A funny thing happened on the way to the rally

A funny thing happened today as equity markets left Virgil in the rearview mirror and started partying with Beatrice. Sure, equities were overdue for a rally; it had been what, a week and a half since the prior upmove of 2% or more? And what could possibly be more bullish than the news that JP Morgan broke even last quarter, once you strip out profits that are unrepeatable (the VISA sale) or of highly dubious provenance (the "profit" created by the fact that the value of the bank's debt went down a lot.) But as stock traders were popping champagne corks and riding the SPX to a 30 point up-day, they seem to have missed a rather interesting and, one might argue, salient point: the next leg of the financial crisis has begun.

The British Bankers' Association issued a directive today that it will expel banks that it believes are manipulating the LIBOR fixings by proffering rates that are not representative of where they are willing and able to borrow and lend in the market place. Macro Man touched on this issue last week, but it really hit fixed-income markets this afternoon. Early indications are that tomorrow's 3 month dollar LIBOR will fix 10-15 bps above where it printed today.

Why is this important? Now, Macro Man is not in expert in banking balance sheets, and anyone who is can feel free to correct him here. But his understanding is that lowballing LIBOR has enabled banks to mask the true state of their funding costs on their income statements and balance sheets. A sudden correction to the LIBOR fix could have some rather deleterious consequences for their liquidity status....and we have a rather recent precedent of how quickly a bank that is struggling with liquidity can hit the skids.

The warning signs are ominous. The spread between eurodollar and Fed fund futures has exploded to levels way beyond anything seen even last year; the chart below shows the spread on the December 2008 contracts, which widened by 13 bp this afternoon alone. That's not really a sign that it's time to begin trading the recovery, is it?

Similarly, two year swap spreads have begun widening again today; having made a higher low last month, will they now go on to blast up to a higher high?
After several sessions of pretty blah trade, the stock market was probably due for a bit of joy. Today's post-close IBM results will ensure that the party keeps rolling this evening. But tomorrow is another day, and one that's like to see bad news in terms of higher funding costs for banks; as Merrill Lynch is likely to demonstrate tomorrow, funny things can happen on the road to recovery.
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CDN Trader
admin
April 16, 2008 at 9:44 PM ×

And can someone please explain how the DJ Transports can rally 3.9% on the same day that oil touches $115??

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shankar
admin
April 16, 2008 at 10:11 PM ×

CDN:

You GOT my support!!!

I am looking at all the fundamental things and confused more than ever.

I sure would love someone to explain me that in addition to how $115 oil would be bullish for stocks and consumer expenditure (which last time I checked was 2/3rd of US economy).


Shankar

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Eventhorizon
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April 17, 2008 at 1:05 AM ×

cdn - not to mention 3 airlines closing their doors and one operating under Ch 11 in 2 weeks. Trans off only 7.5% from all-time high. Go figure.

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April 17, 2008 at 9:48 AM ×

Yes, it's interesting what's happening about Euribor fixing, but we have to remember that fixing is a contribuited rate of a bank's group, or better by a particulat committee.
For example 3M fixing is an "average" , outlier excluded (about 5% less or more). And today for example i see however on interbank market rate as same as yesterday.
I think instead that there's a misleading to the upside, now there's a huge carrytrade because banks, thanks to ECB or other CB, have "unlimited" access to short term rate(4% in Eu or 2.25 in US) but they have mortgages linked to 3M euribor. So according to me they probably have an advantage to let this rate higher.
And maybe there'll be a chance that euribor fixing could be LOWER, not higher!!
Otherwise, why are banks killing themselves??

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April 17, 2008 at 10:14 AM ×

The BBA will ensure that dollar BBA LIBOR continues to be a transparent, objective, accurate rate.

The economic conditions are difficult especially in the lending and credit markets. In response the BBA has brought forward the regular review of the BBA LIBOR setting process. This review is currently underway and the BBA will report on its findings in due course.

BBA LIBOR is overseen by an independent committee that oversees the rates. This committee has absolute authority to select the panel bank membership.

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jcg
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April 17, 2008 at 10:44 AM ×

Hope you saw the Gordon Brown editorial in the WSJ yesterday. Did you realize he was over in NY? Neither did I.

Clearly one area where the Anglosphere can enlighten the rest of the world that he forgot to mention: banking regulation and prudent lending.

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Macro Man
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April 17, 2008 at 12:52 PM ×

Mr./Ms. BBA,

While I think we can all appreciate that market conditions are difficult, the notion that unsecured lending rates amongst banks can be lower than secured lending rates from the central bank suggests that the rates posted each morning at 11 am are not representative of the true cost of funding amongst banks.

The natural conclusion that one has to reach is that banks are posting unrepresentative rates for some reason, and it seems reasonable to deduce that that reason is because it flatters their profits and liquidity standing.

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