Shrinking liquidity exposes markets to crunch

The calm on global financial markets masks a growing threat to their smooth functioning should shrinking liquidity morph into an outright crunch in response to a U.S. interest rate rise or some other shock. 

PHOTO: AFP

1 May5:42 PM

[LONDON] c

The price of German 10-year government bonds plunged this week, triggering the biggest rise in yield in over two years. Some analysts blamed the sell-off on a lack of liquidity, with Commerzbank going so far as to call it a "flash crash".

There was no discernible market instability like a widening of bid/offer spreads, often a reliable sign of thinning liquidity. But there have been signs of potential dislocation in recent weeks - on one day in March the Bund bid-offer spread blew out to nearly 6 basis points, the widest in three years.

Analysis from GreySpark Partners shows that the average spread in high grade US corporate bonds since 2011 is around 12 basis points. In the five years before the global financial crisis, it was 7 basis points.

Liquidity is an amorphous concept and impossible to measure accurately. Its scarcity is only exposed in times of crisis. But everyone agrees it is shrinking, and this could dramatically push up the cost of trading, widen bid-ask spreads and make it harder for traders to close out positions.

As long as asset prices are rising, as most are thanks to super-easy global monetary policy, this isn't a problem. But it will be if there is a sudden reversal and traders are forced to offload assets only to discover there are no buyers.

"This is a critical problem to the functioning of markets,"said Andy Hill, director of market practice and regulatory policy at the International Capital Market Association.

"Without secondary market liquidity, primary issuance will be impaired. We're in a fragile state now," he said, adding that lower rated corporate bonds, high yield debt and emerging markets are most vulnerable to a crunch.

The potential for a sudden freeze across a range of markets is a growing source of concern and debate among global policymakers and regulators.

They are trying to assess the impact on markets of regulatory changes that force banks to hold more capital and less inventory on their books. Financial market participants say this is curbing banks' trading and their ability to act as market-makers in many fixed income, currency and money markets.

There's an important difference between the sea of liquidity worth trillions of dollars provided by global central banks in recent years and the dwindling liquidity as measured by market trading. In some ways, they are two sides of the same coin.

The former is self-evident. As the Bank for International Settlements said in a recent report, global liquidity is "abundant".

Central banks have printed US$11 trillion since 2007, bringing central bank liquidity coursing through the global financial system to more than US$16 trillion, according to Deutsche Bank. The European Central Bank is in the process of adding a further US$1 trillion and China may act too.

But the latter, essentially a measure of the cost and ease of transacting a particular asset without prompting a huge swing in its price, is much less visible and harder to quantify.

This parallel trend of rising cash liquidity from central bank largesse and shrinking market liquidity was outlined in two recent investment bank reports.

In 2005 the US corporate credit asset universe was worth around US$9 trillion, of which 5 per cent was on dealers' inventories. These assets are now worth around US$12 trillion, of which less than 1 per cent is on dealers' inventories.

"Shrinking dealer balance sheets coupled with bond market growth have led to a significant worsening of fixed income liquidity, especially in corporate bonds," Morgan Stanley said.

Primary dealers now hold only around US$50 billion of US corporate bonds on their books compared with US$300 billion before the crisis, according to a study by Deutsche Bank.

In that time the total stock of outstanding bonds has more than doubled to US$4.5 trillion from just under US$2 trillion. Lower inventory means dealers will be less able to match wary buyers with panicked sellers and smooth out any market volatility.

Factoring in all markets - interest rates and repo, currencies, emerging markets and commodities, credit and equities - Morgan Stanley calculates that banks' balance sheets shrank by around 20 per cent last year and will shrink a further 10-15 per cent over the next two years.

The most obvious shock to markets on the horizon is the US Federal Reserve's rate hike. When it comes, it will be the first rise in US interest rates since June 2006. Simply put, there are many traders who have no experience of the world's most important interest rate going up.

REUTERS

    
 

China's Xi says rural residents should get fairer deal

China's rural residents, generally looked down upon and discriminated against in the country's thriving cities, should get a fairer deal so they can share in the fruits of the booming economy, media on Friday cited President Xi Jinping as saying. 

