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Friday, November 30, 2007

High on Rate Cut Euphoria, Again

The market is high on rate cut euphoria again. The broader equity markets have strung together an impressive winning streak this week… Time to get short again.

Three-Month Libor for Euros Soars to 6 1/2-Year High, BBA Says: “The cost of borrowing euros for three months rose to the highest since May 2001, according to the British Bankers' Association.

The London interbank offered rate, the amount banks charge each other for such loans, rose 3 basis points to 4.81 percent, its 13th straight day of gains.

That's 81 basis points more than the European Central Bank's benchmark rate, the biggest gap ever.

The overnight euro rate rose for a second day, up 9 basis points to 4.08 percent, the BBA said today.”

That does not bode well for the equity markets in longer term. Libor rates are signaling that the financial system is under severe strain DESPITE massive injections of liquidity to date. Economic growth will almost certainly drop SIGNIFICANTLY in the near future.

ECB Takes More Steps to Counter Money-Market Tensions (Update3): “The European Central Bank took additional steps to calm money markets after the cost of borrowing in euros for a month rose to a six-year high.

The ECB will extend the maturity of its regular refinancing operation settling on Dec. 19 to two weeks from one, the Frankfurt-based central bank said in an e-mailed statement today. The operation will mature on Jan. 4 instead of Dec. 28. The ECB Governing Council, meeting via teleconference yesterday, decided the extra measure was necessary to “satisfy the banking sector's liquidity needs” for the holiday period over Christmas and the end of the year.

The move comes a day after the Bank of England said it will offer commercial banks emergency funds with longer repayment terms because of the risk that money markets will “tighten” at year- end. The U.S. Federal Reserve has also pledged to provide extra cash through a series of repurchase agreements into next year. Fallout from losses on U.S. subprime mortgages has made banks reluctant to lend to each other, pushing up credit costs.”

Paulson, Banks in Talks to Stem Surge in Foreclosures (Update1): “U.S. Treasury Secretary Henry Paulson is negotiating an agreement with banks to stem a surge in foreclosures by fixing interest rates on loans to subprime borrowers, according to people familiar with a meeting he led yesterday.

The Bush administration cut its forecast for economic growth yesterday, reflecting a deepening housing recession that's roiled financial markets since August. The Commerce Department reported the same day that the median price of a new house fell 13 percent in October from a year earlier, while fewer homes were sold than economists anticipated.”

The proposal is to ‘fix’ rates for 3 years, then allow the resets to occur. This does nothing but postpone the necessary price corrections. If you couldn’t afford a reset now, you won’t be able to afford the reset rate 3 years from now. End of story.

“Bair has proposed letting borrowers with adjustable-rate subprime mortgages, who are living in their homes and unable to afford resets, get extensions on the starter rate for at least five years. They could also be offered 30-year fixed-rate loans. Reich prefers a three-year freeze.

The rout will get worse because defaults on home loans are likely to rise, analysts said. The FDIC estimates that 1.54 million nonprime mortgages valued at $331 billion will reset by the end of next year.”

Stalling won’t solve the problem.

Bernanke Says Fed to Judge Market `Turbulence' Impact (Update2): “Federal Reserve Chairman Ben S. Bernanke said “renewed turbulence” in markets may have shifted the risks between growth and inflation, cementing speculation the central bank will lower interest rates as soon as next month.”

The cuts had already been priced in prior to this speech and even prior to the speech given by Kohn. This was nothing new.

Thursday, November 29, 2007

Oil Surges After Pipeline Explosion

Oil Surges After Enbridge Pipeline Explosion Cuts U.S. Supplies: “Oil surged more than $4 a barrel, the most in a month, after an explosion cut Canadian oil shipments through Enbridge Inc. pipelines that typically provide about 15 percent of U.S. crude imports.

Enbridge closed four pipelines that supply an average of 1.5 million barrels a day after a blast yesterday killed two workers. The company said today a fire is still burning at the Clearbrook terminal in Minnesota where the pipelines meet.

