LIBOR converging with CD rates; CD transparency proves useful

It looks increasingly likely that going forward the dollar LIBOR curve will be set based on term deposit rates (discussed here). There simply is not enough term (longer than one week) interbank unsecured lending to determine LIBOR without the risk of potential manipulation (or perception of manipulation).

A term deposit is commonly referred to as a "CD" (certificate of deposit) and most banks publish these rates daily. In effect it is the rate at which banks can borrow from the public for a period of time. The convergence between LIBOR and CD rates is now clearly taking place.

Source: BankRate.com/Bloomberg

This is good news in terms of transparency because CD rate averages are easily available, leaving little room for manipulation. One can monitor the CD curve over time to see where banks are funding themselves out to 5 years. The chart below shows the CD curve now and a year ago. Rates basically have not changed out to 9 months, but have come in beyond that point. Any funding strains in the banking system will quickly become apparent in this curve.

Source: BankRate.com

CD rates also tell us which banks are having a tougher time raising deposits or issuing bonds. As the table below shows, some of the smaller/newer banks, internet banks, or banking firms that don't have enough bank branches (such as CIT, MetLife, or Sallie Mae) will pay more for term deposit funding.

Highest CD rates (Source: BarnkRate.com)

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Has China's Q3 GDP been grossly overstated?

Here is an interesting interview with Gordon Chang, who believes that China's GDP growth in Q3 has been grossly overstated. In his opinion the number should be closer to zero.

His view is based on slow growth in electricity production across China as well as consistently weak PMI numbers. The HSBC PMI has been showing a mild contraction every month throughout 2012.

China PMI (Source: HSBC/Markit)

He also points to an increasing risk of social unrest in China - which hasn't been covered by the media. This stems directly from the slowdown and the wealth inequalities that have developed in the country in recent years.

YF: - Another area of concern for Chang is the potential for unrest. While the saga surrounding workers at the Foxconn factories where Apple gadgets are made has been well covered, Chang says it barely touches on what is happening on a broader scale.

"Across Chinese society, the one factor that people always talk about is the anger," he says. But the reality is that the central government in Beijing no longer produces statistics on uprisings and protests, which by his estimates are now probably occurring at a rate that is ''north of 200,000 per year."

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Moody's: Echo boomers to reverse declining homeownership

It is a well known fact that homeownership in the US has been on a decline, a trend that started even before the financial crisis. Now Moody's predicts this trend will begin reversing next year.

Dotted curve is Moody's projection (Source: Moody's)

Their explanation has to do with demographics. Baby boomers are moving into the highest homeownership group by age, while "echo boomers" (children of baby boomers) are getting to the age at which they are significantly more likely to own a home than the younger age group.

Moodys: - Demographics will also generate much of the gain in homeownership over the next decade, with a growing share of households aging into the highest homeownership groups. Baby-boomers are aging into the 65 and older cohort, the age group with the highest homeownership rate, while echo boomers have entered the 30- to 45-year-old cohort, which traditionally makes the largest gains in homeownership.

Historical data tends to support this assumption. The jump in ownership from the 25-29 cohort to the 30-34 is the sharpest - which is where echo boomers are now transitioning.

Source: Moody's

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Update on the banking union initiative in the Eurozone

Here is the latest on the Eurozone-wide bank regulation initiatives. The area leadership seems to have agreed on some key principles of bank supervision:

1. The ECB will be the ultimate supervisor for all 6,000+ Eurozone banks.
2. National regulators will run day-to-day supervision for all banks, except...
3. The ECB will directly oversee the 25 largest "systemic" banks.
4. Bank bailouts via the ESM will not take place until the EMU-wide supervision is put in place (supposedly by 2014, though looks unlikely).
5. The ECB will have the ability to intervene in any of the Eurozone banks.
6. The ECB would not object if some EU banks outside of the Eurozone were supervised separately.

Reuters: - While he fully expects the ECB to have authority over all the euro zone's 6,000 banks, the Frankurt-based institution would concentrate on the systemically important lenders and delegate routine supervision of the rest to local watchdogs.

"The main division is the centre will directly supervise the 25 odd banking groups and all the rest will be done by national supervisors under the guidance, umbrella, monitoring and definition of practices by the centre," Constancio [ECB VP] said.

The top banks would include Deutsche Bank, BNP Paribas, Santander UniCredit.

The ECB would reserve the right to intervene in any euro zone lender when needed. "There is no ambiguity in the system and there is very extensive use of decentralisation," he said.

Market participants however continue to remain skeptical that this master plan will instill enough confidence in the near-term to materially improve the banking liquidity conditions in the Eurozone.

GS: - Policymakers appear to hope that establishing a road-map to a new and workable Euro area regime will help to stabilize the current situation, as forward-looking markets price future stability into today's asset prices. Given that the credibility of policy announcements is weak, we are skeptical that this can be achieved in the shorter term.

For now the reliance on the ECB will be as a lender to the periphery banking system and a buyer of periphery government debt - not on the ECB as a bank supervisor.

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Moody's downgrade of Spanish regions should be a signal for Rajoy to request aid

Spanish regional downgrades should not have been a surprise. After all, regional credits are generally tied to the national rating in most rating agencies' methodologies. As the central government bonds got downgraded, regional debt was sure to follow - this was discussed in some detail here.

