Tuesday, 16 December 2008

Fed Slashes Rate to as Low as Zero; Hints Asset Purchases as Next Step

Just a few minutes ago, the Federal Reserve announced that it cut the benchmark interest rate to a range between zero and 0.25 percent. This is probably the penultimate step that policymakers have in mind before buying assets in the financial markets to prop up valuations and counter the worst economic crisis since the end of WWII. 

The Fed is also joining the league of aggressive central banks whose most memorable member is the Bank of Japan. We really hope that the U.S. economy isn't entering the same phase that japan entered in the early 1990s, when a deep recession forced policymakers to keep borrowing costs at zero for years as the country struggled with prolonged deflation signs.

The thing here is, nine reductions in the Fed funds rate and about $2 trillion of government money funneled into banks and the financial system have failed to avert what seems to be the worst recession after the Great Depression. The Fed said today it may expand the programme of repurchasing mortgage and other type of debt into other types of securities (and that is why Treasury and corporate bonds are rallying!) 

We are far away from the end of this crisis. Hopefully, once President-Elect Barack Obama takes office, the stimulus programme that he is devising now will help revive demand. Let's hope the recessive symptoms will only stay around until the end of 2009 and that some recovery signs will begin to be felt around a few months earlier than that. 

Do the Awful Job Data Readings in Sao Paulo Mean that Brazil is Nearing a Recession?

Today, the Sao Paulo State's Federation of Industrialists (FIESP) unveiled the industrial job figures for November 2008 in the most populous state in Brazil. The numbers were awful: 34,000 workers lost their jobs in Sao Paulo last month, following October's 10,000 dismissals. Fiesp said that out of 21 sectors surveyed, 14 fired staff, two kept the same amount of workers and only five hired new employees (Click here to read Fiesp's press note in Portuguese language.)

The bad news didn't stop there. The confidence survey by Fiesp showed that for the first time, business confidence fell below 40 points. Two-thirds of the executives surveyed said that credit dried up and eight in every ten said they were hit by a surge in borrowing costs. And Fiesp warns: ``The crisis is just beginning to unfold.'' Is the Brazilian entrepreneur panicking out?

I wouldn't say yes, even as very few people are actually betting on a downturn. Morgan Stanley economist Marcelo Carvalho is one of the few Brazil analysts saying that the economy is on the brink of a recession. He predicts zero growth next year, down from his prior forecast (which he emphasises was below market-consensus) of 2 percent. He argues that in previous occasions, the Brazilian economy experienced serious and quick downturns -- such as during the Mexico crisis, when growth slowed from 8.5 percent to zero in the space of just four quarters!

There are reasons to believe that Brazil is nearing a violent slowdown -- and proof of that is the government's decisive plan of action (we like it or not.) Carvalho foresees 200 basis points of rate cuts starting next month. The BNDES pledged to lend a record 110 billion reais next year (the problem is, would there be enough borrowers interested in raising money? for what investment projects?) 

For those who invest, stay in bonds. If interest rates drop dramatically (and now that inflation is finally giving signs of relief), the appeal of fixed-income will be, adding the safety of these investments, unbeatable along 2009. Stocks might be cheap but, with an economy growing zero and exports almost dead, the expectations of corporate profits should be nothing but disappointing.    

Follow-Up to ``Keep an Eye on Ethanol Producers'' (Sun., Dec. 14, 2008)

We said last week that the ethanol sector in Brazil would soon turn a concern for analysts and industry specialists (please see: ``Keep an Eye on Brazilian Ethanol Producers''.) Today, Deutsche Bank issued a report in which it recommends investors to remain attentive of developments in the industry, whose outlook it dubbed as ``worrisome.'' 

We will elaborate more as soon as we have more details on the content of the report. 

Latam CDS Market Faces First Real Test With Ecuadorean Default (Update)

Ecuador President Rafael Correa said yesterday that his government won't honour any forthcoming debt payments. The country is now in arrears and, as a consequence of that, it was given a selective sovereign default rating immediately by S&P and Fitch. Argentina and Venezuela bonds took the toll of Correa's decision (Venezuelan bonds dropped almost 1.5 percentage point during yesterday's session, according to Bloomberg.)

