Monday, November 30, 2009

Who? What? Where? Why?

OK, so it looks as if disaster may be averted in Dubai: the latest hot rumour is that the central bank will guarantee all Dubai World debt. This is not altogether shocking- was this not among the rationales for the big intraday equity bounce on Friday?- but has nevertheless provided comfort to bondholders. The (in)famous Dec '09 Nakheel bond was recently quoted 65/70....well below par, but certainly a damn sight better than the 40-mid price that Macro Man saw on Friday morning.

Equity holders, on the other hand, may be left holding the bag...or at least that's the fear. The Dubai stock market, open for the first time since Wednesday, has cratered lower, down more than 8% at the time of writing.

That price action looks pretty grim, doesn't it? Well, yes and no. The chart above is clearly pretty ugly. But it's worth taking a step back and putting it into context. The Dubai equity market was always telling us that they were buggered; the index has barely recovererd any of its massive 2008 losses this year. Seen in this context, today's meltdown barely registers. Indeed, taking the message from equities, one wonders why the recent turbulence surrounding Dubai World constituted that much of a surprise....
In any event, the price action of the last 72 market hours has been ugly. Both longs and shorts have been stopped, in, say EUR/USD, which put in a nice 2% 3-day range not long after Macro Man observed that realized vols were at post-Lehman lows. It took a pretty firm stomach to hold positions through the "Dubai meltdown."
Indeed, observing price action across markets, Macro Man feels a bit like Tiger Woods' next-door neighbour. He can see that something bad is happening and that people are getting hurt, but he's not sure exactly what's happening and the people who do know aren't talking.

Friday's post-NY close price action in equities is a case in point. A few minutes after US equities closed at 6pm London time, someone did a bit of a drive-by in Eurostoxx futures, sending the price more than a percent lower. Macro Man felt like he was enrolled in Journalism 101. Who? What? Where? Why?
Anyhow, for the time being it seems as if we've stabilized. The euro's above 1.50, Western index futures have held onto Friday's gains, and for some reason oil is still chugging higher. But with month-end upon us, there's ample opportunity for fixing-driven noise.

And bubbling below the surface, Greece remains aa source of worry. Wolfgang Munchau suggests that Europe will not ride to the rescue, while the WSJ reports that the Greek government will flog their paper to the Chinese. While China is justly proud of its thousands of years of cultural history, they might do well to consider a proverb based on the Greco-Roman tradition: Beware of Greeks bearing gifts....


Anonymous said...

WTF happened to IBEX futures at the open? 12178! They must have been smoking something pretty powerful.

Macro Man said...

Hmmm...looks like someopne might have put in a market on open buy order for a few contracts...volume > 1200 was miniscule and quickly sold. Nasty.

Anonymous said...

Off topic question:

Recommend any books on FX Trading? Exotic Options?

Merci beaucoup

Anonymous said...

Anyone have a view on what the huge outflows of retail money from stocks means for the extension of the stock upmove? Usually, as we know, retail is seen as a contrary indicator so that has to be a positive sign.

Anonymous said...

dubai markets traded limit down, which means ur chart is meaningess.

risk will come off from here, too much complaceny yield the other side of the boat pls.

Richy Rich said...

To Anon - 9.56

for fx try

For exotic options, read

And then reread the first recommendation

Anonymous said...


I won't even bother going to the links

Darth Trader said...

MM - would it be slightly too melodramatic to say that this feels slighly "sub-prime 2007" in the way it is playing out, in that some initial stories come out, not really sure on the full details, feels like it could be quite bad, markets obviously moving a lot, don't really know that much about it, feel i am not really on top of how it could potentially play out... even the amounts...saying total debt is ~$80bn across all of dubai that is the implied worst case...i recall near the start of sub-prime, bernanke said losses would be $50bn-$100bn...obvioulsy turned out to be "somewhat" more than that...and then since the story broke probably 20+ banks have come out saying they have pretty much no exposure to dubai world...and yet dubai world has $56bn of debt so u would think someone somewhere must have a decent-sized i way off the mark? just wondered if you had any thoughts along those lines? thanks

Nemo Incognito said...

