• Citigroup (NYSE:C) plans to sell Bellsystem 24, a Japanese telemarketing company, to Bain Capital for $1 billion, bringing to $10.8 billion the dollar amount Citi has raised from sales of Japanese assets

• Hedge fund Paulson & Co. reported in a September 30 filing Citigroup (NYSE:C) holdings of 300 million shares, valued at $1.45 billion

• Cisco (NASDAQ:CSCO) raised its bid for Tandberg ASA to $3.4 billion, or about an 11% increase, and extended its offer to December 1

• According to a Bloomberg report, Mitsubishi UFJ has hired JP Morgan (NYSE:JPM) and Morgan Stanley (NYSE:MS) to manage an $11 billion secondary offering, Japan's largest ever. The company plans to sell about 2.5 billion common shares

• Bristol-Myers Squibb (NYSE:BMY) said it plans to spin off its 83% stake in Mead Johnson Nutrition Company

• JP Morgan (NYSE:JPM) said it is offering to purchase the remaining 50% of stockbroker Cazenove, placing a valuation on the firm of $3.32 billion

• General Motors (NYSE:GM) plans to start repaying its Treasury loan early, beginning by yearend with $1 billion quarterly installments to the US and $200 million quarterly to Canada

• General Motors' (NYSE:GM) third quarter revenues bettered estimates at $28 billion versus $22.9 billion expected, rising $4.9 billion from the second quarter. Inventories dropped 158,000 to 424,000

• Lowe's (NYSE:LOW) reported inline third quarter earnings of 24 cents on revenues of $11.38 billion, versus Zacks estimates of $11.27 billion.  The company said, "We are beginning to see signs of improved performance in some of the hardest-hit housing markets including California, Florida and areas of the desert Southwest."

The table at the right summarizes the percent change between January 6 and November 11 in the cash prices of 19 commodities reported in the Wall Street Journal (downloaded via Webstract). The average commodity in this list has appreciated 37% since the start of the year.

A recent paper by Ke Tang and Wei Xiong documents an increasing tendency for commodity prices to move together over the last few years. A decade ago, what happened to oil prices was largely unrelated to movements in most other commodity prices. The graphs below show how the correlations between oil prices and the prices of four representative commodities have increased significantly over time.

Correlation (using a rolling sample beginning one year before indicated date) between returns on oil and specified commodity. Source: Tang and Xiong (2009).

One explanation I often see in the popular press is that movements in commodity prices are driven by changes in the value of the dollar relative to other currencies. However, the magnitude of movements in commodity prices greatly exceeds the size of changes in the exchange rate. For example, the table above shows that since the start of this year oil prices have increased five times as much as the dollar price of a euro; see also Steve Gordon's graphs. While the depreciation of the dollar is part of the story, most of the explanation must be found elsewhere.

Another important factor is resurging real economic growth outside the United States, which produces pressures for both the dollar to depreciate and the real price of commodities to appreciate. According to this theory, the increasing correlations between commodity prices results from the fact that countries like China are so much more important for the world economy today than they were a decade ago.

A third explanation is that investors are making increasing use of commodities as an investment class. Although Treasury Inflation Protected Securities offer a hedge against an increase in the U.S. consumer price index, they don't offer protection for foreign investors against depreciation of the dollar. Insofar as increases in the prices of commodities like oil may depress real economic activity, holding commodities as an investment also offers useful diversification against risks to equities. Particularly when interest rates are low, there is an incentive to hoard physical commodities as an investment vehicle.

The paper by Tang and Xiong proposes that the increased use of commodities as a financial investment accounts for the increasing correlation among commodity price changes over time. In support of that claim, they note the growing popularity of investment strategies based on the Goldman Sachs Commodity Index or the Dow Jones Commodity Index. Tang and Xiong document that correlations among commodities included in the indexes have increased faster than those not included. For example, one of the regressions they estimate relates the return on commodity i to equity returns, bond yields, the value of the dollar, and oil prices, where the coefficients are allowed to grow with time at different rates before and after 2004, and with different trends on these coefficients estimated for commodities included in indexes as for those excluded. The figure below shows their estimated time path for the coefficient on oil prices comparing the indexed and non-indexed groups.

Coefficient relating return on average commodity to return on oil as a function of time for commodities included in the GS or DJ indexes (top curve) and those excluded (bottom curve). Source: Tang and Xiong (2009).

For any of the explanations in this third class, one of the important challenges is to reconcile the story of commodity speculation with supply and demand for the underlying physical commodity. If we propose that speculators have driven the price of the commodity up, the physical quantity demanded should decline as a result. In order to be sustained, a coherent speculation-based theory of commodity price appreciation requires increased physical storage of the commodity.

The solid black curve in the figure below plots the typical U.S. crude oil stocks (excluding those held in the Strategic Petroleum Reserve) for each week of the year, based on the average over 1990-2007. The red line gives the actual values for 2008, which were significantly below the historical average, particularly in the spring of 2008 when oil prices were rising so dramatically. Those below-normal inventories were one reason I focused on what was going on to the fundamentals of supply and demand in trying to understand the behavior of oil markets in the first half of 2008.

Weekly U.S. crude oil ending stocks, excluding SPR, in thousands of barrels, from EIA. Black line: average over 1990-2007. Red: 2008. Green: 2009.

On the other hand, inventories of crude oil this year, shown in green above, have been substantially above normal, meaning that in the absence of that oil going into storage, we would have expected to see lower oil prices than we currently have.

