The Carry Trade Currencies

From Chris Gaffney in The Daily Pfennig:

The best performers over the weekend were the Japanese yen and Swiss franc, both traditional funding currencies of the carry trade. As Chuck [Butler] has explained several times in the past, when market volatility increases, traders typically start to exit the carry trades which are only profitable during times of relative calm in the markets.

The reversal of the carry trades means investors sell the emerging markets and high yield currencies and use the funds to pay down loans which they had taken out in the low yielding 'funding' currencies of Japanese yen and Swiss francs. The Japanese yen strengthened as much as 3.4% vs. the US dollar overnight, and the Swiss franc had the biggest one day gain in six months.

We think that gold is also being used as a carry trade 'currency' as well, as the central banks lease their gold bullion cheaply to the commercial banks, similar to the low interest rates carried by the yen and Swiss franc.

The gold is sold off, probably to the ETFs and the metals markets, and is largely not returnable to the central banks in many cases. This is one of the reasons why the gold price is becoming so volatile; the 'printing' of gold by central bank leasing does not really create anything, it only distorts the market longer term.

Some day that volatility may become breath-taking.

Chris Gaffney continues:

I have to say I am surprised Treasury Secretary Paulson stayed away from helping another bunch of his Wall Street buddies. I read where Paulson said Wall Street has been aware of Lehman's troubles for a long time and had time to prepare for any crisis at the company. I know we closed out all of our currency trades with Lehman a couple of months ago, and hopefully most other prudent companies did the same.

I hope this weekend's events are an indication that some sanity has returned to the Treasury department, and a line has been drawn after the widest expansion of federal safety nets to the financial system since the Great Depression. Its about time we quit guaranteeing the losses at these huge financial firms.

More likely Lehman was a token gesture to free markets as we had suggested last week it might very well be. Paulson and Company appear to be willing to do whatever it takes to control the situation and the markets, to 'inspire confidence' in the system, to feed the bull market in insensible complacency.

In the short term this is a viable strategy, but at the cost of a disabling of the free market system, and significant unintended consequences down the road.

We wish them well, but don't think they have the right motivation and character to achieve a sustainable solution hat would involve systemic reform. They are creatures of the status quo.

Underperforming Banks and Thrifts Most Likely to Fail, ex-Bailouts

CyclePro has updated his list of banks and thrifts which he feels are most likely to fail. You can view his methodology here: CyclePro

The inclusion of Bank of America and Goldman Sachs among the big banks is surely a gutsy call. But remember this list is ex-bailouts and Federal support. Both banks seem to have reserved place settings at the public trough.

His analysis is always interesting, but alas like most good things infrequently available. We have it among the links on this site's sidebar.

His blog is worth watching, and scrolling down through prior posts to see some of the gems there. We have referenced his long term chart and analysis of the deflated DJIA before. Its a pretty grim picture.

Central Banks Soothe Nervous Markets

Kumbaya My Lord, Kumbaya

Someone's cratered Lord, Kumbaya

Need a Rate Cut Lord, Kumbaya

Oh Lord Kumbaya


ECB, Bank of England Join Fed in Soothing Markets After Lehman
By John Fraher

Sept. 15 (Bloomberg) -- The European Central Bank and the Bank of England joined the Federal Reserve in taking action to sooth financial markets spooked by Lehman Brothers Holdings Inc.'s bankruptcy filing.

The ECB said it awarded banks 30 billion euros ($43 billion) in a one-day money-market auction that was more than three times oversubscribed. The Bank of England loaned banks 5 billion pounds ($9 billion) for three days. Earlier, the Federal Reserve widened the collateral it accepts for loans to securities firms.

Stocks plunged and bonds surged after Lehman became the latest victim of a yearlong credit squeeze. Financial institutions worldwide have reported more than $500 billion in losses and writedowns and the credit-market turmoil has erased $11 trillion from global stocks in the past year.

``It remains to be seen whether today's operation will be sufficient to restore market confidence,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc. ``The ECB will likely wait for the U.S. open to consider more aggressive action. Key will be how credit and equity markets develop in the coming days.''

ECB President Jean-Claude Trichet told reporters in Frankfurt as he arrived for an award ceremony that he had nothing to add to today's statement. The ECB said it injected the funds at a marginal rate of 4.30 percent. The Swiss central bank offered liquidity through its overnight facility for the first time since Feb. 22.

The ECB and the Bank of England may nevertheless hold off cutting rates right away as they seek to curb inflation. The ECB has spent much of the past year arguing that it can use its money market operations to tackle the credit crisis and doesn't need to resort to rate cuts.

``Rate cuts are only likely to be forthcoming if financial markets melt down in the coming days or weeks,'' said David Mackie, chief European economist at JPMorgan Chase & Co. ``For the time being, European policy makers look like they will continue to hold the line on the separation of powers. At some point though, that line could be reached.''

The cost of borrowing on money markets may also jump. The so- called OIS spread, the gap between three month dollar funds and traders' bet on the Fed's daily effective federal funds will rate, widened to 105 basis points today, the most since Dec. 6. That compares with 87 basis points at the end of last week.

Story of a Firm Offer for Merrill Lifted Stock Index Futures Off Lows

No source and the companies refuse to discuss, but it looks a little more likely than it did two hours ago. Its hard to believe that the WSJ would print this as fact without qualification if they did not have it from good sources.

But then again....

Keep an eye on the progress with Lehman and Merrill, but don't forget about AIG and Washington Mutual, aka Fatman and Little Boy. And then there's Morgan Stanley and Goldman Sachs....

Wall Street Journal
Bank of America Reaches Deal for Merrill
By MATTHEW KARNITSCHNIG, CARRICK MOLLENKAMP and DAN FITZPATRICK
September 15, 2008

In a rushed bid to ride out the storm sweeping American finance, 94-year-old Merrill Lynch & Co. agreed late Sunday to sell itself to Bank of America Corp. for roughly $44 billion.

The deal, which was being worked out in 48 hours of frenetic negotiating, could instantly reshape the U.S. banking landscape, making the nation's prime behemoth even bigger. The boards of the two companies approved the deal Sunday evening, according to people familiar with the matter.

Driven by Chief Executive Kenneth Lewis, Bank of America has already made dozens of acquisitions large and small, including the purchase of ailing mortgage lender Countrywide Financial Corp. earlier this year. In adding Merrill Lynch, it would control the nation's largest force of stock brokers as well as a well-regarded investment bank.

A combination would create a bank of vast reach, involved in nearly every nook and cranny of the financial system, from credit cards and auto loans to bond and stock underwriting, merger advice and wealth management.

It would also show how the credit crisis has created opportunities for financially sound buyers.At $44 billion, or roughly $29 a share, Merrill would be sold at about two-thirds of its value of one year ago, and half its all-time peak value of early 2007. Merrill shares changed hands at $17.05 each on Friday, after falling sharply in the wake of Lehman's looming demise.

"Why would Bank of America do this?" said analyst Nancy Bush at NAB Research LLC in Annandale, N.J. "Ken Lewis always likes to buy the biggest thing he can. So why not this? You are master of the universe, basically."

Bank of America and Merrill Lynch wouldn't comment on any discussions.

Merrill would give Bank of America strength around the world, including emerging markets such as India. And Merrill is also strong in underwriting, an area Bank of America identified last week at an investors' conference where it would like to be more aggressive. ...