PrefBlog

Accrued Interest presents the case in favour of (US Corporate) fixed income, on the grounds that yield spreads are recessionary; stock prices ain’t. He is severely criticized for this view in the comments, but I think there is a certain amount of truth in his argument. It’s not conclusive … but it’s a piece of evidence.

Michael Woodford of Columbia University wrote a very thoughtful piece on VoxEU, discussing the Fed’s new communications strategy. This new policy was released on November 14:

In the future, the FOMC will compile and release projections four times each year rather than twice a year. In addition, the projection horizon will be extended to three years, from two. FOMC meeting participants will now provide projections for overall personal consumption expenditures (PCE) inflation, as well as for real gross domestic product (GDP) growth, the unemployment rate, and core PCE inflation. Projections of nominal GDP growth will be discontinued. Summaries and explanations of the projections will be published along with the minutes of the FOMC meeting at which they were discussed. These descriptions will provide a fuller discussion of the projections, covering not only the outcomes that most meeting participants see as most likely, but also the risks to the economic outlook and the dispersion of views among policymakers.

Prof. Woodford poses the question:

The commitment [by many central banks] to justify policy to the public in this way increases public understanding of the policy, and so should improve the public’s ability to correctly anticipate the future conduct of policy, increasing the effectiveness of policy. It also serves the goal of making the central bank more accountable, which provides democratic legitimacy for the central bank’s grant of operational independence. And finally, it can improve policy itself, by providing a check on possible temptations to base policy purely on short-run considerations, losing sight of whether policy remains consistent with the bank’s medium-run objectives.

Does the Fed’s commitment to release additional projections, and additional discussion of those projections, serve a similar function?

He concludes:

So the Fed has not yet taken too great a step toward implementation of inflation targeting in the U.S. (This is likely to come both as a relief to some and as a disappointment to others.) Does the new policy matter at all?

I think that it will make a difference, but not primarily to the degree to which outsiders are better able to understand or predict Fed policy, in the first instance. Rather, the most important consequence of the new strategy, in the short run, will be for the Fed’s own deliberations. Requiring the members of the FOMC to consciously consider the way in which the economy is likely to evolve over the next several years, and the nature of appropriate policy not just in the short run, but also over the next several years, is likely to increase the extent to which policy decisions are considered as part of a coherent strategy rather than as a sequence of unrelated decisions. Encouraging them to discuss with one another the extent to which their forecasts differ and why will facilitate the development of a shared understanding of what a sensible strategy would be like. And pressing them to consider the reasons for the changes in their forecasts from one release to the next should ultimately favour the maintenance of consistency over time in the way that policy is approached.

Prof. Woodward’s analysis makes a lot of sense but, while he mentions the issue of central bank independence, he does not address the fact that such projections will help to defend such independence. Such a formalized methodology of explaining the central bank’s decisions will serve to pre-empt political criticism … if a politician says that rates have to come down because unemployment’s up and inflation’s not a worry, there will already be a projection on the table that he will have to address.

There has, for instance, been considerable tension between Sarkozy and the ECB:

Trichet has refused to heed Sarkozy’s call for the ECB to follow the Federal Reserve and cut its benchmark interest rate from a six-year high of 4 percent. Inflation accelerated to 2.6 percent in October, the fastest pace in two years, and the price of oil yesterday rose above $96 per barrel for the first time.

It’s best to nip such tension in the bud by giving political reporters a known source of independent projections and justifications.

Those who hate the Credit Rating Agencies will be overjoyed to learn (hat tip: Financial Webring Forum) that they are firing staff:

DBRS Ltd., the Canadian ratings company, closed its European offices and cut about a quarter of its workforce because of a slump in credit markets.

The offices in Frankfurt, Paris and London closed and 43 European employees were fired, said spokeswoman Caroline Creighton. DBRS also cut jobs in North America, reducing its overall staff to about 200 people, from 270.
…
DBRS joins Moody’s Corp., the second-biggest credit-ratings company, in trimming its workforce because of the decline in credit markets and reduced demand for ratings on mortgage-backed securities and other debt. New York-based Moody’s said yesterday it plans to cut about 275 jobs, or 7.5 percent of its employees.

