Wednesday, July 11, 2007
As many readers will no doubt be aware, there's been a bit of market volatility over the past twenty four hours. The dollar is weaker, equities are lower, credit is wider, and govvys are bid. While these developments had been percolating for a few days, they received fresh impetus yesterday on the new that Moody's has downgraded a small pile of subprime rubbish and that S&P has put another, slightly larger pile of subprime garbage in the queue to be downgraded.
This, combined with heavy private and public sector activity yesterday, helped propel EUR/USD to new all-time highs and taken the DXY within a whisker of 15 year lows. When Big Ben failed to offer out a rate cut lifeline in yesterday's speech, US equities extended the early-session losses to finish sharply lower. This morning, credit has continued its recent rout, with the European crossover index briefly touching a spread of 300, a significant widening from the 197 level posted just 3 weeks ago.
Unsurprisingly, Macro Man's FX carry filter flashed red this morning, and he jettisoned the basket on the opening. While many of the carry crosses have actually come back so far today (the dip-buyers cannot be crushed so easily!) , one would have to believe that another day or two like yesterday could finally generate the dip that you don't want to buy. Insofar as ratings agency action may force liquidation from funds constrained by investment guidelines, yesterday's downgrade action does represent a new factor in the risky asset equation.
Macro Man has been around long enough that he has developed a network of contacts throughout the financial industry. One of his moles in the ratings agencies was kind enough to pass along his firm's "Subprime Analyst Toolkit" in response to Macro Man's query on their rating methodology.
Macro Man was actually quite impressed by the three-pronged approach taken by the agencies, as well as the degree of sophistication embedded in the technology. Fortunately, he received permission to share the contents of the toolkit with his readers:
The most important piece of technology is the pillow. This part of the toolkit is the most actively used by analysts, as they tend to spend most of their time asleep. Some agencies apparently prefer violins (allowing the analysts to fiddle while the market burns), but a pillow is clearly state-of-the-art technology and is now industry standard.
Once the analysts are finally awake, however, they still must perform an evaluation of the merits of the various securities and structures within their bailiwick. Fortunately, the agencies equip their analysts with a rearview mirror so that they can see for themselves what has already passed and act accordingly. The rearview mirrors got a particularly heavy workout in late 2001 and 2002, for example, with the debt of firms like Enron and Worldcom.