Ain't nothing wrong with Linear B. Quite interesting history really.

Yes Darth, we all need to get a better grip on the politics of these countries.

Macro Man said...

Indeed, we've been having that very conversation chez the rhetoric is all very subprime-y...

It will be very interesting, because the UAE as a whole has ample cash to pay off all of Dubai's debt, both soveriegn and ring-fenced. So whether it's down to domestic politics or an insistence that DW, unlike the AGencies in the US, really was private, this will resolve itself into the UAE's willingness to pay, rather than its ability to do so.

Nemo Incognito said...

Unfortunately unlike subprime this isn't a big market in one nation under one set of laws - its going to be an utter mess of various nations with radically differing incentives and domestic political dynamics. There may be some high level similarities but it's going to require some serious research in each nation's case.

Steve said...

This discussion of comparing subprime to Dubai conjured up one of my favorite trading axioms: There is never one cockroach.

PPM said...

The shift in reliance from private to public credit to support economies around the world makes even the whiff of sovereign risk a serious issue. If sovereigns start defaulting who do we call next, the Martians?

And, as Nemo points out, there isn't a pre-existing political legal infrastructure within which all of the competing interests can be reconciled, as was the case in the US. Issues with sovereign credit quality are going to be resolved via anarchic realpolitik.

Nemo Incognito said...

Steve - yes. They include but are not limited to the following:

Russian corporates
Kazakhstan (another sovereign being dragged down by a banking system bailout)

etc etc

Steve said...

I would throw Greece in there too, Nemo. And I wonder about Spain and Ireland.

Credit problems are slow and insidious. There is talk that many US regional banks are lending to companies (RE, construction) so those companies can continue to make interest payments on their loans, keeping the loans out of the writeoff or writedown categories. This sort of gaming went on in Japan. All it does of course is buy time, at a significant cost.

Where is Gregor Samsa when we need him?

Steve said...

...and the biggest "gokiburi" of all, Japan, with 200% govt debt to GDP, a declining population (and its impact on GDP), and a govt that already pays 10% of its revenues on interest payments.

If Japan reflates and rates rise, they're dead. If rates stay low it's because deflation has dug in, and they're dead.

Macro Man said...

So go limit long yen seems to be the message Dr. Market draws from those circumstances!

Steve said...

Yeah, go figure. I have been holding back from shorting it, will be disciplined on this one, we're so close to the old 80 high it may run up there. I don't see how Japan can tolerate it for much longer.

I-Man said...

Long FXY, Short EWJ...

Thats your Junior Varsity macro trade from the I.

Anonymous said...

we must be reading different stories.My take is it will support liquidity for banks so there will be no run (contagion) ,but that it will only consider specific debt case by case.In other words it put a net under wider contagion issues,BUT will not guarantee ALL DW debt which is the trigger issue.
Do you have a link for the information that this is not the case.

Anonymous said...

For Anon 9:56

First read Arthur Sklarew: Techniques of a Professional Commodity Chart Analyst.

It's an old one (1980) but pretty good...

Nemo Incognito said...

There's a good barcap piece on extending and pretending that you should check out steve.

Yes viz Japan, having shorted at 89.2 and hitting a stop on the "toe in the water" position size I'm staying right the hell away until the momentum monkeys get bored. 80 high looks possible, though from there its non-stop to 130 or worse.

Anonymous said...

jpy debt problems are overplayed, other parts of the govt are in surplus so their net debt is less, + they have massive foreign reserves. They could deal with these issues through a death tax + seling state assets.

That japan can run a trade surplus with an 89 usdjpy shows how much further the jpy can appreciate. Crazy stuff but mkt is burning Jim O'Niel's B*llcrap

jill said...

A little off topic Macro Man but maybe you can answer this question:

Why do 30-year Dollar Swaps yield less than 30-year Dollar Treasury Bonds?

Steve said...

Thank you Nemo, is there a link to it? (I get literally 25 ems a day from them)


PPM said...

Some might find this research relevant:

deniz said...

jill -

here is what i could dig out from back in the day when it first went -ve (and stayed -ve since) though there is a lot of technicality. hope it helps a bit. Apparently it had to with Yen strength and Pension / Insurance hedging.