It’s noteworthy that the number of jobs Moody’s cut is greater than the number of jobs DBRS has. Is it any wonder that DBRS is the weak sister among the major agencies?

Not the most exciting of all possible days on the preferred share market, unless you’re subject to margin calls on your BCE.PR.B position! Volume picked up a little with a few good crosses going through and perpetuals ground out another win. Yesterday’s frothy correspondent clarified the view … projecting that a P1 would have to offer at least 5.50% to get a deal done given that demand for perpetuals is still shallow and that there should be a lot of corporate bond issuance this month.

Well, as my more Assiduous Readers will have come to expect by now … I dunno! I think that, regardless of what will happen to spreads in the coming months, spreads are now attractive … and I LOVE trading in frothy market!

One of the first things you learn as an investment counsellor is to be humble. Don’t boast about your great trade, because it jinxes your monthly return. Don’t boast about the monthly return … don’t boast about the yearly return. The market has a way of making you look like an idiot. So I won’t boast, I’ll just point out that I’ve updated Malachite Aggressive Preferred Fund‘s fourth quarter annualized return.

There were eleven other index-included $25.00-equivalent issues trading over 10,000 shares today.

I received an eMail from an Assiduous Reader today, asking whether I agreed that the pref market was looking rather frothy.

Well – I agree it’s frothy, in that there are huge discrepencies between issues – it’s not too difficult to pick pairs of issues where one is as obviously expensive as the other is cheap. However, “frothy” has a connotation of “toppy”, and I’m not so sure that I agree with the word as far as that goes. Having a look at the four bellwether indices:

Toppy? It looks more as if the bad dream of the fourth quarter has faded like gossamer … one might be able to make the case that the OpRet Index is toppy, since there’s not much interest-equivalent premium to bonds … but PerpetualDiscounts still have an average pre-tax bid-YTW of 5.49 … interest-equivalent of 7.69% … long corporates are a shade over 5.6%, according to Canadian Bond Indices …. this is within spitting distance of the October 30 spread.

Meanwhile, long Canadas yield 4.04% (!) for an interest-equivalent spread of about 365bp – this has widened considerably since this was checked on October 10.

So, as with all market-timing type questions, I will respond … “You’re asking me?”

Volume picked up slightly, but not much, on another good day. BNA.PR.C was astounding.

There were seven other index-included $25.00-equivalent issues trading over 10,000 shares today.

There’s a real dearth of news and informed commentary today!

The US had a bad jobs number today, but that’s about it.

Otherwise, the only thing I saw today of even passing interest was Springfield, Massachusetts, getting angry at Merrill because some sub-prime linked CDOs that they bought have gone down in price. According to Steven Syre of the Boston Globe:

City officials say Merrill Lynch, an active player in the municipal finance business, sold them securities that cities in Massachusetts aren’t legally allowed to own for reasons of safety and liquidity. What the broker actually disclosed about the nature of those investments at the time of the sale remains murky.

“We take very seriously the financial cost and the breach of public interest,” said Chris Gabrielli, the chairman of Springfield’s Finance Control Board and former gubernatorial candidate. “Our view is that Merrill Lynch has responsibility here and is accountable. We shouldn’t have to settle for less than getting the money back.”

A Merrill spokesman said Springfield officials had sought AAA-rated securities offering higher returns than they had been getting. “These investments met both those criteria, and each was reviewed, approved, and authorized by Springfield officials.”

Who knows? It is possible, I suppose, that Merrill misrepresented the investment. I consider it far more likely that a few snivel-servants with Springfield were just thrilled to pieces about being big-shot hard-nosed investment geniuses, until they got to the “taking responsibility” part. We’ll see!

An excruciatingly slow day on the preferred share market, but performance continued to be good.

There were three other index-included $25.00-equivalent issues trading over 10,000 shares today.