But the most interesting development of this tale will be the reaction by investors in the sovereign CDS (credit-default swaps) markets. This is the first sovereign default in the region since Argentina's in 2001, and with CDS markets in Latin America fully in motion and fashion.   The triggering of default clauses on Ecuadorean CDS contracts will tell investors what to do if another case of moratorium follows Ecuador's.  I have no information about the size of outstanding contracts and physical bonds, but the issue of default shouldn't be terribly worrisome given Ecuador's total debt size (a relatively small $10-$11 billion) 

One reader was wondering how the settlements would be done among underwriters and holders of Ecuadorean CDS. According to a report by IDEAGlobal that was distributed today, the counterparty risk associated with such default terms is minor because, as what we said above, the size of Ecuador's overall debt is rather small. IDEAGlobal continues: ``A cash settlement auction similar to those famously executed within the confines of the U.S. marketplace for defaulted financial institutions will perform as a bellwether to verify the orderliness of obtaining a clearing price for this debt instrument, as well as clarifying if in fact the market balance was as even as publicised.'' 

The question is, the market for CDS remains quite obscure in Latin America and it is necessary to begin working on a regulatory framework (or self-regulatory framework maybe?) to act orderly in a situation like this. Finally, the closure of Ecuador CDS transactions may lead to an increase in offered prices for Ecuadorean debt instruments in coming days, so stay attentive to new developments.
 

John Bird and John Fortune -- A Lesson on the Subprime Mess

This is a classic. I recommend you to see it. It's a sketch by English comedians John Bird and John Fortune.

Earlybird, Dec. 16, 2008

Headlines for Dec. 16, 2008: 

MARKETS -- Third of Hedge Funds May Disappear as Returns Sink: (Bloomberg) The hedge fund industry is facing a hemorrhage of redemptions and will need to reinvent itself if it's to stay in business. Returns are at a 18-year-low and the recent scandals involving some firms (such as Bernard Madoff's) are driving investors away. In Latin America, the same model that's unraveling in the U.S. and Europe will continue to work, for a little longer.  

BRAZIL -- Companies Begin to Negotiate Employee Perks to Weather Crisis: (Estado) The government may be ready to help mediate negotiations between industry groups and trade unions over the easing of some labour laws that make it harder for companies to fire staff or reduce high labour costs. The story says that 
Lula himself will help mediate such talks -- something that probably tells us that the president is rather worried with the impact of the crisis on the labour market. Although some easing in labour rules is necessary, we insist here that the scope must be long-term, not a palliative measure to fight the effects of the credit crisis.  

BRAZIL -- Vale Buys 50 Percent Stake in African Miner: (Valor) Vale took advantage of the cheap valuations in the industry and bought for C$81 million a 50 percent stake in African Rainbow Materials Ltd. of South Africa. Vale is expanding in copper mining and it may step up acquisitions of rivals as it still has spare cash to do so. 

BRAZIL -- Brazil Government, Companies Borrow Least in Six Years: (Valor) Nice story by Cristiane Perini. Companies and the government of Brazil only borrowed $2.5 billion in the third quarter, the smallest amount raised in international capital markets since the last quarter of 2002 (remember when Lula's victory roiled markets?) It's logical -- risk perception has been worsening and since the crisis started, access to funds is limited. Perhaps we will see a migration to financing such as multilateral lending, or syndicated loans backed by guarantees issued by supranational or multilateral agencies. Banks are trying to avoid getting too exposed to borrowers in emerging markets or specific industries -- such as consumer goods or manufacturing.  

LATIN AMERICA -- Summit Starts in Brazil as Rifts, Disputes Grow: (La Nacion) The presidents of South American countries started a summit today that will probably focus on the response to the credit crisis afflicting the global economy. Nonetheless, the summit takes place amid growing rifts between Brazil and Ecuador and Paraguay over the legality of credits the former gave to the latter countries, as well as formal opposition by Uruguay (and veiled by Peru and Colombia, I was told) to the nomination of former Argentina President Nestor Kirchner to assume the presidency of Unasur. The conclusion will surely be, 1) let's not talk about investments here, and; 2) let's keep spending in great fashion to avert a slowdown. Let's not forget that there will be a heavy election calendar in Latin America in 2010 -- and politicians don't want to see their economies slowing down significantly before election time.