(i) Unwinding/Hedging of Structured Products: Power Reverse Dual Currency Notes (PRDCs) became popular in Japan in the mid-1990s as they provided investor with a way of obtaining high-yield in a low interest rate environment. The coupon payments increase as the Yen appreciates in value, and decrease as the Yen appreciates. Therefore, as the Yen appreciates, this effectively results in the duration lengthening of the note. With increasing coupon on the back of Yen rally, the dealers increasingly bought swaps at the long-end to offset the duration extension of the note.

(ii) Pension Fund Asset-Liability Mismatch: Defined benefit pensions invest estimatedly 2/3 on average in equity markets despite having fixed-rate liabilities. With declining equity prices and falling yields, fund increased the hedges in long-dates swaps

(iii) Insurance Company Hedging of Variable Annuities: Variable annuities offer the upside in the rising value of the benchmark – mostly a combination of bonds and equities- and capped downside through a minimum guaranteed payout. In falling markets, the insurance company is practically short an in-the-money put option. This has made the liability more like a long-term bond annuity, causing insurance companies to receive in long-dated swaps to hedge duration.

Professional Gringo said...

Everybody ready for some QE from the BOJ?

Vampire squids claiming 2/3 of bank losses already realized.

EUR & CHF on the come.

How does it go? When you stare into the abyss the abyss stares back at you.

Our Man in NYC said...

And this risk aversion has returned to the market just as we've hit the valley in-terms of mortgage issues.

The Option Arm recast (note recasts, which mean people have to start paying down principal, are far more important than resets, which just reset the rate) mountain starts in December

Anonymous said...

Anon 3:34pm

Thanks very much.

I'll check it out now


Anonymous said...

Obama to the rescue, Our Man, serve up another trillion. Why pay down mortgages when you can rewrite them?

Anonymous said...

fed needs to talk down rate hike expectations ... why? cause of the arms mentioned above, cause of the 10% politically uncomfortable unemployment rate and cause the money supply pump has been winding down for over a month now.

jill- one other reason for swap rate being lower than bonds is related to credit. there are no natural payers of 30Y anymore ... no one out there doin rate rate locks that far out ... and banks were cutting all sorts of credit lines.

another main driver is the lack of participation in the mortgage market ... ie nobody is buying mortgaes and paying fixed as a hedge cause the fed has been hovering up all the mortgage paper around and making it ridiculous rich. makes you wonder how many more banks would be bust if the FED wasn't buying all their crap at over inflated prices.

Bill said...

This Dubai nonsense is VERY sub-primey feeling. Another case where the market was caught apparently unaware by events that every other industry had been talking about for months if not years.

I mean, a desert country builds an indoor ski slope?

A 170 story building when there are dozens of already empty 30-40 story buildings all over the place?

Three man made islands that appeal mostly to Micheal Jackson?

Beaches with water cooled sand and artificial wave generating machines for a country that wants Marissa Miller to wear a burka?

But just in case you are one of the finance weenies caught off guard by Dubai and the above items didn't clue you in -- consider this:

Moody's investor service issued warnings about a month ago.

You got out played, out maneuvered and out witted by Moody's

Yes, you should feel stupid.

Ian said...

Our Man NYC- Do you have a sense how how that famous recast/reset graph has changed given the level of defaults and loan mods in the past two years?

leftback said...

" case you are one of the finance weenies.."

Thanks for making your views clear, Bill.

Steve said...

That reminds me of the old cartoon of the hot dog going to his mailbox and taking out a letter that reads:


Our Man in NYC said...

Ian: It's hard to say (given the confusion over recast/reset and -ve amort means recast occurs earlier than the scheduled date) but these 2 graphs (both taken from a CS presentation in April) are pretty indicative.

Specifically on option arms, the more bullish folk argue that the heights of the bars are smaller (due to pre-recast default levels) and the bears argue that everything is shifted to the left (due to significant -ve amortisation leading to earlier recast dates vs. those scheduled).

Personally, I think they're both right...the problem hits earlier but isn't as bad as the doomsday scenarios.

Just Like High School said...

