Too ‘Big to fail’ is getting too ‘Big to Bail’

The ‘Good Bank, Bad Bank’ split idea is being floated by the UK government. According to the Independent Newspaper this morning, there is a possibility that Lloyds, RBS and Northern Rock may be split into retail and ‘casino’ entities and sold in a state sale over the next few years. While State side, a US House Bill proposes that the largest firms are to pay for the US financial rescue. The proposed structure would see that any financial institution (Banks, Hedge Funds etc) with a balance sheet greater than $10b ‘would have to pay for the rescue of companies whose collapse would be critical to the financial system’. The Bill also contains provisions that would give the Fed the power to reduce the size of the companies posing a system risk. Finally the cost is being shifted away from the taxpayer!

The US$ is weaker in the O/N trading session. Currently it is lower against 10 of the 16 most actively traded currencies in a ‘whippy’ trading range.

There is no other way to describe it, but US consumer confidence tanked yesterday (47.7 vs. 53.4). Confidence deteriorated on both the present situation (a 26-year low of 20.7) and on the expectations front (65.7 from 73.7) for the 2nd-consecutive month. It’s worth noting that the latter accounted for the most of the decline. The expectations sub-component retreated back to levels last witnessed 4-months ago, even after ‘aggressively’ advancing in Aug. and Sept.! The labor index (jobs plentiful minus hard to get), fell to the lowest level in 26-years (-46.2). The jobs plentiful index fell for the 3rd-consecutive month, while the hard to get index rose to its highest level in three decades. Something seems to be out of sync, as the data is not mirroring recent NFP reports. Despite job cuts potentially slowing, finding employment remains difficult, averaging longer than 26.6 weeks. Other sub-categories show that 6-month spending intentions remain weak for a 2nd-consecutive month, perhaps due to employment concerns. On the inflation front, consumers expect prices to be +5% higher a year from now. This time last year they predicted a +6.8% hike in prices!

Finally there is US data that shows that US home prices are showing some signs of stabilizing. House prices, as measured by the S&P/Case-Shiller home prices index, rose for the 3rd-consecutive month in Aug. yesterday, on a seasonally-adjusted basis (-11.32% vs. -13.26%, y/y). This is the first sign of stability after 3-years of declines! But, will it be sustainable? There are a number of reasons to say it’s not happening. Firstly, the first time home buyers incentives ends at the end of next month. Secondly, analysts remain concerned about the shadow inventories. With more inventories beginning to be released could pressurize prices even further. Finally, resets were at a cyclical low over the last few months. It’s also worth noting that for the month of Aug. prices rose +0.97% vs. the +1.16% gain in July.

The USD$ is currently lower against the EUR +0.08%, CHF +0.11%, JPY +0.51% and higher against GBP -0.10%. The commodity currencies are weaker this morning, CAD -0.30% and AUD -0.67%. BOC Governor is insistent that a strong loonie will damper longer term growth. In his testimony before the House of Commons Finance Committee yesterday, he said efforts by Cbanks to affect their currencies need monetary policy to back them up. FX intervention without complimentary policy moves is seldom effective in the long term. He has options, like credit and quantitative easing to influence the loonie and meet their 2% inflation target. The commodity based currency was dealt a blow from softer crude prices as OPEC suggested that they would increase output production if higher oil prices threatened global economic growth. With equities under pressure, and the USD remaining better bid on risk aversion strategies, is curtailing the demand for the loonie. With a large percentage of the market being long CAD on the back of recent commodity advances, one should expect the technical traders to dictate the short term direction. Weak longs are being squeezed out. Dealers expect to see better levels to own their domestic currency. After breaching the 1.0600 level earlier this week opens up the top side to 1.0750.

The best performer, the AUD, amongst the 16 major currencies managed to retreat in the O/N trading session on its inflation reports. Australian inflation cooled to the slowest pace in 10-years (+1.0% vs. +0.5%, q/q) and easing the pressure on Governor Stevens at the RBA to hike the benchmark lending rate (3.25%) by 50bp next week. A 25bp hike looks increasingly likely to be the best case scenario from the RBA next month. Governor Stevens said it was ‘possibly imprudent’ to keep borrowing costs at a 50-year low in the minutes of its Oct. meeting. For now, the currency remains better bid on deeper pullbacks (0.9118).

Crude is lower in the O/N session ($79.36 down -19c). It was the tri-factor of trading reasons why crude prices softened this week. Firstly, OPEC is starting to talk crude down. Members will increase output production to protect the global economic recovery if oil prices continue to rise. They have indicated that both ‘producers and consumers were comfortable with oil prices at between $75 and $80 per barrel and that higher price’s could put the brakes on the pace of global economic recovery’. Ideally, they want to ‘maintain balance’ and will act accordingly in Dec. depending on where crude is trading. This will surely put a short term dampener on speculative trading. Secondly, the dollar has rebounded from its 14-month lows, thus diminishing the appeal of commodities to investors. Finally, equities managed to see red. Oil prices had been pushed to New Year highs last week on the back of the weekly EIA report showing a bigger than forecasted decline in supplies of gas. Gas inventories fell -2.2m barrels to +207m vs. an expected drop of only -850k. On the flip side crude stocks rose +1.3m barrels to +339.1m vs. the forecasted climb of +1.5m barrels. Technically, prices have been aggressively mobile on pure ‘speculation’ in the face of positive overall supply fundamentals. Keep an eye on the USD for directional play until we get the weekly inventory numbers today.

Heading for its longest slide in nearly 3-months, the ‘yellow metal’ is being sold on upticks on concerns that the greenback may extend its recent rally, in the short term at least. Up to this point the precious metal has been well supported, but, with 4-days of greenback strength may encourage speculators to step aside from buying at current levels ($1,039).

The Nikkei closed at 10,075 down -137. The DAX index in Europe was at 5,640 down -4; the FTSE (UK) currently is 5,200 up +18. The early call for the open of key US indices is lower. Despite a record amount of product to offload this week, the 10-year bonds eased 8bp yesterday (3.47%) and are little changed in the O/N session. Dealers are expected to try to soften prices with a record $116b worth of US debt to be taken down this week (Yesterday’s $44b 2’s was a strong auction). Despite the record supply, Treasuries rose for the first time in 5-days on the back of US consumer confidence numbers unexpectedly falling last month for a 2nd-consecutive month. Today, the US government is scheduled to sell $41b 5’s and $31b of 7’s tomorrow. With Treasury planning to lengthen the ‘average due date’ of its outstanding debt to 72-months from 49-months should put extra pressure on the long end of the US yield curve over the coming year. Yesterday’s price action certainly caught the market flatfooted!

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