Tuesday, October 2, 2007

Two Weeks After the Fed Rate Cut and All Is Not Well in the Credit Markets

Two weeks after the Fed cut the Fed Funds rate, liqudity has not been restored to the credit markets like many thought (although I am not sure why). The only people that have benefitted from the rate cut are those in the stock market. However, there even seems to be a problem in this area. The stock increases of late are not broad based and the volumes are not that high, suggesting that the stock market increases of the last few weeks are somewhat anemic. (Portions in bold are my emphasis and not in the original article.) From Bloomberg:

As far as the world's biggest bond investors are concerned, the Federal Reserve is failing to restore confidence in the U.S. credit markets.

Pacific Investment Management Co., TIAA-CREF and Insight Investment Management say the central bank's decision to lower the overnight lending rate between banks by half a percentage point last month won't prevent the economy from slowing or corporate defaults from increasing. Lehman Brothers Holdings Inc. strategists say last month's rally in high-yield corporate bonds, the biggest since 2003, may fizzle by year-end.

While indexes of derivatives that measure the risk of default show increasing investor confidence, the difference between the interest that banks and the U.S. government pay for three-month loans is wider now than a month ago. That's a sign the Fed's Sept. 18 rate decision has yet to persuade bondholders that lower borrowing costs will stop ``disruptions in financial markets'' from hurting the economy.

``The reality is the fundamentals haven't gotten any better, and, if anything, they've gotten worse,'' said Mark Kiesel, an executive vice president at Newport Beach, California-based Pimco who oversees $85 billion in corporate bonds.

About three-quarters of 30 fund managers who oversee $1.25 trillion expect a hedge fund or credit market blowup in the ``near future,'' according to a survey by Jersey City, New Jersey-based research firm Ried, Thunberg & Co. dated Oct. 1.

Former Treasury Secretary Lawrence Summers said Sept. 27 that there is an almost even chance the economy will fall into its first recession in six years. New York-based Goldman Sachs Group Inc., the world's most profitable securities firm, reduced its estimate of economic growth in 2008 last week by about a third, to 1.8 percent from 2.6 percent, because of fallout from the worst housing slump in at least 16 years.

``I'm still bearish,'' said Alex Moss, a senior credit analyst at Insight, a London-based money manager with $94 billion of fixed-income assets. ``I can't see any real excuse to get involved in this market.''

More than 3 percent of company bonds were distressed in September, triple the amount in July, Standard & Poor's said in a report last week. Bonds are considered distressed when they yield at least 10 percentage points more than comparable- maturity Treasuries. Moody's Investors Service forecasts the U.S. default rate will more than double to 4 percent in the next year. New York-based S&P and Moody's are the largest credit- rating companies.

``The big picture is you're going to have a consumer that is going to be pulling back significantly,'' Pimco's Kiesel said. ``The rate cuts by the Fed are unlikely to save housing.'' The Fed's Sept. 18 reduction of its target federal funds rate to 4.75 percent was ``intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets.''

The difference between the dollar London interbank offered rate, which banks use to lend to each other, and the three-month Treasury bill yield shows . . . . that (The) so-called TED- spread has climbed to 1.33 percentage points from 1 percentage point on Aug. 27.

The North American CDX investment-grade index rose 5.75 basis points last week to 55.5 basis points, the biggest increase in more than a month, according to Deutsche Bank AG prices.

While banks working for New York-based Kohlberg Kravis Roberts & Co. sold $9.4 billion of loans to finance the leveraged buyout of First Data Corp. in Greenwood Village, Colorado, lenders still need to find investors for more than $300 billion of loans and bonds to fund pending takeovers.

Morgan Stanley, Lehman and Bear Stearns Cos. in New York reported lower third-quarter profits last month after writing down the values of unsold loans and losses on securities linked to subprime mortgages for people with patchy credit histories.

This rally will be ``pretty short-lived,'' said Richard Cheng, who co-manages $45 billion in investment-grade corporate bonds at TIAA-CREF in New York. ``The economy might be slowing down and third quarter earnings releases may be a little bit difficult. We see spreads widening a little bit more.''

Sales of collateralized debt obligations, the biggest buyers of corporate loans in the first half, fell 54 percent in August to $17 billion from July, the lowest in more than a year, according to Morgan Stanley. CDOs are created by packaging bonds, loans or credit-default swaps and using their income to pay investors interest.

The reduction in collateralized loan obligations may make it more difficult to sell the debt, according to Dan Fuss, vice chairman of Boston-based Loomis Sayles & Co. CLOs bought as much as 60 percent of loans for LBOs this year, according to New York-based JPMorgan Chase & Co. analysts.

``The impact of the CLO freeze up is certainly not out yet,'' said Fuss, who oversees $22 billion of bonds.

More than 65 percent of investors in mortgage-backed securities are struggling to find bids for their holdings, according to a survey of 251 institutions last month by Greenwich Associates, a Greenwich, Connecticut-based consulting firm. Among holders of CDOs, the figure is 80 percent.

The U.S. commercial paper market is shrinking. The amount of debt outstanding that matures in 270 days or less fell $13.6 billion the week ended Sept. 26 to a seasonally adjusted $1.86 trillion, according to the Fed. It's down 17 percent in the past seven weeks.

``People said this subprime liquidity issue was going to go away after Labor Day,'' said Tom Quindlen, CEO of corporate lending at GE Commercial Finance in Norwalk, Connecticut, a unit of General Electric Co. that has $14 billion of assets.

``The bankers were going to return from vacation and just jump right back in,'' said Quindlen. ``That's what I heard in August. Well, they get back from vacation and they're saying it's the first half of 2008. I think it's going to be longer rather than shorter.''

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