Moreover, much of the current stockpiling may be taking place outside the United States. For example, Yves Smith noted this story from Bloomberg last August:

Copper, nickel and other base metals stockpiled by speculative Chinese investors including pig farmers may be sold when "market sentiment turns," said Scotia Capital Inc.

A price surge and easy bank credit this year encouraged pig farmers, stock brokers and businessmen to buy copper and nickel for speculation, Liu Na, an analyst with Scotia Capital, wrote in a note dated Aug. 17, citing reports from the state-owned China Central Television....

"These stockpiles are in 'weak hands' as speculators have no real use for base metals," Liu wrote. "When the market sentiment turns, they are very likely to turn into quick sellers, especially when the bank's money is involved."

I also found this November 3 story from the Financial Times of interest:

Gold prices continued to rise on Wednesday extending the all-time highs which followed India's central bank bought 200 tonnes of the precious metal, swapping dollars for bullion as the country's finance minister warned the economies of the US and Europe had "collapsed".

India's decision to exchange $6.7bn for gold equivalent to 8 per cent of world annual mine production sent the strongest signal yet that Asian countries were moving away from the US currency.

Policy-makers in the Federal Reserve have traditionally thought of inflation as a broad movement in all wages and prices, which to some extent is under their control, and viewed changes in relative commodity prices as outside their control. I believe that this is not the correct understanding of the current situation. Concerns about inflation, particularly on the part of foreign dollar-holders, are likely to show up first in the relative prices of internationally traded commodities. Insofar as these relative price changes can be destabilizing in themselves, it cannot be wise for U.S. policy-makers to ignore them.

Sterling's paper is in part a response to earlier analyses by John Taylor (2008, 2009) and John Cochrane and Luigi Zingales who noted that the spread between the LIBOR interest rate (London Interbank Offered Rate) and the OIS (Overnight Index Swap) rose only gradually following the Lehman bankruptcy, leading these scholars to see Lehman as just one of many relevant developments at the time. But Sterling questions the meaningfulness of the LIBOR or OIS indicators during these weeks given that markets seized up and little trading activity was occurring in these instruments. Sterling instead proposes to take a look at Bloomberg Financial Conditions Index, which Bloomberg launched in August 2008. The index is based in part on the observations by Rick Mishkin on some of the regularities observed in earlier historical financial crises. The components of the Bloomberg index are as follows:

Source: Sterling (2009)

Here's Sterling's graph of the behavior of the Bloomberg index, in which the remarkable character of events following September 12 is pretty striking.

Source: Sterling (2009)

Even if the Lehman failure is agreed to as a definitive event, it is not clear to me that this establishes that all would have been fine if the Fed had only bailed out Lehman as they had Bear Stearns and AIG before. That question is inherently and unavoidably counterfactual. We can't know-- and decision-makers at the time couldn't know-- which domino might have been next to fall had this one been propped up.

But I think it is fair to conclude that the middle of September of 2008 marked a clear turning point in the unfortunate sequence of events through which we have recently come.

It is indeed an old adage that while goods things are to be preferred over bad things it is possible to get too much of the former. Looking at recent comments from the governor of the Reserve Bank of Australia it is not difficult to imagine how these, albeit old and worn, pearls of wisdom may well have inspired Mr. Stevens in his effort to tiptoe the thigthrope between signalling the intention to raise rates into an expected economic recovery on the one side and trying to prevent the Aussie shoot of on helium into the sun with wings of wax on the other.

(quote Bloomberg)

Australia’s central bank Governor Glenn Stevens signaled a surge in the nation’s currency to near parity with the U.S. dollar has given him scope to slow the pace of future interest-rate increases.

Stevens, who yesterday became the first central banker in the world to raise borrowing costs twice in 2009, said the 28 percent gain in the currency this year may hurt exports and cool inflation, allowing him to “gradually” raise borrowing costs. Just last month, he warned it may be “imprudent” to keep rates at “emergency levels.” The local currency and bond yields fell as traders slashed bets on another quarter-point boost next month, after Stevens raised the overnight cash rate target to 3.5 percent from 3.25 percent. Investors have been driving the Australian dollar toward parity with the greenback, betting China’s economic growth will boost exports from Australia, the biggest shipper of iron ore used in making steel.

Policy makers “are probably glad for the parity talk as it reduces the amount of work they need to do with monetary policy,” said Matthew Johnson, an interest-rate strategist at UBS AG in Sydney. “A December move is a 50-50 proposition.” Traders are betting there is a 50 percent chance Stevens will increase the key rate by another quarter point on Dec. 1, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange at 12:22 p.m. today. Prior to Stevens’s comments, they had a 96 percent bet on such a gain.

Mr. Stevens' comments follows in the heels of the recent push by part of the Aussie towards parity with the US dollar reflected primarily in the fact that the RBA has already raised twice in 2009 (from 3.00 to 3.5%) as well as a growing risk sentiment which is a fundamental prerequistie, in the current market, for observing investors react to (growing) yield differences. In so many words, this is all about carry trade and more specifically about the fact that in a world where the G3 and others are still fiddling with quasi- or outright QE it takes a brave sould to initiate a hiking process since it will mean an immediate reaction in the currency market. This is especially the case when the liquidity anchor effectively constitutes the US and thus; while the US pump priming keeps a floor under risky assets and volatility at low levels it becomes a veritable turkey shoot to gun for those currencies whose central banks are on the hike (see more here).