While I don't agree with Bill's exact phrasing, I have to agree with him and earlier commenters that this whole Dubai episode feels very similar to the subprime crisis.

At this stage of the game, there is little excuse not to know that real estate is over-built. Iceland, Spain, Ireland, UK, USA, Japan, Shanghai -- why is a country where camels outnumber people building a skyscraper and man made islands? And how is the financial world caught in surprise that this set-up is failing?

I think the subprime crisis came about after a rampant rise in cronyism. Smart people shifted over to buy side firms, and (ahem) ethically challenged CEOs put cronies into their place. If the CEOs had used merit (not cronyism), the new traders would have pointed out the rewards of subprime did not come close to the risks. But cronies don't ask questions.

One of the unfortunate results of Bernanke/Geithner/King/Trichet propping up politically connected (but failed) banks is that this culture of cronyism remains.

So the same yes-men who signed off on subprime loans are still hoping that loans for empty sky scrapers in the middle of the desert will work.

The same yes-men are also hoping all the empty office buildings in the USA won't effect their CMBS holdings... no need to write those down.

And with official US unemployment surpassing 10% (and unofficial numbers more like 17-18%) ... the same crony yes men are going to be shocked, just shocked, when they learn that consumers are not buying more Christmas presents than they did last year

It turns out that Bernanke is making those 0% loans only to politically connected banks -- consumers have to pay more like 8% if they are lucky to still have a home equity loan, or more like 21% on their credit card.

ZIRP is only for politically connected people, as it is in Japan. Cronies win, masses of voters lose.

hear today guanno tommorrow said...

money printing only ever benefits those that are closest to the printing press

leftback said...

Options ARMs are a big reason why we are not going to see the FED raising rates any time soon, and why there will therefore have to be a limit on any future stimulus packages. Get used to low rates, they are here to stay for a long time, because if rates were to rise quickly, the FED's attempts to save the big banks would be undone, and its efforts would be in vain.

Meanwhile we get to watch Japan cope with increasing debt/GDP and deflation as a glimpse into our future.

Anonymous said...

Ian / Our Man in NYC:

This is admittedly based on a lot of anecdotal evidence, but rate resets on ARMs doesn't really matter.

Most ARMs have annual and lifetime caps / floors -- so even if the 1yr CMT rate is 0.3% and the mortgage costs 1yr CMT + 2.75% (a common spread) ... the mortgagee is paying more like 5% if not more.

Many mortgages hit their lifetime floors 200-300bp ago, so they cannot go any lower.

If Bernanke raised Fed Funds to say 2% (which would still be VERY stimulative), it wouldn't effect most ARMs at all, as they would still be paying the lifetime floor rate.

The issue with mortgages isn't rate resets, it is minimum amortization amounts. With many loans "underwater", and many OptionARMs paying less than the minimum required to amortize the loan -- when these loans hit a reset date, the ARM **rate** probably won't change, but the minimum payment is likely to reset much higher anyway

And if the home owner lost their job to boot -- even an unchanged monthly payment is a problem.

Assuming housing inventory is about "normal" (not overbuilt as it likely is) ... home prices have historically oscillated around 3x annual income (assuming one has annual income).

Until inventory levels are worked off, and annual incomes stabilize -- mortgages will continue to fail.

Having the President announce that the most reckless / speculative mortgagees in society will have their mortgages subsidized by taxpayers isn't likely to make anyone feel bad about defaulting to a government owned bank

It will take several more years to work through this mess

Our Man in NYC said...

LB -- agreed.

Anon -- I think we're making the same point; it's the reset/recast confusion I was referring to.

- Reset: Date when the interest rate changes.
- Recast: Date when the payment changes (i.e. you have to start paying down principal not just interest).

The situation you describe is the recasts, which happen either at the reset date OR when the balance of the loan hits a predetermined amount (normally 125% of initial loan balance).

With the significant majority of people with Option Arms negatively amortising, the recast date will be before the reset date & their payments change to include principal payments. This change will be far bigger than any change in interest rate.

Just Like High School said...