PHOTO: REUTERS

1 May6:36 PM

[BEIJING] China's rural residents, generally looked down upon and discriminated against in the country's thriving cities, should get a fairer deal so they can share in the fruits of the booming economy, media on Friday cited President Xi Jinping as saying.

China aims for 60 per cent of the population of almost 1.4 billion to be living in cities by 2020, turning millions of rural dwellers into consumers who could be a driving force for the world's second-largest economy.

Chinese leaders have pledged to loosen their grip on residence registration, or hukou, to try to remove obstacles to the urbanisation drive. Such registrations prevent migrant workers and their families from getting access to education and social welfare outside their home villages.

Speaking at a meeting of the Politburo, one of the Communist Party's elite ruling bodies, Mr Xi said hukou reform should be speeded up and people given equal employment rights so they can live in equality in urban areas, including setting up businesses.

"We must ... give new impetus to rural development, and allow the vast majority of farmers to participate as equals in the process of reform and development so they too can enjoy its fruits," state news agency Xinhua quoted Mr Xi as saying.

"(We must) protect the legal rights of farmers and guarantee equal employment rights with urban workers."

Rural services also needed to be improved to look after children left behind in villages, women and the elderly, Mr Xi added.

China could not achieve its aim of becoming a middle-income country if rural areas were ignored, he said.

Agriculture needed to be modernised too to guarantee food security, Mr Xi said.

The Cabinet said last year it would ensure "orderly" migration of some 100 million rural workers into cities by 2020, supported by expanded social welfare and job opportunities, as part of plans to push its urbanisation programme.

The government is struggling to balance goals such as encouraging the migration of millions of former farmers into cities, while avoiding the slums and unemployment problems that have occurred in other countries experiencing similar migration.

REUTERS

    
 

China announces measures to boost creativity, jobs

China on Friday announced measures aimed at promoting innovation and job creation, state media said, as authorities seek to ensure that slowing economic growth doesn't harm employment. 

PHOTO: EPA

1 May7:47 PM

[BEIJING] China on Friday announced measures aimed at promoting innovation and job creation, state media said, as authorities seek to ensure that slowing economic growth doesn't harm employment.

According to measures released by the State Council, which functions as China's Cabinet, the government should broadly encourage entrepreneurship as well as startup enterprises to serve as a new engine for economic growth, the official Xinhua news agency said.

The announcement comes as China's economic growth in 2014 registered its worst annual performance in nearly a quarter century, expanding 7.4 per cent, while gross domestic product (GDP) decelerated further in the first quarter of this year from the previous three months.

Chinese authorities are tolerant of the slowdown, seen as a necessary element of their attempt to oversee a transformation of the economy in which consumer spending drives growth, a change that they and analysts envision as leading to more sustainable long-term expansion.

But they are sensitive to the potential impact on job growth, which is seen as a key element of social stability in the country with the world's largest population.

A total of four measures call for governments at all levels of the country to place priority on creating jobs, increase employment through the encouragement of entrepreneurship and startups, help university graduates to secure employment or establish businesses, and offer improved government and training services, according to Xinhua.

"In order to encourage entrepreneurship and startups, governments at all levels were called on to speed up related reforms and refine policies to ensure fair treatment, favourable financial and tax conditions, and basic social safety benefits for startups," Xinhua said.

The government said in March when releasing the first quarter GDP figure that China's unemployment rate was "stable" at about 5.1 per cent and that 3.2 million new urban jobs were created in the period.

Such a pace would put the country on course to best its annual target of more than 10 million new urban jobs.

AFP

    
 

One thousand Europeans missing after Nepal quake

One thousand people from the European Union, mostly tourists, are missing in Nepal nearly a week after a devastating earthquake, the head of the EU delegation here said on Friday. 

PHOTO: AFP

1 May7:52 PM

[KATHMANDU] One thousand people from the European Union, mostly tourists, are missing in Nepal nearly a week after a devastating earthquake, the head of the EU delegation here said on Friday.

"We don't know where they are, or they could be," Ambassador Rensje Teerink told reporters, adding that those unaccounted for were mostly tourists in the Langtang and Lukla areas.

Langtang is a trekking region to the north of Kathmandu that has been hit by a huge avalanche and mudslides, while Lukla is the jumping off point for walkers and climbers making the nine-day trek to Everest base camp.