Following Mr. Stevens' comments, the Aussie did lose a bit of its steam even if many currency punters still see it racing towards parity over the course of the coming year.

For example David Forrester who is currency economist at Barclays Capital expects the Aussie to test the parity level in 2010, a call based on the idea that the RBA will have hiked rates to a full 5.5% by the end of next year. Needless to say, in a world where risky assets continue to fly and risk aversion is kept in check this will provide a juicy interest rate differential vis-a-vis the G3 and thus the carry trade flows (be they actual carry trades or simply spot market piggy backing) will be plentiful. 

The question is of course; can you blame the RBA for wanting to raise rates?

As it turns out, not really and particularly not in light of global central banks' new found focus on asset prices in setting the policy rate. You know, it was all Greenspan's fault and all that jazz. Still, for those worried about a too rapid V-shaped recovery, Australian house prices seem to offer plenty of things to worry about.

From Q3-08 to Q1-09 the house price index (weighted for the 8 biggest cities) fell a modest 5.6%, a drop which has been decisively paired in Q2/Q3-09 with the index rising a cumulative 8%. This picture is repeated if we look at a general gauge for consumer spending in the form of a sector break down of retail sales.

Consequently, the annual as well as monthly flow of retail trade turnover never really went decisively into negative in the context of the financial crisis which has no doubt contributed to the fact that the RBA never really contemplated a move into ZIRP and QE.

What happens next then?

Well as I noted recently, the burden of rebalancing may be tough to carry for those economies who have central banks brave enough to raise interest rates. Ironically of course and if it is really asset prices you are worried about, the risk is naturally that you just end up sucking in liquidity as you which in itself defeats the purpose of the hiking campaign (see Edward's recent piece on Norway for a Scandinavian perspective on this). Naturally, you can retort to Brazil like capital controls, but in a world where capital flows freely and where the global economies are largely interdependent, this is like trying to stop a freight train with a VW Polo. Also, allow me to finish with a small quibble of mine in relation to the sudden urge by part of central bankers to target asset prices. I mean, this is fine and all and for those who know a little bit about monetary policy this is not something completely new. The problem is merely that targeting asset prices may not only be counterproductive in a world where asymmetric liquidity conditions and carry flows are the norm, by targeting asset prices also entail targeting a price which is considerable more volatile than traditional prices (because I assume that forecasting long term asset prices is not as easy as many believe). In this way, a steady gaze at asset prices may also conflict with central banks' general propensity to favor incremental and gradual moves.

Whether this is the case in Australia, only time will tell. Yet, from the lovely fjords of Oslo, to the beaches of Rio, and on to the Great Barrier Reef policy makers may soon learn that you can indeed get too much of a good thing.

Matt’s argument is that “most ETNs offer daily redemptions at net asset value, meaning that (even ignoring the quoted market) an investor of size (50,000 shares in the case of iPath ETNs) can sell out of the product within 48 hours and get the full net asset value of the note from the issuer.”

In other words, even if you become concerned about the credit risk of the issuer and there is insufficient liquidity in the secondary market for you to trade, you can get out of a position by selling it back to the ETN issuer.

I agree with Matt that the tax treatment of ETNs gives them a huge advantage for US investors (ETNs are taxed at long-term capital gains tax rates and only on a deferred basis when sold, rather than annually like ETFs). ETNs also offer superior tracking ability since the issuer bank guarantees to pay you the relevant index return.

It’s also undoubtedly true that the credit risk component in banks’ unsecured debt (of which ETNs are a part) has dropped substantially this year, as can be easily seen by plotting a chart of credit spreads or from a glance at the counterparty risk index, so the market is telling investors that the risks of ETNs are nowhere near as large as they were (less than a third the levels of February this year, in fact, if you look at an average of issuers’ CDS spreads).

All the same, I’m a little uneasy about his argument.

Matt’s reassurance that you can put back an ETN holding to the issuer within two days, giving you time to get out if there are problems, sounds fine in theory but may not offer you full protection in practice.

There was a fascinating article yesterday on Bloomberg in which reporters Richard Teitelbaum and Hugh Son tell us that during the summer months of last year, AIG was trying to write down – by up to 40% – the value of credit default swaps it had written to banks.

The central thrust of the Bloomberg article is that the Fed, which paid out AIG’s unsecured creditors at par, was more generous than it needed to be by paying out counterparties in full rather than enforcing a “haircut”.

The reporters quote Janet Tavakoli, a credit market specialist, as saying, “There’s no way they should have paid at par. AIG was basically bankrupt.” As an example of a haircut being applied in similar circumstances, the article cites a case involving Citigroup Inc., which last year agreed to accept about 60 cents on the dollar from New York-based bond insurer Ambac Financial Group Inc. to retire protection on a US$1.4 billion CDO.

What’s the relevance of all this to ETNs? Well, the whole question of whether unsecured bank creditors (such as ETN holders) should be protected by the authorities or forced to accept some cut in the amount they are due if the institution concerned gets into difficulties (or, for example, to suffer a forced conversion into equity) has been swept under the carpet since credit market concerns peaked earlier this year, but it hasn’t gone away.

If anything, given public disquiet at the way banks have gone back to “normal” in their pay policies while still relying on taxpayer support, I’d argue that it would be much harder for governments to convince the public that financial institutions must be saved at all cost should we enter a second round of the credit crisis.

