[Marxism] Stock investors still on edge

[Greg McDonald <sabocat59@xxxxxxx>]

Jitters hint at further intervention
By John Authers in New York
Financial Times
Updated: 12:12 a.m. ET Aug 25, 2007

A week after the US Federal Reserve's decision to cut the rate at  
which it lends to banks, the move has yet to achieve its purpose of  
reviving global money markets.

Instead, the cut in the Fed's discount rate was followed by the most  
extreme panic in short-term money markets since, at least, the "Black  
Monday" stock market crash of October 1987.

The money markets spent the rest of the week slowly recovering, but  
by Friday the difficulties for many companies in raising short-term  
financing remained acute.

These difficulties, in turn, strengthened the belief that the central  
bank would be forced to intervene further by cutting the main Fed  
funds rate, at which banks lend to each other.

The market in Fed funds futures, which investors use to hedge against  
moves in the Fed funds rate, signalled throughout the week that such  
a cut was a certainty, and that a reduction from the current 5.25 per  
cent to 4.5 per cent was overwhelmingly likely by the end of the year.

The crisis of confidence in the money markets was most plainly  
visible in the prices of short-term Treasury bills, which are  
regarded as the safest and most liquid investments in the global  
financial system.

When investors lose confidence in other assets, they pile into T- 
bills in what is known as a "flight to quality". This pushes up the T- 
bills' price and pushes down the yield they pay.

Normally, T-bill yields scarcely vary from the Fed funds rate. But at  
the time the Fed cut its discount rate last week, three-month T-bills  
were yielding only 3.8 per cent.

The flight to quality continued, despite the Fed's action, and  
reached extreme levels on Monday, when the three-month T-bill briefly  
yielded less than 3 per cent, while four-week T-bills yielded less  
than 2 per cent.

They have recovered since then, but three-month yields rose above 4  
per cent only on Friday morning – still just slightly up from when  
the Fed intervened.

"Although some signs of normalisation have emerged, it remains clear  
that we are a very long way from normality," said Charles Diebel,  
fixed-income strategist at Nomura International. But he added: "All  
the signs are that we have seen a temporary lull and that further  
distress is in the pipeline."

The greatest problem is in asset-backed commercial paper, used by  
large companies to raise short-term funds, usually at a rate that  
varies only slightly from the Fed funds rate.

Investors, particularly money market fund managers, have been worried  
that the collateral for the commercial paper might be contaminated by  
bad subprime mortgage bonds. When financing could be raised this way  
over the past week, it was at rates of about 6 per cent.

The amount of money raised through asset-backed commercial paper  
dropped by $77bn (€56bn, £38bn) last week, while issuers resorted to  
borrowing over ever-shorter terms. This suggested that the problems  
in this market were worsening.

Stock markets, meanwhile, remained mostly only 5-6 per cent below  
their peaks, and still in positive territory for the year. They were  
buoyed by hopes of rate cuts, and by evidence that corporate  
profitability remained strong in the second quarter. According to  
Thomson Financial, profits for S&P 500 companies rose by an average  
of 8.1 per cent in the second quarter – far more than the 4.1 per  
cent that had been forecast at the beginning of last month.

Other signs of risk aversion abated slightly as the week progressed,  
but re-mained very high.

The Chicago Board Options Exchange's Vix index, also known as Wall  
Street's "worry gauge" – which derives equity market volatility from  
the price of options on the S&P 500 – fell over the week to 21 after  
reaching 37.5 at one point last week. But it remains at a higher  
level than at any point since the invasion of Iraq in March 2003, and  
shows that stock investors remain very much on edge.

Apart from the Fed, market worries centred on hedge funds. It is  
known that several large quantitative hedge funds suffered severe  
losses in the first week of August, and speculation turned to where  
losses would show up next. There was also gossip that some of the  
large private equity buy-outs that have yet to be financed may need  
to be renegotiated. This would have a very negative impact on  
confidence in the stock market.

Traders said it would be hard for money markets to revive until  
uncertainty had been removed over the extent of subprime losses and  
of the contagion to losses elsewhere in the financial system. That  
will take time.

Marco Annunziata, chief economist at UniCredit in London, said: "The  
main lesson of the past week is that, unless and until the  
'information crunch' can be eased, financial markets will not  
stabilise."
Copyright The Financial Times Ltd. All rights reserved.



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