Moody's: - The ratings of the following five regions have been downgraded:

- Junta de Extremadura: long-term issuer rating downgraded by one notch to Ba1 from Baa3; negative outlook;

- Junta de Andalucia: long-term issuer and debt ratings downgraded by two notches to Ba2 from Baa3; negative outlook;

- Comunidad Autonoma de Murcia: long-term issuer and debt ratings downgraded by two notches to Ba3 from Ba1; negative outlook;

- Castilla-La Mancha: long-term issuer and debt ratings downgraded by one notch to Ba3 from Ba2; negative outlook;

- Catalunya: long-term issuer and debt ratings downgraded by two notches to Ba3 from Ba1; negative outlook;

Note that none of these bonds are now investment grade based on Moody's, which may ultimately impact their eligibility for the ECB collateral. What's troubling is that Moody's is basically looking beyond the internal rescue fund (called the FLA) set up by Spain to bail out the regions (see discussion).

Moody's: - Moody's decision to downgrade the ratings of the four Spanish regions of Andalucia (to Ba2 from Baa3), Castilla-La Mancha (to Ba3 from Ba2), Catalunya (to Ba3 from Ba1) and Murcia (to Ba3 from Ba1) was driven by the deterioration in their liquidity positions, as evidenced by their very limited cash reserves as of September 2012 and their significant reliance on short-term credit lines to fund operating needs.

In addition, Catalunya, Andalucia and Murcia face large debt redemptions in Q4 2012 when retail bonds issued in 2011 are due to mature. In this context, five regions -- namely, Catalunya, Andalucia, Murcia, Valencia and Castilla La Mancha -- have already requested liquidity support from the Fondo de Liquidez Autonomico (FLA) to cover their financing needs in the second half of 2012.

While the FLA greatly reduces the risk of a region's liquidity driven default in the short term, it does not address their fundamental economic and financial weaknesses, namely: (1) the significant uncertainty regarding viable long-term funding alternatives, and the resulting considerable reliance on government funding; and (2) the regions' significant difficulties in controlling their deficit and debt trajectories in an economic environment in which the implementation of cost-cutting measures to redress the regions' structural deficits will likely take longer than expected.

As discussed before (see this post), Spain's government is waiting for the market to force its hand before the officials finally request a bailout package from the ECB/EC. But Spain should use this downgrade as an opportunity to ask for help, since it may give politicians some cover. If Mariano Rajoy waits much longer, he may end up asking for aid under duress.

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The INSEE survey shows more jitters within the French business community

The National Institute of Statistics and Economic Studies (Institut national de la statistique et des etudes economiques or INSEE) of France conducts a monthly survey of French business conditions. The October results show a continuing deterioration. In fact the indicator hasn't been this low since 2009. It is entirely possible that survey indicators ("soft" data) do not fully represent the reality on the ground, but it certainly speaks to the lack of confidence within the French business community.

INSEE: - According to the business leaders of the main economic sectors, the French business climate loses one point again in October to reach 85 points, still under its long term average (100). Business climate indicator in manufacturing industry decreases by 5 points in October and the indicator in services loses 1 point. The indicator in the building sector remains stable whereas that of retail trade gains 2 points.

Source: INSEE

Economists who monitor developments in France will be looking to the PMI release tomorrow to see of this weakness in business climate is also reflected there. The PMI number for September was quite bleak (see discussion). Economic conditions in France provide a good glimpse into the trajectory of growth in the Eurozone as a whole.

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As crude prices decline hurting revenues, Iran threatens to cut off supply

Crude oil prices have been on a steady decline in the past couple of weeks as global demand remains weak. These declines are pressuring Iran, who is already selling oil below market prices. That's why it was no surprise today when Iran tried to prop up prices by threatening to cut off oil sales altogether.

Reuters: - Iran said on Tuesday it would stop oil exports if pressure from Western sanctions got any tighter and that it had a "Plan B" contingency strategy to survive without oil revenues.
... 

"If sanctions intensify we will stop exporting oil," Iranian Oil Minister Rostam Qasemi told reporters in Dubai.

Qasemi's statement is the latest in a series of threats of retaliation by Tehran in response to the sanctions, which have heightened political tensions across the Middle East and, analysts say, led to a sharp drop in Iranian oil exports.

"We have prepared a plan to run the country without any oil revenues," Qasemi said, adding, "So far to date we haven't had any serious problems, but if the sanctions were to be renewed we would go for 'Plan B'.

"If you continue to add to the sanctions we (will) cut our oil exports to the world... We are hopeful that this doesn't happen, because citizens will suffer. We don't want to see European and U.S. citizens suffer," he said, adding that the loss of Iranian oil on the market would drive up oil prices.

Brent rallied on the announcement but not nearly enough to offset recent declines.

Source: FOREXPROS

Market participants don't believe Iran would cut off its only major source of funds to "punish" the West. This simply shows an increasing desperation of the government as it tries to cling to power. Internal rift within the government is escalating (see NYTimes story), and it looks increasingly likely that Ahmadinejad is on his way out. It is possible that he will be used as a scapegoat by his successor who will blame him for the nation's deteriorating economic conditions. Additional declines in oil prices combined with increased sanctions from the EU and the collapsing currency will further destabilize and already strained political situation in Iran.

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Sharp declines in equity correlations should improve alpha generation

The implied correlation futures contract has touched a new low recently. With the Eurozone seemingly stable for now, correlations among US stocks have declined. That means share prices are now driven to a somewhat larger extent by company fundamentals than by macro events in Europe. This is good news for stock pickers who have struggled to outperform the market in recent years (see discussion). Alpha generation by strong portfolio managers should improve.

Source: CBOE

For those interested in learning more about how the implied correlation index is computed please see this paper from the CBOE.

Implied Correlation Indicator

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