“It's an important pipeline and it's also where it's being hit, these pipeline junctions are a nightmare,'' said Rob Laughlin, a senior broker at MF Global Ltd. in London. Oil “could go up further if it's shut for some time.””

As of 7:00 AM this morning, two of the four lines have been re-opened. Crude has given back some of the gains.

““All our lines are shut down until we can safely start up the system,” Denise Hamsher, a spokeswoman for Calgary-based Enbridge, said today by telephone. “At least one or two lines will be shut down for quite sometime.”

The leak and explosion occurred at the No. 3 pipeline, which was undergoing maintenance, according to Enbridge.

U.S. refineries operated at 89.4 percent of capacity, the highest since the week ended Sept. 14, the energy department said. Refiners usually start in November units that were shut during the previous two months for repairs after the summer driving season ends and before demand for heating oil picks up.

OPEC has no plan to raise oil output when it meets next week in Abu Dhabi because the market is well supplied, Qatar's oil minister said yesterday.”

There isn’t much slack in the system here. With pipeline troubles, even an OPEC production hike wouldn’t matter in the least.

Wednesday, November 28, 2007

Just Another Short Covering Rally

U.S. Stocks Stage Biggest Two-Day Rally Since 2002; Banks Gain: “U.S. stocks staged the biggest two- day rally in five years, led by financial shares, after Federal Reserve Vice Chairman Donald Kohn buttressed expectations for another interest rate cut.

Citigroup Inc., Lehman Brothers Holdings Inc., Morgan Stanley and Goldman Sachs Group Inc. rose more than 5 percent as banks and brokerages in the Standard & Poor's 500 Index gained the most since 2002. EBay Inc. and Inc. helped push the Nasdaq Composite Index to a 3.2 percent gain after Sanford C. Bernstein & Co. forecast a “strong” fourth quarter for both.

“Kohn's comments just add to a perception that the Fed is embarking on a sustained path of easing,” said Michael Metz, the New York-based chief investment strategist at Oppenheimer Holdings Inc., which manages $60 billion. “There's also huge relief that the worst of the financial crisis may be behind us.””

It’s a little crazy to think the Fed would cut by 50 basis points in December…

“Traders boosted wagers that the Fed will cut its benchmark lending rate when it meets Dec. 11. Odds of a half-point cut rose to 8 percent today from 2 percent yesterday, while the likelihood of a reduction of any size remained 100 percent.”

A 50 basis point cut would destroy the US dollar, spike oil over $100 and send gold to $1000. Far more probably is a 25 basis point cut and a 50 basis point cut in the discount window to narrow that spread still further.

Kohn Sees Risk of Reduced Credit From Market Upheaval (Update7): “Federal Reserve Vice Chairman Donald Kohn said market “turbulence” may reduce credit to businesses and consumers, reinforcing investors' expectations the central bank will cut interest rates again next month.

“The degree of deterioration that has happened over the last couple of weeks is not something that I personally anticipated,” Kohn said in response to a question following a speech to the Council on Foreign Relations in New York. “We are going to have to take a look at'' the stress in credit markets “when we meet in a couple of weeks,” he said.”

It was Kohn speech that prompted traders to increase their bets on a 50 basis point cut in December. This in turn burned the shorts who scrambled to get out of their positions in financials.

U.S. Economy: Home Sales Slide More Than Forecast; Durable Order Decline (Update5): “Sales of previously owned U.S. homes fell more than forecast in October and orders for cars, planes and other durable goods dropped for a third month, the longest slump in 3 1/2 years.

The figures came as Federal Reserve Vice Chairman Donald Kohn signaled he's open to lowering interest rates again given “the degree of deterioration” in financial markets. Stocks rose as Kohn's remarks cemented forecasts for a rate cut next month to help keep the economy from sliding into recession.

Falling “consumer confidence and the slowing in capital- goods orders does bring us closer to recession,” said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. “I take Kohn's remarks as a good sign that the Fed is looking at the credit market issues, as well as the economic data, and deciding to react.”