But, more importantly, the Bloomberg article tells us that a writedown of creditors’ claims against AIG could quite conceivably have been negotiated and then imposed across the board with little or no warning. Such negotiations were apparently going on in private and, while they didn’t lead to any settlement, it would be foolish to imagine that such a scenario could not happen again.

So, all in all, Matt, while I agree that unsecured debt exposure to banks via ETNs may well make sense for a number of reasons, this type of investment instrument is likely to remain a poor cousin to ETFs in the tracker market. With almost all ETFs, investors are collateralised and shouldn’t have to lose sleep at night over credit risk.

[This blog originally appeared on IndexUniverse.eu, the leading source for insight and analysis into the European ETF market.]

(From Bloomberg)

U.K. gross domestic product unexpectedly dropped in the third quarter as enduring slumps in services, manufacturing and construction kept the economy mired in its longest recession on record.

Gross domestic product dropped 0.4 percent from the previous three months, the Office for National Statistics said today in London. Economists predicted a 0.2 percent increase, according to the median of 33 forecasts in a Bloomberg News survey. The economy has now contracted in six quarters, the most since records began in 1955.

Chancellor of the Exchequer Alistair Darling said this week he will focus on spurring economic growth as he struggles to cement a recovery in time for a general election due by June. Today’s data may add to pressure on Bank of England officials to expand bond purchases at their Nov. 5 decision after completing a plan to buy 175 billion pounds ($291 billion) in assets.

Where goes Sterling on this?

First, a little background. The traditional tool of monetary policy is an open market purchase, in which the Fed purchased U.S. Treasury securities that had previously been held by someone in the private sector. The Fed would pay for those securities by crediting deposits in an account that the selling bank had with the Federal Reserve. These reserve deposits of banks represent claims that the bank could use, if it wished, to withdraw green currency from the Federal Reserve. The volume of reserve deposits historically was extremely important in determining the interest rate at which banks would lend the deposits to one another overnight. The traditional understanding of monetary policy was that the Fed would use open market purchases to achieve its desired objectives for the overnight interest rate and the money supply.

If the Fed wished to implement a purely temporary increase in the volume of reserve deposits, historically the tool of choice was a repurchase agreement, in which the Fed would buy a particular security with a promise to return it at a specified future date. The purchase was again implemented by creation of reserve deposits, and when the security was returned, those deposits came back into the Fed.

The Fed began to see a new potential use for these repos after the initial banking difficulties in August 2007. Although repos were traditionally used as a device for temporarily injecting reserves, their structure amounts to a collateralized loan from the Fed to the counterparty. The Fed's objective subsequent to August 2007 was to increase the volume of its lending and support the market for certain securities that it could accept as collateral for repos. Thus the Fed utilized an expansion of repurchase agreements as one of the initial tools for responding to the crisis, simply rolling them over to create a de facto expanded lending facility.

The graph below tracks the various assets held by the Federal Reserve since the beginning of 2007. The height of the graph represents the total asset holdings at the end of each week, with the colors indicating the contribution of each category. Repos are represented by the turquoise band. This traditionally had been small and highly variable, but grew significantly in the early phases of the financial crisis. Later the Fed came to use direct loans through its Term Auction Facility in preference to repos. Since January, the Fed has been directly buying up mortgage backed securities and agency debt in the way it used to purchase Treasury securities.

Figure 1. Factors supplying reserve funds, in billions of dollars, seasonally unadjusted, from Jan 1, 2007 to September 23, 2009. Wednesday values, from Federal Reserve H41 release. Agency: federal agency debt securities held outright; swaps: central bank liquidity swaps; Maiden 1: net portfolio holdings of Maiden Lane LLC; MMIFL: net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility; MBS: mortgage-backed securities held outright; CPLF: net portfolio holdings of LLCs funded through the Commercial Paper Funding Facility; TALF: loans extended through Term Asset-Backed Securities Loan Facility; AIG: sum of credit extended to American International Group, Inc. plus net portfolio holdings of Maiden Lane II and III; ABCP: loans extended to Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility; PDCF: loans extended to primary dealer and other broker-dealer credit; discount: sum of primary credit, secondary credit, and seasonal credit; TAC: term auction credit; RP: repurchase agreements; misc: sum of float, gold stock, special drawing rights certificate account, and Treasury currency outstanding; other FR: Other Federal Reserve assets; treasuries: U.S. Treasury securities held outright.

A separate question is what happens to all the reserve deposits created through this process. The Fed has never wanted to see the huge volume of reserves it created end up as currency held by the public, for fear this would be inflationary. It has relied on several devices to keep that from happening. One was use of the Treasury's account with the Fed, another traditional feature of Fed operations that ballooned as it became adapted to new purposes. The Fed asked the Treasury to borrow funds that it simply left in deposit in its account with the Fed. These idle reserves held by the Treasury absorbed some of the vast increase in new reserves created by the Fed.

A more important tool was that the Fed started paying interest on reserves in October 2008, and by November had increased that rate to the target fed funds rate itself. This created a very strong incentive for banks to simply hold reserves idle at the end of each day rather than lend them out on the overnight fed funds market. In effect, by paying interest on reserves, the Fed is borrowing directly from banks and using the proceeds for the various asset expansions detailed above.

The graph below shows the Fed's liabilities at the end of each week. The height of the graph is, by definition, exactly equal to the height of the previous graph at every date. The first graph tracks what assets the Fed acquired with its operations, while the second graph shows where the funds it created ended up. The surge in the Treasury account (in yellow) and excess reserves of member banks (green) explain why the huge expansion in the Fed's balance sheet has not translated so far into a massive increase in the quantity of currency held by the public (blue).

