As I walk into work this morning, I am surprised to see the futures down some 7 points from last nights Globex session, from watching the idiot box, one would assume that the markets wont ever go down ever again. This is in stark contrast to the print/blog media who are still not convinced that we have seen the worst. How strange is this? The print media is more suspicious then TV? Yes, correct after being spoon fed lie after lie about "Yellow Cake", "Mushroom Clouds", and "CIA Gate", most of the print media fell for it whole, after the fact they looked like fools, so naturally now they are more reticent to follow the herd. Very smart and correct of them.
Back to business of risk and credit.
The US $$$$ has made fresh lows for the year, as more unwinding of the safety trade is happening. Investors/traders are selling any risk averse asset to claw back into equities which is the ultimate risk class.
Is this good for the markets? Yes, as it will keep a bid in for equities.
Is it good for Main Street? Hmmm...short term good as people will feel good about the economy, and rising 401k balances, although we all will have to wait a long time before daylight here.
Is this good for Wall Street? NO! Let me explain. Although the equity side of Wall Street will do very well, its the fixed income/credit side that gets the girl.
You see, as the credit markets have healed, money is flowing back into equities, at the expense of MBS, Corporates, and Treasuries. This one single unraveling of the safety trade has lifted global equity prices.
Trading in debt like corporate and MBS have been a boon to banks as an aversion to taking risk has kept the range of prices between bids and offers wide in the second quarter. The wider the price band, or the bid/ask spread, the greater the profit opportunity when making a sale.
Some spreads have now closed to their tightest levels since before the worst episodes of the financial crisis in late 2008, illustrating a technical, but key, part of the credit market recovery. Spreads will contract further if volatility slows, leaving banks to turn elsewhere to boost profit.
You would think the competition was stripped out of the market with the demise of Bear/Lehman, but competition is as fierce as ever, and spreads will tighten even more.
Trading played a huge role in helping banks/financials out of their toughest period in decades after the collapse of Lehman Brothers. GS for example, this month reported $3.4B in 2ND Qtr net income after trading revenue almost doubled. Looking ahead, thinner bond trading profits mean the banking recovery, the expansion of much needed credit and the return of U.S. economic growth could be delayed.
Back to competition and spreads.
Tighter spreads are coming amid a growing playing field, where smaller firms are filling holes left by the exit in 2008 of big shops such as Bear Stearns and Lehman. Jefferies, Broadpoint Capital, TD Securities MF Global, and Citadel are among those that have ramped up trading ops. The end result is spreads have come in, volatility stripped out, and the frequency of transactions is a lot lower. All of this is going to hobble profits for the foreseeable future if equities continue to get a bid at the expense of bonds.
Implications of Tighter Spreads.
Tighter trading spreads are correlated with other positive trends, such as smaller risk premiums as measured by bond yields, which were following signs of economic rebound and support from U.S. government programs. As sentiment improves and volatility ebbs, the bid/ask should shrinks because dealers take less risk in trading and more are willing to make markets for investors.
In the Commercial MBS market for example, bid/ask spreads have returned to 20 basis points, around levels of mid-2008, from as much as 100 basis points at the depths of the credit crisis in late 2008, according to one trader friend of mine. Yield spread premiums on CMBS have declined to near 600 basis points, less than half their peak in November. CMBS bid/ask spreads were as little as 2 basis points to 4 basis points in 2006 and early 2007.
Although banks can still profit as more demand in credit markets reduces yield spreads on inventory, and because they can fund themselves at levels close to zero, Thanks Ben Bernanke! A return to record tight trading spreads may never occur, meantime, given a new, lower floor to what traders consider acceptable risks.
What does this all mean? Well Goldman will be OK, as they are virtually and realistically bankrolled by the Treasury/FED, but other bigger shops will have bad trading comps going forward, meaning estimates have to come down.
No comments:
Post a Comment