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Tuesday, May 20, 2008

ZEW Hits Record Lows, LIBOR Woes Hurting Eurodollar

Just another 15 year record low…

German Investor Confidence Unexpectedly Fell in May (Update3): “Investor confidence in Germany unexpectedly fell for a second month in May on concern faster inflation, the stronger euro and fallout from the U.S. housing slump will hurt economic growth.

The ZEW Center for European Economic Research said its index of investor and analyst expectations declined to minus 41.4 from minus 40.7 in April. Economists expected a gain to minus 37, according to the median of 41 forecasts in a Bloomberg News survey. The gauge reached a 15-year low of minus 41.6 in January. A negative reading means that pessimists outnumber optimists.”

In case you live in a cave and missed it, this actually correlates quite well with recent U.S. consumer sentiment… and makes it hard to argue for a 'second half recovery'.

U.S. Consumer Sentiment Decreases to 28-Year Low, (Update1): “Confidence among U.S. consumers fell in May to the lowest level in almost 28 years as record-high fuel prices, lower home values and fewer jobs rattled Americans.

The Reuters/University of Michigan preliminary index of consumer sentiment decreased to 59.5, the weakest level since June 1980, from 62.6 in April. The measure averaged 85.6 in 2007.
Consumer spending, the biggest part of the economy, is cooling as surging food and fuel costs erode Americans' buying power and job losses mount. Declining home prices and stricter lending rules are also preventing owners from tapping real- estate equity to buy expensive items like cars and furniture, raising the risk that growth will stall in coming months.”

I keep saying it, if the economies with most of the world’s wealthy consumers dive into simultaneous recessions, you can’t expect the rest of the world to do well. Everybody, from Latin America, India and China will feel serious pain as they don’t yet have a sufficient consumer base to absorb the higher margin consumer goods they currently produce for export.

TED Spread Falls to 9-Month Low, Signaling Credit Crunch Easing: “Lending confidence at banks rose to the highest level in more than nine months, according to a key market indicator, signaling the global credit crunch is easing.

The so-called TED spread, which measures the difference between what the U.S. government and banks pay to borrow in dollars for three months, dropped below 78 basis points for the first time since August. It held at that level as of 11:56 a.m. in London, after touching 77.7 basis points. The cost of borrowing dollars overnight dropped to the lowest level since December 2004, the British Bankers' Association said today.”

Volatility (VIX) too has dropped drastically. This can’t be good. Complacency is back in a big way. With the S&P 500 (SPX) less than 10% of the record highs reached during the world’s largest credit and real estate bubble, I will say this: Look out below.

Eurodollars' Appeal For Rate Speculation Dims Amid Libor Woes: “Eurodollars, the world's most actively traded futures contract, are becoming a less attractive tool for speculating on Federal Reserve monetary policy amid concern about the accuracy of the London interbank offered rate.

Trading volume in Eurodollars slid 7.5 percent in April from the prior month, to an average of 2.6 million contracts a day, according to Chicago Mercantile Exchange data. Eurodollars are U.S. dollars held in commercial banks outside the U.S. The value of the contract at expiration is determined by the interest rate on three-month Libor, and its yield in the meantime represents the market's forecast.

An average spread of about 11 basis points between Libor and the Fed's target rate for overnight loans between banks since 1997 had made the contract a popular way to make wagers on interest-rate expectations. That changed in the past year as volatility in the difference in the spread surged after the collapse of the U.S. subprime mortgage market, prompting traders to rely more on options such as federal funds futures.”

The financial system is so rotten now that prices of all kinds of financial instruments are being adversely affected. Markets require transparency to most accurate estimate risk. Greater transparency results in a more accurate pricing of risk. This in turn reduces overall volatility and increases price multiples. Now that all major financial participants are busily reducing their transparency, volatility will increase, volume will fluctuate wildly and price multiples have to contract significantly as a greater level of risk must be priced into all financial instruments.

“Trading in fed fund futures, which were first offered on the Chicago Board of Trade in 1988, surged 55.3 percent in April from the prior month to an average of about 98,500 contracts a day. The contracts settled against the average daily fed funds overnight rate as calculated by the Federal Reserve Bank of New York.

Eurodollar futures open interest, or the total number of futures contracts that have not been closed, liquidated, or delivered, declined 17.6 percent in the past two months, according to CME Group data. Outstanding contracts dropped 3 percent in April from the prior month, and were down 21.4 percent versus the previous year. Open interest in fed fund futures at the end of last month more than doubled from the prior month, and has risen 9.2 percent from the prior year.”

Trading the Fed Funds Futures appears to be much safer as, unlike LIBOR, nobody can mess with the calculation.

But before you get excited about the volatility dropping, the TED spread narrowing and LIBOR easing off a bit…

“The difference between the rate of three-month dollar Libor relative to the overnight index swap rate, a measure of what traders' expect the overnight federal funds rate to average over that time, averaged 11 basis points for the 10 years prior to last August, when the global credit crunch began. The spread, known as Libor-OIS, ranged from 24 basis points to 90 basis points this year. A basis point is 0.01 of a percentage point. The gap narrowed 2 basis points to 68 basis points today.”

The LIBOR-OIS Spread is still indicating stress.

“Eurodollar futures are almost useless as a tool for predicting changes in Fed interest-rate policy. With less and less trading in Eurodollar futures, the federal funds contracts are quickly becoming the liquid arena of the fixed income market in terms of betting on central bank policy.” -Stan Jonas, who trades interest-rate derivatives at Axiom Management Partners LLC in New York

“Because Eurodollars settle to Libor, if there is an issue with the Libor fixing, it throws the whole thing off. If you just wish to speculate on what the Fed is going to do, then Fed fund futures are certainly the place to do it.” -Alexander Manzara, a futures broker at TJM Institutional Services on the Chicago Mercantile Exchange

Related Posts:
Libor Poised For Shake-Up, Credibility GONE
RISE Dark Lord Libor! RISE!
Ambac Gets Crushed, Another Bank Wobbles
Fragile Banks: More Bailouts, More Capital
The Race To The Bottom Accelerates
The South Sea Bubble and Today’s Central Banks: FRB, BOE, ECB
Dammit, Why Won’t You Learn?
The TED Spread, LIBOR and EURIBOR = Scary Bad
Mortgage Insurers (Quietly) Downgraded: CDS Spreads Scream Trouble


BundFox said...

Although the ZEW did indeed fall, the current conditions part of the index improved and the head of the ZEW said he expected an improvment in Germany going forward with an ECB rate hike later this year. Very unusual as ZEW is often asking for cuts. The IFO on Wednesday may offer more insight into the Eurozone economy. Bond yields are not pricing in a major leg down in the Euro Equities quite yet.

BundFox said...

Well the IFO came in better and the stocks rose but oil has put paid to the strength seen early on, so look out below!

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