Our Man in NYC:

While I agree with you 100% that mortgage recasts **should** be a problem, we should never underestimate the willingness of crony bankers to pretend like the problem doesn't exist

And never underestimate the willingness of inept and corrupt politicians to change the accounting rules by diktat to delay recognition of the problem

Anonymous said...

In the spirit of recent Youtube-isms and concerns of U, V, W and whoknowswhat, please allow me to link to this one by Chief Economist of Handelsbanken, Norway:

Gregor Samsa said...

Steve, I was away from keyboard, other than that I am trying to read between the lines, like everyone else.

This Japan bashing might just be wishful thinking again. No one's ever come up with a convincing reason why the US aren't the ones stuck in the deepest pile of shit. I wouldn't want to bet any money either way.
I do still think Europe is better off than the US, because when Europe was on the verge of following the US into the structured turd mess, the crisis hit before we were in to deep.

Don't see any worthwile equity upside anywhere on the globe, once the US uptrend breaks, it will pull all the other markets along.

There's at least one industry not suffering from the crisis: Giesecke & Devrient brought a new paper mill online last week. From the press release:

"The number of banknotes in circulation around the world is constantly growing, and with it the demand for high-grade banknote paper."

Our Man in NYC said...

JLHS: Too true!

Gregor: true, though that hasn't helped DLAR much!

jill said...

Deniz/Anon 5:46pm

Thankyou for your response.

I have brainstormed this issue today and listened to other interesting theories...

Currency Risk?

It can’t be currency risk, because both are quoted in US Dollars for all payments, both principal and interest. One thing I’m sure the Treasury will always have is access to Dollars to pay its debts. I’m not saying anything about what those Dollars will be worth when you get them, but I’m comfortable assuming the Treasury will definitely pay me $1 million US Dollars for my million-dollar Treasury Bond when it comes due.

How about option risk?

It can’t be option risk, because neither one is callable or extendable. Is the market saying the Treasury will decide to force investors to take a ten-year extension when the Long Bond comes due? Is it saying that the Treasury will force borrowers to take their principal early? Is the market simultaneously saying that private market counterparties like banks wouldn’t do the same if some strange circumstances brought about these actions?

Credit Risk?

It can’t be credit risk, at least the way I look at it. If Treasury Bonds were denominated in Yen or Euros, I might be able to swallow the idea that some bank counterparty could more easily pay the interest and principal than the Treasury. But these aren’t in another currency. The Treasury has the printing press, so Dollar debt simply can’t be safer from a credit perspective when it’s issued by some bank or brokerage firm.

Liquidity Risk?

Perhaps the market is remembering the October Surprise of 2001, when the Treasury announced they would stop issuing the 30-year maturity. Of course that announcement came when there was a budget surplus, and the operating cash for the Federal budget did not include as much as $400 billion a year borrowed off budget.

Still, the staggering size of the swap market for interest rate derivatives gives some credence to this theory. Put simply, the Treasury doesn’t borrow enough to satisfy the demand for non-callable long term investments, so the swap market has to step in. The fact of lower rates on swaps says that even that market can’t satisfy the demand.

While not a more liquid market on a daily basis (though nobody knows for sure), one might say that there are far more 30-year swaps than there are 30-year Treasury Bonds.

Still, if a company or a strong bank or insurance company can get 30-year funding cheaper than the US Government, why aren’t they doing it? Seems like they’d do it until the yields went up (at least until they couldn’t turn around and buy Treasuries to lock in a 30-year profit).

More about the credit issue. Given the fact that nobody is willing to take a counterparty risk for 30 years these days in the private market, I am sure virtually all of the 30-year swap market includes collateral posting agreements to maintain credit standards. So all you have to depend on with your 30-year swaps is that your counterparty will actually post collateral when they have to (the mechanism by which AIG counterparties got so many tens of billions of bailout dollars).

Thankyou again for the responses. Time for more research.

Gary said...


In the short term, there are still loads of structured deals that rely on swaps for functioning (including the early 2000s favorite of hedge funds, swapping 30yr munis into synthetic money markets). The natural swap payors (mortgage hedgers) are basically out of business.

Long term, there is an "option play" you aren't considering: while the US Treasury will presumably give you $1 million dollars for your bonds (however worthless those dollars turn out to be) -- the same cannot be said for swap obgligations.