REUTERS

    
 

Singapore PM says given 'all-clear' from prostate cancer

Singapore Prime Minister Lee Hsien Loong said on Friday he has been fully cleared of prostate cancer after undergoing surgery in February. 

PHOTO: SPH

1 May8:30 PM

[SINGAPORE] Singapore Prime Minister Lee Hsien Loong said on Friday he has been fully cleared of prostate cancer after undergoing surgery in February.

"After the op the doctor told me to wait two months, do a blood test, then we'll know whether you are clear," Mr Lee, 63, said in a May Day speech to workers, union leaders and business owners.

"Two weeks ago, two months were up, I went for the follow-up blood test and the results were good. Doctors gave me an all-clear," said Mr Lee, the eldest son of Singapore's late founding prime minister Lee Kuan Yew.

It was Mr Lee's second bout with cancer. He underwent chemotherapy for lymphoma in 1993 and is now in remission. The illnesses are not linked, his office has said.

News of his illness came amid widespread expectations that the next general election will be held before it is due in early 2017, possibly this year.

In the last election in May 2011, Mr Lee's People's Action Party (PAP), which has governed Singapore since 1959, suffered its worst setback after a large district was wrested by the opposition and its share of the popular vote plunged.

After the polls, Mr Lee launched reforms to address voters' gripes over the large influx of foreign workers and immigrants into the compact city-state as well as the rising cost of living.

In his speech on Friday, Mr Lee, who took over as premier in 2004, said "leadership renewal is the most important issue" for the upcoming election.

Mr Lee, a former army brigadier-general, first entered politics in 1984 and held various key government portfolios before taking over from Goh Chok Tong, the successor of Lee Kuan Yew.

"Give me and my team your support so that after the next election, and well before the election after that, a younger team will be ready to lead us forward," he said.

AFP

    
 

Fed needs better view on housing and stability link: Mester

Seven years after the crisis triggered by the mortgage market, the Federal Reserve still needs a clearer understanding of how problems in housing might destabilize the US economy, a top Fed official said on Friday. 

PHOTO: AFP

1 May8:39 PM

[PHILADELPHIA] Seven years after the crisis triggered by the mortgage market, the Federal Reserve still needs a clearer understanding of how problems in housing might destabilize the US economy, a top Fed official said on Friday.

Cleveland Fed President Loretta Mester said that if the central bank wants to achieve its goals of stable inflation and full employment, it must be able to better quantify the effects that changes in household finance might have on the broader economy.

"More work needs to be done on the nexus between monetary policy and financial stability policy," Ms Mester said, including "determining the most effective way to address emerging risks to financial stability and developing models that can be used to evaluate how policymakers should incorporate financial stability concerns into monetary policymaking."

Speaking at a conference on consumer credit at the Philadelphia Fed, Ms Mester said so-called macroprudential tools like countercyclical capital buffers, capital conservation buffers, and stress test scenarios "show promise" but are"largely untested."

A collapse in the US mortgage market, reckless leveraged lending, Wall Street securitization, and lax regulations led to the 2007-2009 financial crisis that spawned a global recession.

The US economy is still recovering, though Ms Mester said improvements in household balance sheets "is one of the important fundamentals underlying the outlook for continued expansion, further improvement in labour markets, and inflation gradually moving back to the Federal Reserve's 2 per cent target over the medium term."

She did not directly discuss monetary policy.

REUTERS

    
 

US factory activity growth slows in April: Markit

1 May9:54 PM

[NEW YORK] Expansion in the US manufacturing sector weakened in April as growth in output and new orders fell, according to an industry report released on Friday.

Financial data firm Markit said its final US Manufacturing Purchasing Managers' Index fell to 54.1 in April from 55.7 in March. The preliminary reading was 54.2.

A reading above 50 indicates growth in the sector.

April's growth was the slowest of 2015, and "the survey results raise worries that the dollar's appreciation is hurting the economy," said Chris Williamson, Markit's chief economist.

The index's output component fell to 55.3 from 58.8 in March. The preliminary read was 55.4.

The final reading of the index measuring new orders also weakened in April, coming in at 55.3, under the preliminary reading of 55.4 as well as March's reading of 57.2.

Employment growth also weakened in April from March, Markit said, though the drop was more modest.