… and the market melted up. There may have been some bargain hunting. That much is for sure. The rest however, was pure short covering.

Tuesday, November 27, 2007

Citigroup Raises $7.5 Billion

Citigroup to Raise $7.5 Billion From Abu Dhabi State (Update2): “Citigroup Inc., the biggest U.S. bank by assets, will receive a $7.5 billion cash infusion from Abu Dhabi to replenish capital after record mortgage losses.”

This might be the catalyst to give the financials a little bit of a relief pop.

“With the purchase of a 4.9 percent stake, Abu Dhabi, the largest emirate in the United Arab Emirates, would rank as Citigroup's largest shareholder ahead of Los Angeles-based Capital Group Cos. and Saudi billionaire Prince Alwaleed bin Talal, data compiled by Bloomberg show.

Mortgage writedowns cut Citigroup's “tier 1” ratio, a metric used to assess banks' ability to weather loan losses, to 7.3 percent on Sept. 30. The figure, while above U.S. regulators' 6 percent threshold for a “well-capitalized” bank, was below the bank's 7.5 percent target.

The Citigroup equity units that ADIA will purchase can be swapped for as many as 235.6 million shares starting in 2010. The securities will convert into Citigroup shares at prices ranging from $31.83 to $37.24 between March 15, 2010 and Sept. 15, 2011. Citigroup fell to $29.80 in New York Stock Exchange composite trading yesterday, the lowest price in five years, and traded in Germany at $31.51.

“The structure of the deal suggests that Abu Dhabi is very bullish, effectively participating in the upside beyond $37.24, and sharing in the downside below $31.83,” said George Nikas, who helps manage $1 billion at Deutsche Bank AG in Sydney.

Abu Dhabi will have “no role in the management or governance of Citi, including no right to designate a member” of the company's board, Citigroup said in its statement.”

If the markets can’t build a little bit of positive momentum on this, then that would be a bad sign indeed.

Citigroup Plans Cost Cuts After Mortgage Writedowns (Update1): “Citigroup Inc., the largest U.S. bank, is reviewing ways to cut costs as it seeks a new chief executive officer and grapples with mortgage writedowns that may lead to the first quarterly loss since at least 1998.

Citigroup may cut as many as 45,000 jobs in the next two months, CNBC reported earlier today, citing unidentified people within the company. CNBC also said the bank had “no timetable or set numbers” for the cuts. Citigroup spokeswoman Pretto said “any reports on specific numbers are not factual.””

Maybe the combination of a cash infusion and job cuts can breathe some life into Citigroup for a little while.

U.S. Notes Fall; Citigroup Equity Sale Cuts Demand for Safety: “Treasury two-year notes fell the most in almost a month after Abu Dhabi agreed to invest $7.5 billion in Citigroup Inc. and the Federal Reserve pledged funds needed to avoid a year-end shortage of capital.

The promises calmed investors who drove two-year yields to 2.87 percent yesterday, the lowest since December 2004. The Fed said yesterday it will provide funds to the money markets, while the Citigroup purchase may help the world's biggest bank replenish capital hurt by subprime mortgage-related writedowns.

“The buying pressure on Treasuries has gone away,” said Christoph Kind, a Frankfurt-based fund manager at Frankfurt Trust Investment GmbH, which manages about $9 billion in fixed- income assets. “The news about Citigroup restored confidence a little. There's more value left in other bond markets.”

The “TED” spread, or the difference between three-month bill yields and the London interbank offered rate, narrowed 1 basis point to 1.94 percentage points, still near the widest since Aug. 20. The decline indicates easing willingness among banks to lend to each other. Three-month Libor still rose for a 10th day today to 5.06 percent, the highest in four weeks, the British Bankers' Association said today.”

Yen Declines as Citigroup Stake Sale Revives Carry-Trade Demand: “The yen fell against the world's 16 most-active currencies after Abu Dhabi said it will buy a stake in Citigroup Inc., giving investors confidence to buy higher yielding assets with loans from Japan.