No one does a 30yr swap with itsy bitsy bank -- they are (were) done with the big money center banks that are now, directly or indirectly, nationalized.

After the Chrysler and GM fiasco, no one has any confidence in how the politicians will handle claims if (when!) these banks are recognized as insolvent. Your "senior" claim can be arbitrarily nullified by executive decree, by an inept/corrupt Treasury Secretary, a state attorney general, etc. The swap market is supposed to be between AAA institutions -- not between insolvent banks run at the whim of politicians.

Hence, the liquidity in long dated swaps has really dried up. Its pretty much insolvent bank "A" trading with insolvent bank "B", using swap spreads determined by the Treasury/Federal Reserve, which owns both banks anyway.

A pension fund isn't going to defease long term liabilities using a contract with an insolvent institution. In most states, doing so is a prima facie breach of fiduciary duty.

Further, if you can defease said liabilities cheaper using actual US Treasuries, why would you take the risk?

Long dated swaps are essentially illiquid. Yes, I know there is whatever daily volume -- but if you subtract out unwinds of earlier trades and interbank trading to get "market priced" trades, the market is essentially dead.

There are no "true" AAA institutions with which to trade swaps, hence no market

Steve said...

Funny, this talk of resets, there was a small article buried in the WSJ a few days ago about whether to keep paying the mortgage, or just walk.

It was one of those anecdotal things where the guy, who came across as midstream, was sitting on a $650k mortgage and a (now) $400k house. He was making the payments but they were stressing him out, so he was getting closer to walking, because he didn't "want to be the victim of this mess."

Say what?

So now that we are giving $8k to first-time home buyers and cash for clunkers, even ordinary upstanding sorts feel like victims. Victims of what? Lower home prices?

This recession (to use the popular description) is so much worse than anything in my lifetime. I doubt a 20-25% decline in RE would have been a major ordeal 30 years ago, but now we've added a layer of second mortgages (this guy had one) and turned the public into the "getters" and the "not-getters" and suddenly we have 300 million "victims."

And the S&P is at 1094? I don't think so...

Gary said...


Declaring yourself a victim and getting "free" money from the taxpayer is God's work (and very profitable).

Actually earning money is hard work, and is taxable.

Our Man in NYC said...

Gary -- Brilliant, I laughed out loud!

Steve said...

Yes indeed Gary, and now due to the wonders of structured finance and government intervention homebuyers can get a free call AND a free put. It's Options-A-Go-Go.

Skippy said...

For those that missed it, the Bank of Japan has called an emergency meeting at 2pm. Has the pain threashold been reached?

Nemo Incognito said...

And Australia looks like its going to vote down its emissions trading deal.

Nic said...

Does anyone think that the Dubai problems would put enough of a chill on debt issuance in Gulf and Arab states that they might start selling a lot more of their stored oil instead? To raise money they either have to issue bonds or sell assets, right? Crude is still at pretty lofty price levels ...
Maybe I am just fantasizing about it ...

Skippy said...


Interesting point. Dubai World may indeed be forced to sell assets (real estate). But Dubai does not have the oil, Abu Dahbi does and their annual oil revenue is around $50bn p.a. (along with $400bn in the sovereign wealth fund) which can easily cover the losses (if they chose to).

If the losses are a lot larger than currently reported, perhaps there may be an incentive to sell (supply) a lot more oil?

Nic said...

Yeah I don't mean Dubai, I mean the other Arab States, they all seem to have been issuing bonds ... I guess it really depends on how much of a chill this puts on the bond market in that part of the world.

Nic said...

For example ...

Skippy said...

Sorry Nic, I missed your point.

I guess it may slow appetite for debt and therefore future development may occur out of oil revenue.

However it is important to differentiate between the haves and the have nots

Skippy said...

A less hawkish RBA today?

I found it interesting to describe 75bp of policy tightening "material" when rates are still well below neutral. Perhaps it is - in a global context?

Anonymous said...

Dubai..goodbye..the markets have said small problem let's leave it with those effected whilst the rest of us march on reflating.
Dubai's last weeks news and the markets appears to have absorbed it and moved on.