REUTERS

    
 

Consumer sentiment in US rises to second-highest since 2007

Consumer confidence increased in April to the second-highest level in more than eight years as Americans grew more upbeat about their financial prospects. 

PHOTO: AFP

1 May10:20 PM

[WASHINGTON] Consumer confidence increased in April to the second-highest level in more than eight years as Americans grew more upbeat about their financial prospects.

The University of Michigan said Friday that its final index for the month increased to 95.9 from 93 in March. The median projection in a Bloomberg survey of economists was for 96, little changed from the preliminary April reading of 95.9.

A stronger sense of job security and building momentum in wage growth are helping to buoy confidence, which may encourage consumers to spend rather than save their paychecks. Low fuel costs and continued labour market progress will help keep households upbeat even as the Federal Reserve considers raising interest rates for the first time since 2006.

"Confidence is down from its absolute high in the last couple months, but it still shows a clear net pickup recently," Jim O'Sullivan, chief US economist at High Frequency Economics in Valhalla, New York, said before the report. "The confidence numbers look consistent with consumer spending picking up."

Estimates in the Bloomberg survey of 59 economists ranged from 93 to 97.5. The index average 84.1 last year.

The sentiment survey's current conditions index, which takes stock of Americans' views of their personal finances, rose to a three-month high of 107 in April from 105.

The measure of expectations six month from now increased to 88.8 from 85.3.

"Personal financial prospects have improved significantly," Richard Curtin, director of the Michigan Survey of Consumers, said in a statement.

"Financial gains were expected by 37 per cent of all consumers in April. Although just above the 36 per cent recorded in the prior two months, it was the highest proportion recorded since April 2007."

Americans expected an inflation rate of 2.6 per cent in the next year, down from 3 per cent in March. Over the next five to 10 years, they also expect a 2.6 per cent rate of inflation, compared with 2.8 per cent in the previous month.

Friday's consumer sentiment report is at odds with other figures released this week. The Bloomberg Consumer Comfort Index fell to 44.7 in the period ended April 26, the third consecutive drop, from 45.4 the prior week.

The Conference Board's consumer confidence index dropped to a four-month low of 95.2 in April, weaker than the most pessimistic forecast in a Bloomberg survey of economists.

Fed policy makers are keeping an eye on consumer attitudes, inflation and other markers of economic health as they weigh the timing of their first increase in the benchmark interest rate since 2006. The outlook took a hit this week as a report showed the economy barely grew in the first quarter, expanding at a 0.2 per cent annual rate after a 2.2 per cent in the final three months of 2014.

"Overall, the near- and longer-term outlooks for the economy, while slightly below the peaks recorded three months ago, were the second-most favourable levels recorded since 2004," Mr Curtin said. "Prospects for the unemployment rate in April were only more favourable in four other surveys since 1984."

In a statement issued on Wednesday after a two-day meeting, Fed policy makers left open the possibility of raising interest rates in the second half of the year by chalking the economy's slowdown up to "transitory factors."

"Households' real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high," Chair Janet Yellen and her colleagues said in the statement.

"Although growth in output and employment slowed during the first quarter, the Committee continues to expect that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labour market indicators continuing to move toward levels the Committee judges consistent with its dual mandate."

The Fed repeated that it will raise rates when it sees further labour-market improvement and is "reasonably confident" inflation will rise back to its 2 per cent goal over time.

Bigger pay gains might help price increases get closer to that target. Wages and salaries climbed by 0.7 per cent following a 0.6 per cent increase in the fourth quarter, the Labour Department said Thursday. Private wages, which exclude those government workers, rose 2.8 per cent in the last year, the biggest advance since the third quarter of 2008.

In the meantime households may be counting on continued savings from cheap gasoline to help pad their balance sheets. While the average cost of a gallon of regular gasoline was $2.58 on April 29, the highest since mid-December, it's down from last year's peak of $3.70.

Cheap gas may persuade more Americans to hit the road, benefiting companies such as midscale hotel owner and franchiser La Quinta Holdings Inc, Chief Executive Officer Wayne Goldberg said on an April 29 earnings call.

"We feel very good that all of the indications from a leisure standpoint are very positive," Goldberg said. "We see an economy improving."

