks that were pooling those mortgages for assembly into a CDO were misrepresenting those proportions. In other words, the CDO you just bought may have contained fewer prime mortgages and more subprime mortgages than represented. Clearly that CDO then becomes a lot more risky.
Given most CDOs had maturities of 5 years, plenty of them still actually exist despite being written down to zero by all and sundry. Savvy investors have been quietly buying up this “junk” for mere pennies in the dollar and amassing sizable pools. The intention here is clearly not one of simply hoping the CDOs actually come good – the intention is to sue the creators of the CDOs for fraud. And that includes all of the big banks, and particularly those like BofA and Citi which bought up distressed mortgage lenders after the subprime crisis had hit to add to their own portfolios.
That's why US bank stocks were being slapped about 5% last night. It's not enough that they're already having to deal with imposing moratoria on mortgage foreclosures, because it seems some homes may have been foreclosed on erroneously.
Weekly new jobless claims were also out last night, and they jumped 13,000 when a rise of 1,000 was expected. That's okay – more fuel for QE2. The September producer price index rose 0.4% at the headline due to higher food costs but only 0.1% at the core, which is not enough for the Fed to change its mind.
The August US trade balance blew out 8.8% over July to US$46bn. The Chinese September trade balance released earlier this week showed a reduction in surplus, which eased some of the pressure on Beijing to revalue, but this result, in which the specific US deficit with China blew out from US$25.9bn to US$28bn, will only be another call to grab the torches and pitchforks and meet in the town square.
Perhaps the biggest surprise last night, however, came from the Treasury auction of US$13bn of thirty-year bonds. Demand was quite simply woeful. Just prior to the auction at 1pm, the thirty-year was yielding 3.82%. But when the auction settled at 3.85% there was a selling scramble which saw the yield close the day at 3.92%. Foreign buyers bought only 32% compared to a 37% running average. In sympathy, the ten-year yield jumped seven basis points to 2.51% and is looking increasingly nervous.
In recent months, the spread between the US ten-year and thirty-year maturities has blown out to greater and greater records. That's because the Fed allowed the mortgage (30yr) securities in its portfolio to mature and replaced them with 2-10yrs. If QE2 does eventuate, it will also be concentrated in the 2-10 range. So as that day approaches, it appears bond traders are deciding that this particular rubber band has also stretched too far. Time to get out in case things don't quite go the way they're expected to.
And the US dollar tanked last night, down 0.7% on its index to 76.53. Despite secular weakness, last night's fall was assisted by a “tightening” of monetary policy in Singapore, affected by the Singapore central bank expanding the range of it's peg against the US dollar – a revaluation by any other name. We always point to the Chinese miracle, but Singapore is also booming.
The euro finally reconquered US$1.40 last night – its pre-crisis level. The Canadian dollar reached parity for the first time in six months. And with the US dollar index down 0.7%, one might have expected the Little Aussie Battler might also be waving the parity flag. Not so.
The Aussie is up 0.3 of a cent over 24 hours to US$0.9937. In yesterday's local trade, the forex cowboys gave parity a red hot go, no doubt attempting to trigger stop-loss orders that might be foolishly set at the magic number (word of advice – if you're going to set a stop never set it at a significant number). But like a small child climbing a large tree, the Aussie took a lot at the top and suffered a bit of vertigo. It thus climbed back down a few branches, now breathing deeply and steeling itself for the final assault. Anxiety is heightened by the fact the tree-top is actually in the clouds – no one knows what lies beyond.
Funnily enough, on Wednesday night the US dollar index fell only slightly and gold rallied US$20, while last night the dollar fell significantly and gold managed only a US$8.20 gain to US$1380.60/oz. More vertigo? I'd wager the sellers are ready in ambush in that cloud above US$1400.
And wobbles as well in commodities? Oil was down US19c to US$82.82/bbl while base metals also ticked slightly lower.
The SPI Overnight lost 10 points or 0.2%.
After the NYSE bell, Google reported Q3 earnings of US$7.64ps against expectations of US$6.69ps on revenue of US$5.48bn versus US$5.27bn. Google shares are up 9% in the after-market and the scene is thus set for another strong session on Wall Street tonight.
Aside from the forex cowboys in action, yesterday's push in the Aussie was assisted by a flood of risk-taking money sweeping in across Bondi Beach and straight down to Bridge Street as foreigners sought Aussie big-caps after the strong session on Wall Street. Just don't tell them that an Aussie above parity is bad news for commodity exports and pushes up the funding cost for banks.
It's General Electric night tonight in the US.
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