Wednesday, November 5, 2008

Long Term Interest Rates Drop

Long term interest rates, as shown on the 5 year and 10 year AAA rates, eventually drop in a consecutive 4 days, to 6.79% and 8.29% respectively. However, the spread between them and the FED target rates, 5.79% and 7.29%, remain high and higher than 3 months prior at 2.98% and 3.92% respectively. Further observation is needed to determine if the loan market will further lessen despite the fact that immediate liquidity issue is relaxed by FED money injection program. It can be further verified by the M2 supplies announced on thursday for last week.

Corporate bond market confirms this message. Corporate bond indexes show that the total return value, price, yield and volume of transaction increased. This is a mixed message: on the one hand the bond price advances with the drop of interest rate (i.e. discount rate); on the other hand, coupon also increases which indicates the issuers have to offer a higher coupon rate to attract investors for a justified risk-adjusted rate of return. Meanwhile, the volume increases reveals that equity market, to corporates now, is still not the market for finance. Nor do the investors are willing to completely return to equity market owing to the high risk of insolvency of corporates in the recent future.

Combining both the loan market and corporate bond market performance, even though corporate risk of immediate liquidity issue may have lessen by FED money injection policies, in the long run the risk of insolvency still exists. The market is resettling to a reasonable level, which is still high comparing with the level 1 year or even just 3 months prior.

Mortgage Rates also start to drop yet but a few basis points only - insignificant to claim the ease of property market. With the property market at risk, the down side of the equity market and even money market are still valid and threatening, though may not be at the paranoid level before.

US T-bill have price dropping and yield rising. An indication that money injection program injects some confidence to the market of which previously un-harmed investors start to long for relatively low P/E, i.e. cheap, stocks. Money is moving out from shelter to the market for the moment.

In conclusion, immediate liquidity issue of the market stops progressing. Bank is willing to do short-term loans as reflected on decreases on LIBOR. It is also willing to lend money to corporates at a safe (i.e. high) level. Corporates can borrow money to continue operation and longer term projects if they can afford a higher cost of equity. The once broken money flow is restored, though the volume and speed are way weaker than before.

1 comment:

Felix Kan said...

But still, restored liquidity does not change the slowdown of the economy recently hammered by real estate prices and layoffs.

even if banks are more willing to lend now, there is not enough buyers / consumer of goods out there anymore.

de-leveraging still in its works