More gains in consumer confidence may persuade households to boost spending, which was lackluster in the first quarter. Consumption climbed at a 1.9 per cent annualized rate in the first three months of the year, less than half the pace of the prior three months, when spending climbed at the fastest rate since 2006.

BLOOMBERG

    

US, Canada release tougher oil-train safety standards

1 May11:22 PM

[WASHINGTON] Long-awaited new safety rules for trains carrying oil in the United States and Canada were announced on Friday as regulators seek to reduce risks after a series of explosive accidents accompanied a surge in crude-by-rail shipments in recent years.

Canada's Minister of Transport, Lisa Raitt and US Transportation Secretary Anthony Foxx jointly announced the rules that within three years would phase out older tank cars that are widely considered to be unsafe during derailments.

The rules, which have already created a fierce debate between tank-car owners, railroads and federal regulators, call for thicker tank-car hulls, head shields, electronic pneumatic brakes and pressure-relief valves for oil train cars, all of which have been deemed by regulators to be crucial in improving the safety of transporting oil by rail.

In perhaps the most contentious part of the rules, the entire fleet of DOT-111 cars built before October 2011, and considered prone to puncture during accidents, must be phased out within three years. Cars built after that, known as CPC-1232s, will be phased out within five years.

The regulations come nearly two years after a train carrying crude oil came off the rails in the Canadian town of Lac Megantic in July 2013, exploding and killing 47 people. Since then, a series of fiery accidents involving crude trains have occurred in rural areas across North America.

"This stronger, safer, more robust tank car will protect communities on both sides of our shared border," said Canada's Ms Raitt.

The rail and energy sectors have both resisted measures that they consider too costly to implement for the small safety improvement they deliver.

Electronically controlled pneumatic (ECP) brakes trigger all axles simultaneously rather than one at a time in current design, which safety advocates have said is an important advance.

Large rail operators have lobbied against including an ECP brake mandate in the oil train rules, telling US regulators in March that they "would not have significant safety benefits" and "would be extremely costly." The oil industry is concerned that a demand for a 9/16th-inch steel tanker frame will make the existing tanker car obsolete, since upgrades would be too costly.

Charles Drevna, the president of the American Fuel & Petrochemical Manufacturers, a leading voice for the refining indistry, said a five-year phase out of existing tank cars - a timetable endorsed by the US National Transportation Safety Board - was unrealistic.

REUTERS

    
 

US auto sales pick up in April

1 May11:54 PM

[WASHINGTON] US car and truck sales picked up strength in April in a sign that the auto market remains firm after the winter economic downturn, the top three automakers reported Friday.

GM sales rose 5.9 per cent from a year ago to 269,056 vehicles; Ford sales rose 5.4 per cent to 222,498 vehicles, and sales by FCA US, the US unit of Fiat Chrysler Automobiles, gained 5.8 per cent at 189,027 units.

Pickup truck and SUV and crossover sales remained strong, but overall sales were a bit below analyst expectations, amid more general signs that US consumers remain cautious and business investment is slow.

"Consumer and commercial customer demand for pickups and utility vehicles has been building since last fall, and that's a clear sign that the slowdown in GDP growth during the winter months was caused by factors that are mostly transitory in nature," said Kurt McNeil, GM's vice president for US sales.

For GM, truck sales were up 13 per cent from April 2014, and crossovers 25 per cent.

Ford said it was continuing to expand capacity to meet demand for its aluminum-bodied F-150 pickup. F-150 retail sales gained 8 per cent, it said, but overall sales of the F line of trucks fell 0.9 per cent.

"Kansas City Assembly, the second assembly plant building the popular new F-150, continues to ramp up production through the second quarter. Once the plant is fully online, Ford will be able to fill many fleet orders," Ford said.

SUVs, crossovers and utility trucks grew by 14.5 per cent from a year ago.

At FCA, total car sales rose 29 per cent in the month, led by the popular Jeep and Chrysler brands, while Dodge brands sank 16 per cent and the Ram truck divisions saw sales growth slow to 4 per cent.

For the first four months of the year, GM sales were up 5.9 per cent over 2014. Ford 2.9 per cent and FCA 3.4 per cent.

"The auto industry continues to be on track to have its best sales year since 2006," said Mr McNeil.

AFP