Figure 2. Factors absorbing reserve funds, in billions of dollars, seasonally unadjusted, from Jan 1, 2007 to September 23, 2009. Wednesday values, from Federal Reserve H41 release. Treasury: sum of U.S. Treasury general and supplementary funding accounts; reserves: reserve balances with Federal Reserve Banks; misc: sum of Treasury cash holdings, foreign official accounts, and other deposits; other: other liabilities and capital; service: sum of required clearing balance and adjustments to compensate for float; reverse RP: reverse repurchase agreements; Currency: currency in circulation.

The question under discussion at the moment is the extent to which the Fed could continue to rely on these two devices-- Treasury borrowing on its behalf and banks' willingness to simply hold the ballooning reserves-- to contain the monetary consequences of its expansion. The traditional political gamesmanship over the debt ceiling could well induce the Treasury to want to discontinue its facilitation of the expansion of the Fed's balance sheet, in which case the Fed must either reduce some of its lending or count on banks to hold even more excess reserves. Some in the Fed are assuming that they could always ensure the latter outcome, if needed, by raising the interest rate the Fed pays on reserves. But clearly the Fed has no desire at the moment to raise interest rates, so it's difficult for me to imagine them taking that step any time soon.

Where else could the Fed get the funds? Fed Chairman Ben Bernanke described his contingency thinking last July:

the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements with financial market participants, including banks, government-sponsored enterprises and other institutions. Reverse repurchase agreements involve the sale by the Fed of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date.

Just as the Fed converted the use of repos, which had historically been used on a small scale to temporarily add reserves, into a much larger operation with which it could lend broadly on a long-term basis, it is now contemplating using the reverse repo, which had historically been used on a small scale to temporarily drain reserves, into a much larger operation with which it could borrow broadly on a long-term basis. Thus we saw the following report from Bloomberg last week:

The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.

Central bank officials are discussing plans to use so-called reverse repurchase agreements to drain some of the $1 trillion they pumped into the economy, said the people, who declined to be identified because the talks are private. That's where the Fed sells securities to its 18 primary dealers for a specific period, temporarily decreasing the amount of money available in the banking system.

There's no sense that policy makers intend to withdraw funds anytime soon, said the people. The central bank's challenge is to decrease the cash without stunting the economy's recovery and before it sparks inflation. Fed Chairman Ben S. Bernanke said in a July Wall Street Journal opinion article that reverse repos are one tool to accomplish that goal without raising interest rates.

"One thing the Fed has to figure out is if they can launch pilot programs without spooking the market and creating the perception that they are about to tighten," said Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm that specializes in government finance. "They are discussing things like accounting issues, and updating the governing documents to the volume of reverse repos the dealer community could absorb."

Is this a feasible interim plan for handling the liability side without increasing either the money supply or interest rates? In a mechanical sense I believe the answer is yes. But the nature of inflationary pressures that we should be watching at the moment would arise from a depreciation of the dollar relative to other currencies and increase in the dollar price of internationally traded commodities. A modest move toward a weaker dollar and slightly higher inflation would be welcome. But the concern in my mind is whether a flight from the dollar could become more precipitous and destabilizing. It may not be the most likely scenario, but it is one for which I hope there has been some contingency planning.

And if the Treasury and the Fed think they could prevent that simply by borrowing even more without raising interest rates, they are mistaken.

But perhaps more important than when to exit is the question of how and whether indeed it will be so easy and simple for central banks to simply wind down the supply of medicine. In the context of the ECB for example, I remain rather sceptical.

However, this day is all about the Fed decision  and although I only rarely delve into account of US monetary policy decisions (comparative advantage you know!) this one is important since it was always going to be parsed very closely for signs of hawkishness on rates on the one side as well as indications of the future wind down of asset purchases. Now, for those who expected a big bang, I have to side with Macro Man that it seems to be much ado about nothing in the sense that the Fed basically reiterated the general view that although economic activity had been showing positive signs lately and especially in the context of leading indicators pointing to a strong bounce in Q3 and Q4 activity, the fundamentals of very low capacity utilisation and deleveraging across the real economy remain intact. In the context of Fed speak this translates into maintaining the current rate target at the zero bound and the the forward looking statement that rates are to kept low for an extended period; 

Conditions in financial markets have improved further, and activity in the housing sector has increased.  Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.  Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.  Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

So far so good then and this was really all we needed, one would imagine, to extent the rally in risky assets as well as the downward trend in the USD as the new funding currency for carry traders and others of their ilk. So far, there has been no signs of panic anywhere and everything seems to be all engines go.

Meanwhile, the Fed did actually give away some details as to how the future bout of asset purchases are to be conducted. On the matter of treasury purchases the Fed will its total purchase of $300 billion by the end of October. Most of us would naturally like to be able to predict what this will to do yields and prices and really you could spin this two ways. In the context of supply side worries, the Fed's withdrawal from the treasury market should push down yields if we add the, perhaps dubious assumption, that the $300 billion worth of supply of treasury bills has only been there to the extent that the Fed has been the main bidder (Say's law and everything). On the other hand it could also push up yields in a world where one assumes that there has been a decisive need to issue such bills and now that the Fed is stepping aside new buyers must step in and notwithstanding those with a printing press of their own, it should push up yields. Although this may seem quite innocuous and technical (i.e. unimportant) it may turn out to be important in a general context when it comes to the ability of economies (not just the US) to lift themselves out of the mire without the crutches of stimulus to lean on.

