Sunday, October 26, 2008

Exceptional Movement on Rates

LIBOR is down but the crisis is far from over.
5 Year and 10 Year banking and finance rate, after the continuous drop from last Monday, has increased to the new high 7.03% and 8.31% respectively on Friday, following the plummet of US stock market.

Apparently the market is worrying about both the profitability and solvency issues of the corporates. With an expected huge retreat on corporate profits, the operating cash flow that can at least pay off the cost of working capital will be greatly decreased. The potential enormous write-off and impairment on short-term investment and hedging is already no news. Even if LIBOR is decreased enough for corporates to survive today, their abilities to deal with their loans and losses, and hence their longer term of survival, are highly questioned by the market. Any banks, in trouble or not, will no longer provide windows for corporates to re-finance, or even finance potential long term projects. The increase on AAA banking and finance rate, plus the high corporate bond coupon rate at 10% by giants like GE and Caterpillar, are proofs to the above observation.

Under huge credit pressure, plus the plummet of commodity markets, a traditional hedging tool of USD inflation, further dries up the pool of current asset of the corporate, and drives them to sell as much of these asset as possible to stop loss, polish their balance sheets, and preserve cash to fund the projects/operation of the coming year, under the assumption that no new line of credit will be available.

The collapse of these markets will also induce the collapse of the high-yield commodity currency. USD's strength against these currencies is a proof. The drops on the T-bill yield is another. Besides, the spread between yield and target rate keeps narrowing, another hint on the closed-money-loop: money loant by FED to banks will simply go back to FED via t-bills, at the absence of other low risk investment tool.

Combining the above observations together, it is too early to say the market has already reached bottom. The new figures and saving measures showing up on the coming weeks may ease the pressure by little; nevertheless, as long as Main Street and Wall Street as well as property market are still dropping, and the black holes of the corporates have not been filled up, all the measures by FED are only pain-killers with its potency shrinking unstoppedly.

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