Here’s a switch! US ABCP outstanding actually increased last week, from USD 747.6-billion to USD 773.8-billion. It has been suggested that the market is stabilizing … but I’ll wait for a little more data, not taken at year-end in the midst of an enormous liquidity injection, before celebrating.

An article on the collapse of the Bear Stearns hedge funds provides some food for thought:

Some 90 percent of the face value of the CDOs was loaned to Bear by Merrill, as is normal in such transactions. When the prices of the funds’ CDO holdings started to fall in June, Merrill demanded that the firm increase collateral in what’s known in the debt markets as a margin call.

Bear Stearns executives pleaded for time, arguing that the forced sale of their assets would push down all CDO prices. Merrill Lynch officials brushed off the entreaty, according to people involved in the discussions.

In June, the hedge funds, run by Ralph Cioffi, sold $3.8 billion of CDOs to meet margin calls by Merrill and other lenders that were following its lead. The fire sale led to a further drop in CDO prices.

Whenever this sort of thing has happened in the past, regulators have responded by tightening margin requirements. Perhaps derivative debt should be eligible for only 15% margin; perhaps 20%. I suspect we will be hearing a lot more about this over the next while. There will be definitional problems, to be sure!

In what may well turn out to be a sign of the times, there was a US junk bond default today:

Buffets, a closely held company based in Eagan, Minnesota, failed to make the coupon payment yesterday on its 12.5 percent notes maturing in 2014, according to Matthew Lee, a customer service representative at U.S. Bank National Association in St. Paul, Minnesota, the trustee for the debt.

Buffets is at least the second company to miss an interest payment in the past week as the worst home sales market since 1981 stokes concern about a slowing economy. Tousa Inc., the Florida homebuilder that lost 99 percent of its market value in the past year, also missed interest payments on $485 million in debt, the company said in a regulatory filing yesterday.
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The 12 month dollar-weighted high-yield default rate will rise to 2.25 percent by the end of this year from 0.34 percent in December, JPMorgan Chase & Co. high-yield strategist Peter Acciavatti in New York predicted in a report dated yesterday. The rate will climb to 4 percent by year-end 2009, he forecast.

And finally, Accrued Interest reminds us of what “crisis” really means:

In my mind, a marriage in crisis is one where divorce is an imminent possibility. Not one where the couple just had a big ugly fight.
…
So back to the “crisis” question. It is these speculators who are insolvent. So what we have are people who speculated in houses and lost. We have are banks who lent to the afore mentioned speculators and have lost too. Bear in mind, these banks are the ones who agreed to limited documentation of income (perhaps so the speculator could claim this would be his/her primary residence?) or minimal down payments.
…
All this isn’t a crisis. Its how the credit cycle works. When credit becomes too easy, bad loans get made. People get hurt. But that’s the way of the world. You move on.

Where a crisis could develop is when the innocent are hurt just because capital becomes tight. Where a good borrower can’t get a mortgage loan. Where a solid commercial real estate project can’t roll over its bridge loan because banks are short on capital. That’s where the real crisis can get going. Foreclosures happen that didn’t need to happen, driving the price of assets lower. Lenders start taking losses on good loans, and suddenly are unwilling to lend to anyone. Investors struggle to value assets, not because of unknown losses, but because of unknown liquidity. Bids dissappear.

That’s a crisis.

Meanwhile, President Bush is contemplating fiscal stimulus. Some might say there is far too much fiscal stimulus already.

Another day of light volume and strong returns for preferreds. It should be most interesting to see whether the returns stand up next week when I assume volume will return … particularly with stocks looking sick in Japan and the US.

There were five other index-included $25.00-equivalent issues trading over 10,000 shares today.

Accrued Interest leads off with a very informative discussion of American Municipal Bond Insurance, something that is in the news lately, what with credit problems and Berkshire Hathaway’s entry to the field.

A very light day on the preferred share market, but performance was good.

There were five other index-included $25.00-equivalent issues trading over 10,000 shares today.