Saxo 10 October. The equity slide continued almost unabated yesterday - even accelerating, and the fallout continued to boost the lower yielders and hit especially EM currencies the hardest. The Mexican Peso is in ruins again and the Eastern European currencies felt an acceleration in selling pressure yesterday as trading in the Hungarian bond market broken down - with effectively no buyers showing up at an auction of 10-year government paper. In G-10 land, the moves were actually relatively muted in JPY crosses compared to recent degrees of volatility, and we can't help but wonder if the BoJ is walking softly and carrying a big bid in places to stem the kind of carnage we've seen over the last week or two. CHF was especially on the bid yesterday, possibly due to the Eastern Europe fall-out and EURCHF slammed 2% lower from yesterday's highs. 1.5000 would appear to be the next support level, though technical levels don't seem to have much viability as long as we are in freefall across markets. In general, it appears that the moves within the G-7 are pointing to easing pressures relative to the moves in equity markets, meaning that some kind of reversal in the situation is nearing - though we're certainly not gambling types in this environment.
Key today will be the Lehman CDS settlement (in which all the bets placed in the CDS market on whether Lehman would go bankrupt must be settled). This will be nearly as large as the one related to Fannie and Freddie (which took place just this Monday) - on the order of $350-400 billion. With these settlements, an enormous amount of cash changes hands - cash that must be raised in this market environment if it is not already on hand, which it probably isn't in many cases. The only market functioning properly right now is in equities, so the need to raise funds for these settlements may be one reason for the liquidation going on (others being real and anticipated redemptions in the pipeline for mutual funds and hedge funds). The initial recovery price for the Lehman settlement will be published around 1330 GMTand then a competitive bidding process then the final price for the settlement is established around 1700 GMT. The times are to the best of our knowledge - stay tuned to this story as it is very important and these times may be wrong or could change. The additional layer of worry here is that Morgan Stanley seems to be threatened by a meltdown as well and the world probably doesn't feel it can deal with another Lehman-like blowup. After the lessons of Lehman, we feel that it is unlikely that the Morgan would be allowed to fail by the authorities - still follow the Morgan Stanley situation closely.
Here's the potentially positive spin on the Lehman settlement, if we are to find anything positive in this market: the CDS settlement itself is a zero-sum game, but when it is over, the "winning " side has hundreds of billions of dollars in its hands to plow into something - so the subsequent bounce could be very large if we also get a break in the clouds at least temporarily on the credit market front.
On the policy response front, the response is still lagging the bloodletting going on in markets and the authorities are still behind the curve. It is vital that the G-7 this weekend roll out some serious shock and awe this weekend and stop the pattern of the market simply pushing them to respond in piecemeal, serial fashion. A coordinated action is absolutely mandatory and will almost inevitably take place this weekend with the markets going into the worst nosedive since the 1987. Apparently, the UK bank rescue plan is being circulated as a model for possible copying by the US and elsewhere and the US treasury may also be looking at guaranteeing all deposits at least temporarily to stem any panic runs on banks. The other coordinated measure that is possible is global coordinated guarantees on interbank lending, which could get those all important Libor rates to finally begin to ease - finally giving the world a needed de facto rate ease (or at least a cessation of the credit tightening - so much of world lending is linked to Libor rather than CB rates....) on top of the feeble attempts to cut CB rates.
The fall-out from a the last couple of weeks is fearsome contemplate at the moment as this situation has become outright scary in an almost physical sense, but the real economy effects of this will be significant - and possibly more significant will be the policy responses in the aftermath of this crisis around the world going forward - these are huge - we are seeing a complete paradigm shift and we won't go back to the way things were before. This will mean opportunities and dangers for the new paradigm that eventually takes over. The dangers are that some of the countries that find their economies in ruins in the wake of this storm will turn back to the insular kinds of reactions we saw in the 1930's depression era - but we'll save those worries for now for later discussion. For now, emergency care is necessary to keep markets afloat and we need to hope that the authorities can provide this care in time. Do the right thing, G-7!
In a crash environment, it is important to realize that while we know some kind of short-term cyclical low is near in a time sense, we cannot know with any remote degree of accuracy where the low will arrive in a price sense - but the short term bounce from wherever that climax low occurs could be absolutely head-spinning, so keep leverage reasonable regardless, realizing that 25% of the leverage employed last year still might leave you more than 2 x more exposed to markets than you were back then.
Stay very very careful out there and let's hope this ship rights itself soon.
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