In the context of the Fed's outright asset purchases, the statement delivered good news for bulls/doves in so far as goes the fact that although the Fed was invariably going to issue a deadline, it seems to have been pushed somewhat out in the distance; well, at least a quarter. Consequently, the Fed will buy $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt, purchases which are set to be concluded by the end of the first quarter and not by year end which was the final date I had been led to believe judged by the points made in various economics report digested over the last week.

So, it is here perhaps that we may be looking at a disappearing bid in the context of the Fed gradually but surely reducing its presence in the market for MBS turds not to mention the agency market which went belly up as Fannie and Freddie crashed and burned. In the nice soothing light of efficient markets it is difficult to expect the decision to wind down purchases to be a big market mover as long as the incoming bout of data continues to provide plenty of upside and no downside. But if we get a setback just around the time when the Fed had envisioned to stand down its most aggressive measures of QE, one finds it difficult not to expect general sentiment and thus, in a forward looking perspective, real economic activity to take a hit which is exactly what we would all like to avoid; the double dip recession or "WL" recession if you will.

Ultimately, it is of course all still a great big mess, something which was neatly conveyed by the way Bloomberg handled the message carried by the IMF envoy to the G20 summit. On the one hand, the IMF was quoted for urging central banks to map a viable and transparent exit strategy and on the other hand Managing Director Dominique Strauss-Kahn was quoting for urging policy makers to not withdraw fiscal stimulus to quickly. Lost in translation are we?

Well, I am perhaps being unfair here to the editors of Bloomberg not to mention the IMF in particular since ultimately; talking about exit strategies is not the same thing as enforcing them. However, I do feel rather strongly about the need to make the following point that the two are of course intimately connected and withdrawing QE cannot but affect the trajectory of fiscal stimulus. This is a point which I believe for example is absolutely crucial to understand in the context of the Eurozone where the ECB's refinancing operations seem to be implicitly underpinning national governments' efforts to shore up their capsized economies.

In this context and assuming that both the BOJ and the ECB will be trailing the Fed somewhat, it will be most interesting to see whether Bernanke manages withdraw the bid on financial markets currently offered by the Fed's policies and indeed whether others may follow in his footsteps and withdraw theirs.

Tensions between China and Rio grew when the world’s second-largest miner spiked a deal with Aluminum Corp. of China (ACH). According to the contract, Chinalco would have invested $19.5 billion in the debt laden Rio. However, the Rio decided to form a joint-venture with rival BHP instead. Again, tension over the talks rose when four Rio employees were detained on July 5 and later charged with bribery and commercial espionage.

China, the world’s largest importer of iron ore, is now looking for just a 35% price cut, versus the 40% it wanted back in June, according to a Bloomberg report. That is slightly over the 33% cut that Rio has been proposing all along.

Surprisingly, China is holding out against Rio for a marginal concession despite being the only country to actually increase steel production. Thus, it would probably need iron ore more than any other nation.

The World Steel Association’s July data shows that China’s production increased 12% year over year, double the increase in June. In contrast, Japan and the U.S. saw declines in production.

Despite short-term uncertainties, we expect Chinese demand to continue growing rapidly in the medium term due to sustained economic growth and urbanization in the country. However, the outlook for 2009 is uncertain as we have no reliable information on price adjustment for iron ore for the year.

Bloomberg had reportedly been approached to acquire BusinessWeek earlier, even before the start of the official auction process began in July. However, the company did not consider the proposal on grounds of higher valuation.

Bloomberg’s renewed interest in the struggling magazine is part of its business strategy to sustain expansion beyond its core business. The company has a news service, publishes books and magazines, and circulates business information through TV, radio, and the Internet.

Earlier in July, parent group McGraw-Hill Co.s (MHP) said that it was seeking strategic options for BusinessWeek, which was severely battered by plunging advertising demand amid the global recession. Advertising pages in BusinessWeek's global edition declined 34.3% in the second quarter of 2009. The company has hired investment bank Evercore Partners to manage the sale.

McGraw-Hill has been able to attract potential bidders for the magazine. These include Bruce Wasserstein, the Chairman and CEO of investment banking firm Lazard Frères, media business manager ZelnickMedia Corp. and private equity firms OpenGate Capital, Platinum Equity and Warburg Pincus.

1. STOCK TRADING AHEAD OF MEMORIAL DAY: THE NUMBERS IN THE CROSSHAIRS
2. BEST TRADING DAY(S) OF THE MONTH?
3. SELL IN MAY AND GO AWAY: THE HISTORICAL EVIDENCE AND THE CURRENT CHARTS

Investors see Hungary becoming “significantly” less risky, allowing for further reductions in interest rates, central bank Deputy Governor Ferenc Karvalits said. “Over the past few months, international risk appetite has improved significantly, the risk assessment of the region and Hungary has stabilized, and this allows for further easing of monetary conditions,” Karvalits said in an interview on Kossuth Radio today.

The Magyar Nemzeti Bank lowered its benchmark interest rate by half a percentage point to 8 percent on Aug. 24 as it works to jolt the economy out of its worst recession in 18 years. The bank has shaved 1.5 points off the key rate since July as confidence rises in the first European Union nation to get a bailout. Hungary received 20 billion euros ($28.5 billion) in an emergency loan from the International Monetary Fund, the EU and the World Bank.

