April 30, 2008

Professor Dennis Snower reminds us on VoxEU that the effects of the credit crisis will be with us for a while, due to influences that both lag and interact:

  • reduced interbank lending leads to less firm & household lending leads to reduced consumption and investment leads to reduced sales of goods and services leads to lower stock market valuations leads to lower interbank liquidity.
  • unpaid mortgages leads to increased foreclosures leads to forced sales leads to lower prices leads to increased foreclosures.
  • decreased household wealth leads to lower consumption leads to lower profits leads to lower investment leads to lower employment lads to lower labour income leads to lower consumption
  • reduced US lending rates leads to a lower dollar leads to higher import prices leads to inflation leads to lower consumption and investment

Cheery fellow, isn’t he?

With respect to lagging effects, a Reuters story picked up by Calculated Risk quotes S&P:

“Due to current market conditions, we are assuming that it will take approximately 15 months to liquidate loans in foreclosure and approximately eight months to liquidate loans categorized as real estate owned (REO),”

The Fed announced:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

You, too, can be a Fed Watcher! According to me, the most telling change from the March 18 Statement is that April is missing the March sentence “However, downside risks to growth remain.” By me, I’d say the Fed’s done cutting. But what do I know? At least the Bear Stearns guy agrees with me. The fear is, as has often been mentioned here, that cuts in the Fed Funds rate are very broad in effect – perhaps too broad, they may be pushing on a string.

Accrued Interest, while careful not to get too precise, thinks that the 2-year note is cheap:

Unless the Fed’s favorite inflation gauges start rising, or the Fed really believes inflation expectations are rising, there will be no impetus for hikes any time in 2008.

Look back at the 2-year Treasury. The long-term spread between short-term inter-bank lending rates and Treasury rates is about 40bps. So if Fed Funds were going to remain at 2.25% for the next 2 years, fair value for the 2-year Treasury would be 1.85%. So with the 2-year actually in the 2.30% range, the market seems to be expecting Fed Funds to average something like 2.70% over the next 2-years.

Feels to me like that expectation is a bit high. If the Fed holds at 2% for 9 months, the Fed would have to hike 112bps immediately thereafter for Funds to average 2.70%. The hike would have to be more extreme if we used a discounting method rather than a straight average.

I’m not sure how much this analysis should be trusted, because the 2-year / FF spread is very sensitive to economics (it would be most interesting to know precisely how good a predictor of future Fed Funds rates the two year note is. I’m sure this has been looked at – post a link in the comments if you have one). AI has been taken to task in the comments …

Meanwhile, Carney said in Ottawa:

We at the Bank project that the Canadian economy will grow by 1.4 per cent this year, 2.4 per cent in 2009, and 3.3 per cent in 2010. The emergence of excess supply in the economy should keep inflation below 2 per cent through 2009. Both core and total inflation are projected to move up to 2 per cent in 2010 as the economy moves back into balance. There are both upside and downside risks to the Bank’s new projection for inflation; these risks appear to be balanced.

In line with this outlook, some further monetary stimulus will likely be required to achieve the inflation target over the medium term. Given the cumulative reduction in the target for the overnight rate of 150 basis points since December, including the 50-basis-point reduction announced last week, the timing of any further monetary stimulus will depend on the evolution of the global economy and domestic demand, and their impact on inflation in Canada.

Month end was no great shakes, with routine volume and few significant price changes. Of note was W.PR.H which, after a day of weakness, fell out of bed completely in the last hour.

And that’s another month! CPD finished the month with the same NAVPS as last month: $17.60, total return zip, zero, zilch. My actively managed fund did much better, returning … somewhere between 0.50% and 1.00% … the precise value, in all its four-decimal-place glory, will be posted on the weekend.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.97% 4.99% 32,868 15.60 2 +0.1017% 1,094.6
Fixed-Floater 4.75% 4.99% 60,265 15.56 8 +0.6986% 1,058.5
Floater 4.48% 4.52% 60,410 16.37 2 +0.0540% 842.1
Op. Retract 4.85% 3.58% 87,432 3.34 15 +0.0304% 1,050.5
Split-Share 5.32% 5.77% 88,929 4.07 14 +0.1218% 1,041.9
Interest Bearing 6.16% 6.27% 60,813 3.85 3 +0.1016% 1,099.5
Perpetual-Premium 5.90% 5.08% 169,348 5.49 7 -0.1055% 1,020.9
Perpetual-Discount 5.72% 5.75% 332,677 13.88 65 -0.0135% 914.0
Major Price Changes
Issue Index Change Notes
W.PR.H PerpetualDiscount -5.1033% Now with a pre-tax bid-YTW of 6.15% based on a bid of 22.50 and a limitMaturity.
CIU.PR.A PerpetualDiscount -1.1294% Now with a pre-tax bid-YTW of 5.57% based on a bid of 21.01 and a limitMaturity.
BAM.PR.N PerpetualDiscount -1.1031% Now with a pre-tax bid-YTW of 6.72% based on a bid of 17.93 and a limitMaturity.
BNA.PR.B SplitShare +1.1673% Asset coverage of just under 2.7:1 as of March 31 according to the company. Now with a pre-tax bid-YTW of 8.04% based on a bid of 20.80 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (6.35% to 2010-9-30) and BNA.PR.C (6.75% to 2019-1-10).
POW.PR.B PerpetualDiscount +1.2876% Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.60 and a limitMaturity.
BCE.PR.C FixFloat +1.2876%  
PWF.PR.F PerpetualDiscount +1.6839% Now with a pre-tax bid-YTW of 5.60% based on a bid of 23.55 and a limitMaturity.
BCE.PR.Z FixFloat +2.4789%  
Volume Highlights
Issue Index Volume Notes
BAM.PR.I OpRet 157,422 Scotia crossed 150,000 at 25.50 just after the opening, then cleaned up with a cross of 5,500 at 25.51. Now with a pre-tax bid-YTW of 5.09% based on a bid of 25.65 and a softMaturity 2013-12-30 at 25.00. Compare with BAM.PR.H (4.94% to 2012-3-30) and BAM.PR.J (5.43% to 2018-3-30).
BMO.PR.J PerpetualDiscount 130,000 Now with a pre-tax bid-YTW of 5.65% based on a bid of 19.95 and a limitMaturity.
RY.PR.H PerpetualDiscount 101,970 New issue settled yesterday. Now with a pre-tax bid-YTW of 5.75% based on a bid of 24.68 and a limitMaturity.
BNA.PR.C SplitShare 50,200 Nesbitt crossed 50,000 at 21.00. See BNA.PR.B in Price Movers, above.
W.PR.H PerpetualDiscount 30,500 See Price Movers, above.

There were sixteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

One Response to “April 30, 2008”

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