The yen declined the most in two weeks against the dollar after the biggest U.S. bank announced the $7.5 billion cash infusion, which will shore up its capital following record losses related to subprime mortgages. The yen dropped the most against the New Zealand and Australian dollars, favorites of so-called carry trades. The dollar rose versus the euro and the U.K. pound.

“The market has taken this as a positive sign that there is funding out there for these banks should they need it,” said Daragh Maher, London-based senior currency strategist at Calyon, the investment-banking arm of Credit Agricole SA. “This has reduced some of the strain and given carry-trade investors a boost in what is clearly a very jumpy environment.””

Monday, November 26, 2007

The First SIV Goes On Balance Sheet

HSBC Will Take on $45 Billion of Assets From Two SIVs (Update2): “HSBC Holdings Plc, Europe's largest bank, will add $45 billion of assets to its balance sheet by consolidating two structured investment vehicles it manages.

Investors in the SIVs will be able to exchange their holdings for debt issued by a new company, backed by loans from HSBC, the London-based bank said in a statement. HSBC doesn't expect any “material impact'' on its earnings or capital strength, according to the statement.

HSBC's decision reduces the worldwide assets in SIVs as U.S. lenders led by Bank of America Corp. seek to persuade competitors to help finance an $80 billion bailout of the companies. HSBC's Cullinan Finance Ltd. and Asscher Finance Ltd. have more than $34 billion of senior debt, making it the second-largest bank sponsor of SIVs after Citigroup Inc.”

How taking onto your balance sheet an unexpected $45 billion isn’t going to have a ‘material impact’ is beyond me.

Bank of America Takes Lead in Backing `SuperSIV' Fund (Update1): “Bank of America Corp., the nation's second-largest bank, will lead efforts by Citigroup Inc. and JPMorgan Chase & Co. to convince smaller competitors to help finance an $80 billion bailout of short-term debt markets.

The campaign starts this week with New York-based Citigroup and JPMorgan in supporting roles to Charlotte, North Carolina- based Bank of America, said two people with knowledge of the matter, who didn't want to comment publicly before the plan is formally announced.

The “SuperSIV” fund, backed by U.S. Treasury Secretary Henry Paulson, would buy assets from so-called structured investment vehicles, whose $300 billion of holdings include corporate and mortgage debt in danger of default. Analysts including Richard Bove of Punk Ziegel & Co. have criticized the proposal because it may saddle new participants with losses created by their bigger rivals.

``Why should we put something on our balance sheet that is going to result in further writedowns?'' is how most contributors will respond, Bove said in an interview. ``The job of the Treasury isn't to go out and defraud investors.''

Bank of America, Citigroup and JPMorgan, the three largest U.S. banks, want SuperSIV in place by year-end because some SIVs haven't been able to trade, people familiar with the fund said. BlackRock Inc., the biggest publicly traded U.S. money manager, probably will manage the fund, said a person with knowledge of the plan.”

Bad ideas are hard to kill. With HSBC moving their SIV assets onto their own balance sheet, the likelihood of the Super SIV ever seeing the light of day is greatly reduced.

Northern Rock Favors Virgin Offer; Treasury Approves (Update3): “Northern Rock Plc, the U.K. mortgage lender bailed out by the Bank of England two months ago, said the government backed Richard Branson's Virgin Group Ltd. as the preferred bidder for the company.

Northern Rock rose as much 57 percent in London trading after saying today in a statement that Virgin offered an immediate repayment of 11 billion pounds ($22.7 billion) toward about 25 billion pounds lent by the central bank. Virgin would also inject 1.3 billion pounds into Northern Rock, half funded by new shares offered at 25 pence each to existing holders.

“It's an indicative proposal and not an offer, and could leave the door open to a counter-bid,'' said Simon Willis, a London-based analyst at NCB Stockbrokers. “That's why I can see the shares trading higher.””

An acquisition by Virgin at these prices would definitely act as a catalyst for a short lived ‘relief’ rally in the broader indices.