The country has a “good chance” to finance its budget deficit from the market and may not need the next installment of the IMF loan, Karvalits said. The forint weakened 0.3 percent against the euro and was trading at 268.82 at 7:48 a.m. in Budapest.

You see, one of the principal reason why Hungary is in such a mess is that as inflation shot up in the months leading up to the crisis Hungary chose to loosen its peg against the Euro. At the time, the rationale seemed wise albeit very bold. In an environment where investors were willing to take risk (i.e. hunting for yield) their objectives could be aligned with that of public authorities in the sense that the former got their yield whereas the latter got the nominal appreciation needed to keep inflation in check.

It did not work quite like that.

As the crisis hastened its grip on global markets and as its locus steadily moved to Eastern Europe the Hungarian Forint plummeted and lay bare the country's vulnerabilities in the context of balance sheet (on the liability) side denominated in Swiss Francs. The result was that Hungary crashed into a recession unable to tweak monetary policy downwards because of a fear that this would scythe the Forint and thus essentially bankrupt scores of households and companies. On the other, the government also had (and has) difficulties raising funds on international capital markets.

Now however things appear to have changed at least for a moment and Hungary's central seem poised to take advantage of the relatively benign market conditions to lower interest rates to support its ailing economy. The underlying idea is simple. If you believe that risk aversion is to stay low, the Forint should not be sensitive towards the lowering of nominal interest rates since after all the carry remains plentiful. In this way, my view is that Hungary's central bank is trying to claw back the control over monetary policy by locking in a lower interest rate for the Forint. The key question which we should be asking ourselves however is of course whether Hungary could actually be forced to raise rates further down the road to defend the Forint. Clearly, bets are being made inside Hungary at the moment that this is not the case.

This is very interesting in a practical as well as a theoretical sense as I have discussed for example in this post about carry trade and global monetary policy. More recently, Edward Hugh mused on the same topic (more or less) invoking the idea of the (eternal) triangle of monetary policy in an open economy context.

In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.

The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.

Edward's account here is important since it alerts us to the fact that it was only at the very end that e.g. Hungary opted for float because it was believed that it would make the inflation problem go away. At that point however, the structural imbalances and essentially damage were already embedded in the system of course. Nevertheless, it is unequivocally the fact that Hungary, at the moment, is attempting to benefit from the relative benign market conditions which means that risk aversion remains relatively subdued.

Elsewhere in Market Land ...

If our little trip to Hungary suggests that risk is on, if only a little bit and potentially in the case of Hungary news elsewhere suggest that the waters are more choppy. Of course, none of this is earth shattering by any means of the word, but since much, if not everything, seems to be revolving around China at the moment it seems worthwhile to dwell at recent news on how China are expected to "tweak" its hitherto lax lending policies to skim the worst of the mounting bubble (quote below from Bloomberg).

China’s banking regulators are “tweaking” lending policies to remove “froth” from the system while growth remains the top priority for policymakers, according to Royal Bank of Scotland Group Plc. The goal is to manage risk exposure among banks and asset quality by checking lending from going into A-shares traded on the mainland and properties, Wendy Liu, Hong Kong-based head of China research at RBS ABN Amro, said in a report dated yesterday.

(...)

The banking regulator sent draft rule changes to banks on Aug. 19 that would require lenders to deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital, said the people, who have seen the document and declined to be named as the matter is private. This may cut lending by as much as 700 billion yuan ($102 billion), China International Capital Corp. said Aug. 24.

Of course, the main bias of the Chinese stimulus program and thus the authorities' objective remain one of promoting growth through the expansion of domestic investment and, one would assume, consumption. As RBS ABN Amro's Wendy Liu is quoted of saying; "policymakers have a far greater tolerance for asset-price appreciation over the medium term than before". That sounds about right to me even if I am no sage, at all, on China.

What is interesting in the case of the recent news from China was also the following piece by Bloomberg whose headline (Yen Strengthens as China Policy Concern Spurs Demand for Safety) makes a direct link between policies in China and risk sentiment in the market and thus also the movement of the Yen and the USD (remembering of course the narrative that repatriation of profits may ultimately be the main driver of the Yen at the moment).

The yen rose for a third day against the euro in the longest stretch of gains since July on concern Chinese production curbs would slow economic recovery, fanning demand for the relative safety of Japan’s currency. The currency gained versus major counterparts including the pound on speculation Japan’s exporters are repatriating earnings to take advantage of a new tax law. A government report today may show a faster contraction in the U.S. economy than previously estimated.

“We have talks from China cutting back expanding, trying to sort out the balance sheet and prevent too much reckless lending,” said Peter Frank, a London-based currency strategist at Societe Generale SA. “But domestic factors, like capital repatriation, are driving yen’s strength right now.”

Whether there is a history to be made here is debatable, but one thing is certain. China seems to have decidedly taken center stage in the global market discourse. Finally and essentially as a small footnote, yours truly took notice of the fact that despite the decidedly positive sentiment in the core of Europe at the moment on the back of the Q2 GDP print and upbeat confidence readings in Germany, aggregate retail sales continued their steady decline.

Whether all this signifies that risk is "on" or "off" I will allow the reader to decide for themselves. Personally, I am still bearish, but it is difficult to deny that the relative calm and positive environment that has prevailed since spring seems rather strong. I would expect sentiment to change once we return to "normal" in Q4 once the elections in Germany and Japan have been resolved and, more importantly, once OECD stimulus packages start to wane. Most importantly however, there is the situation in Southern and Eastern Europe still loom as the most likely harbringers of, if you will, black swans in which case risk almost surely would be off.

