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Thoughts On Risk Appetite
Submitted by Nic Lenoir of ICAP
We had the pleasure of discussing recent economic developments and the Federal Reserve's policies with ICAP's chief economist Louis Crandall. He views the Fed on hold most likely until Q3 2010. Not until the August 2010 meeting does he see more than 50% chance of a change in the target rate. While the first increase may only be 25bps, he believes the Fed means business when they say policy accomodation may need to be removed fast, and sees possibly a second move between 50 and 100 basis points. He also thinks it is unlikely that the Fed will be using reverse repo heavily this year, and will keep the Fed effective low until year-end.
Beyond these policy observations however, one comment struck me in particular. According to him the Fed is watching very carefully risk appetite. Their removal of policy accomodation, whether it is low rates or liquidity facilities, will be driven just as much by a pick up in market risk appetite as by traditional economic indicators such as production and employment. It makes sense to think the Fed is watching the effect on risk appetite and potential asset inflation of the liquidity it is pumping in the system given that it is a just about universal worry that has triggered a lot of animosity towards the US's monetary policy. However what is interesting is to think right now the Fed views risk appetite as subdued. Is it really?
CapEx is still weak, but so is demand, so one can't really expect companies to plan for big expansion plans, especially given that the consumer and many coporations are considered over-levered already. But not just focusing on fundamentals, let's look at the markets: Commodity inventories are huge but prices have recovered massively, China's stock market doubled from the lows even when their capacity utilization is 60%, the Chinese stock market on July 28 traded more volume on the A-Share exchange in terms of notional than exchanges in New York, London, and Tokyo... COMBINED, US equities price in 4% established growth to come, Turkey's CDS is at all time lows when the country shares a border with Iran, Brazil's Bovespa is only 16% off its highs, up almost 4 folds from 2000 highs, and with a president that has not graduated from high school... Is that risk appetite or what??? When Venezuela feels comfortable enough to issue bonds in USD, I'd say risk appetite is pretty good.
I am not criticizing the Fed for trying to re-establish a certain sense of confidence in the economy and the markets before removing accomodative policies, but I fully disagree with what they think is still a lack of risk appetite. With electronic brokerage accounts and ETFs, money can move very fast, and I am not sure that the impacts of it are fully appreciated yet. Maybe the amounts invested in buy-and-hold strategies have not picked up drastically, but has it occured to anyone that given the state of the economy such strategies might be foolish? Money moves so fast into whatever is in fashion that price targets are blown by in days or weeks not years, and when it comes to credit: with defaults looming around every corner and firms like CIT considering bankruptcy after being rescued once already it is hard to ask for spreads to come back down close to all time lows. Here is an idea: maybe nobody will ever want the $1.3Tr worth of securities on the Fed's balance sheet unless housing prices rise 15% a year thereby improving recovery rate and reducing defaults on mortgages... If the Fed wants to go that route they better flood the system with some serious liquidity, because last time I checked real estate does not look like a great buy just yet. The risk may be that a certain form of risk appetite has disappeared and may not be back. There is a lot of money in a few hands that has really high speculative velocity, and on the flip side the average American's 401K is depleted and makes future unfunded retirement funds liabilities a solid issue that may not entice to gamble whatever is left. Average measures of velocity, liquidity, or production, may not tell the whole story.
Good luck trading,
Nic
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Basically the system is just as leveraged and risk neutral as pre crises levels but the system is infinitely more fragile? Literally greatest amount of speculation in the history of the world and way too many moving parts for the governments and CBs of the world to control all of them. Something will go pop and the cascading effect and ultimate collapse will be talked about for centuries to come.
"fragile"? kinda like todays 160pt dji swing?
...well my dear Tyler, tonight we are serving up some Citimonotonic with a delightful red wine, are you interested?
CIT Group, the lender nearing collapse under the burden of $30 billion in debt, has turned to Skadden, Arps, Slate, Meagher & Flom to negotiate a last-minute rescue deal with a group of bondholders represented by Paul, Weiss, Rifkind, Wharton & Garrison, according to sources close to the matters.
That news comes as no surprise. Skadden and Paul Weiss sat across from each other in July, when CIT negotiated the terms of an emergency $3 billion loan from its main bondholders, according to our previous reporting on the issue. That loan, on top of $2.3 billion in government bailout funds, was intended to shore up CIT's cash base going forward, according to the AP. Those measures apparently weren't enough, and CIT is on the verge of a deal with bondholders to cut about 40 percent of its outstanding $30 billion in debt in exchange for a significant chunk of equity, the AP reports. If that fails, CIT could file for Chapter 11 protection.
http://www.law.com/jsp/article.jsp?id=1202434211400&Skadden_Paul_Weiss_S...
Most folks lose their appetite after they choke on vomit
You do realize what you are saying right? Risk appetite is code for "bag holders". Until teh banx can dump the garbage off on someone else they can't crash the market. Duh.
Risk appetite? AIG traded at $55 a few weeks ago. CIT was up and down 40% in the past two days.
What more proof do they need?
I have a nightmare that I will still be alive when the Mother of All Ponzi Schemes finally beggars the nation, and the heroic, eco-friendly childless couples starve to death as they realize they forgot to manufacture their old-age meal tickets.
By David Kahane
http://article.nationalreview.com/?q=NzYyNGNlNTBkNmFlMjJiNzU1MzA3NzllMGM...
Anybody read Andy Xie's bottleneck theory? He projects that reflation attempts will result in excess liquidity creating a lot of bubbles as pools shift from one target to another, driving up prices and then cashing out, while the economy as a whole stagnates, or even deflates as excessive debt is destroyed.
And given the level of toxic debt still infecting the system, are the CB's countering it with anywhere near enough liquidity as it unwinds? Many people still see deflation as the elephant in the room, while the Fed is talking about tightening.
Way off topic, but did anybody catch The Daily Show tonight? They did a hilarious piece on high frequency trading.
" Maybe the amounts invested in buy-and-hold strategies have not picked up drastically, but has it occured to anyone that given the state of the economy such strategies might be foolish? "
Let me try to answer for them:
"Uhh, no. Why would we think that?"
"I am not criticizing the Fed for trying to re-establish a certain sense of confidence in the economy and the markets before removing accomodative policies"
And, by chance, are you also not criticizing the Fed for telling us everything was ok in 2006 and 2007? You kidding me?! I am very much a critic of this confidence game the Fed insists on playing. Further, what the Fed is, and has been, doing is far more than 'trying to establish confidence"... give me a break.
Risk has been bought out by traders looking for the riskiest assets and making a presumption that the Fed won't let anything fail.
Been a correct presumption so far, so we're in a situation where nothing can fail unless the Fed fails. So the hidden bet behind all these trades is that its impossible for the Fed to fail.
I for one believe that this bet on the Fed will be seen in the future to have been far riskier than it appears at this moment in time
Very interesting comment. I very much doubt that the Fed cares about risk appetite in a symmetric fashion. That is the whole problem with policy in the US. When risk appetite is too high, they do not think it is a problem. The risk appetite measures I look at say that it is nearly as high as it was in Q3 2007. Will the Fed do anything about it? Yes. They will pump it UP.
ReturnFreeRisk
The Fed will unload all of it's bad MBS (and other) assets just as soon as risk appetite for it shows up?!? Well, duh. But don't hold your breath...anyone who still has money, has it because they aren't stupid enough to buy a Fed's pig in a poke.
The Fed will sell it's bad assets just as soon as an appetite for them shows up?!? Well, duh. I would presume that there isn't any stupid money left....certainly not enough to buy the Fed's pig in a poke. The Fed is now a long term landlord.