Chicago, IL – August 25, 2009 – Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include: News Corp. (NWS), McGraw-Hill (MHP), NYSE Euronext (NYX), Thomson Reuters (TRIN) and Novartis (NVS).

Get the most recent insight from Zacks Equity Research with the free Profit from the Pros newsletter: http://at.zacks.com/?id=5513

Here are highlights from Monday’s Analyst Blog:

Dow Jones to Change Hands

Dow Jones & Co., owned by News Corp. (NWS), has started seeking potential buyers for its stock market index business, including the renowned benchmark Dow Jones Industrial Average.

Goldman Sachs has been appointed to explore strategic options for the business. News Corp. bought Dow Jones & Co. in 2007 for $5.7 billion, and has never released any financials for the unit since its acquisition. As an independent company, Dow Jones last reported results for the first nine months of 2007, when its revenue increased 18% year over year to $101.3 million.

Market analysts believe that competitors, like McGraw-Hill’s (MHP) Standard & Poor’s, FTSE, a joint venture between the Financial Times and the London Stock Exchange, MSCI Barra, Russell Indexes, NYSE Euronext (NYX), Bloomberg and Thomson Reuters (TRIN), will be interested in Dow’s index business.

Xolair Label Expanded in EU

This morning, Novartis (NVS) announced that it has received approval from the European Commission (EC) for the use of Xolair (omalizumab) as an add-on therapy for severe persistent allergic asthma in children in the age group of 6 to 11 years.

The approval is positive news for the company and should expand the patient base for the drug. Asthma is a chronic lung disease which is estimated to affect about 10% of children in Europe. It is also the most common cause of school absenteeism and children often use oral corticosteroids to deal with the disease. However, despite conventional therapy, severe asthma remains uncontrolled in more than 50% of children with this condition.

Xolair is a humanized monoclonal antibody aimed at treating the underlying mechanism of allergic asthma. The product works by blocking the action of immunoglobulin E (IgE). This helps in preventing the onset of debilitating symptoms, such as shortness of breath and wheezing, in severely affected patients.

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Goldman Sachs has been appointed to explore strategic options for the business. News Corp. bought Dow Jones & Co. in 2007 for $5.7 billion, and has never released any financials for the unit since its acquisition. As an independent company, Dow Jones last reported results for the first nine months of 2007, when its revenue increased 18% year over year to $101.3 million.

Market analysts believe that competitors, like McGraw-Hill’s (MHP) Standard & Poor’s, FTSE, a joint venture between the Financial Times and the London Stock Exchange, MSCI Barra, Russell Indexes, NYSE Euronext (NYX), Bloomberg and Thomson Reuters (TRIN), will be interested in Dow’s index business.

The company’s stock market index business consists of 130,000 equity indices and earns revenue by licensing them for use as benchmarks for investment in hedge fund, real estate and commodity markets. Its best known index is the Dow Jones Industrial Average, which was introduced in 1884 by Charles Dow and Edward Jones comprising 11 stocks. Currently, the basket comprises 30 stocks.

Law Firms Threatening Action Against Leveraged ETF Providers

At least two law firms say they're talking to clients who use leveraged exchange-traded funds about potential lawsuits against the funds' providers.

The list is large and includes ETFs sponsored by ProShares, PowerShares, Direxion and ETF Securities, which recently entered the U.S. (see story here.)

How do we know this? The law firms, of course, put out a press release. You can read it here.

Two Deutsche Bank Funds Hit By CTFC Ruling

A pair of PowerShares-DB commodity ETFs will be curtailed in how much they can buy in soybeans, wheat and corn due to a decision by the Commodity Futures Trading Commission.

You can read this Bloomberg News report for more details. Also, check Matt Hougan's blog here.

SSgA's Hoguet: Sovereign Wealth Funds To Buy SDRs

Special drawing rights, or SDRs, are what the International Monetary Fund uses internally as currency markers to traverse its global reach. China has nominated SDRs as a natural new world currency, replacing—or complementing—the de facto U.S. dollar.

When the suggestion was made, critics voiced their displeasure at the notion. But now, according to this interesting Reuters report, several big sovereign wealth funds are considering buying SDRs.

The report is based on information supplied by George Hoguet, a State Street Global Advisors emerging markets expert. (His work has been profiled at IndexUniverse.com several times in the past few years, including a Q&A earlier this year.)

You can read the Reuters story here.

Fidelity President Looking For Successor

Rodger Lawson, who took over as president of Fidelity Investments in 2007, tells Bloomberg News he's looking for a replacement. The position has been a bit of a revolving door at the mutual funds giant in recent years.

The story addresses that issue and also includes Lawson's rebuttal of Morningstar data showing the company is lagging its peers in performance, particularly compared with arch rival Vanguard. (For more about the battle between Vanguard and its competitors, see related story here.)

You can read the Bloomberg interview with Lawson here.

In related news, Fidelity says its assets rose to $2.8 trillion. See a Wall Street Journal story on the firm's finances here.

Hedge Fund Bets Big On Natural Gas Prices

It might be interesting to note that with all of the furor going on over UNG and commodities markets, a hedge fund has apparently made a rather large bet that natural gas prices will triple by winter.

The Financial Times story also gets into the most recent forecasts for the market from analysts and their reaction to the unusual play.

You can read the story here.