Morning Strategist Summary: Wieseman, Caron, Peters & Chakrabortti

Subject: Morning Strategist Summary: Wieseman, Caron, Peters & Chakrabortti

Ted Wieseman

• LIBOR spreads over Fed Funds are high and have been rising
  

·         The blowout in the spread of LIBOR over Fed Funds has partially short-circuited the transmission of the Fed's lowering of the fed funds rate into a positive impact on the economy

·         The pressure in the interbank lending market is a key symptom of the biggest challenge facing the economy at this point: the forced reintermediation of the banking system that is pressuring bank balance sheets and reducing the availability/raising the cost of credit

·         With significant, rising, and unpredictable demands on their capital, banks have preferred to stay liquid and demanded a significant premium to lend term in the interbankmarket

·         Problems have recently been exacerbated by balance sheet pressures tied to the year-end for a number of key firms

·         The Fed announced steps to attempt to tackle this problem directly by offering regular term repos bridging the year-end

·         If targeted and unconventional measures fail and the Fed is determined to get LIBOR down, the only alternative would be the blunt measure of overcoming the widening in LIBOR/fed funds spreads through more aggressive fed funds rate cuts

o       Even if spreads of LIBOR over fed funds stay wide or widen further, enough fed funds rate cuts could at least get the absolute level of LIBOR down substantially

·         Expects Kohn to signal a change in Fed stance in his speech tomorrow: the market  is fully expecting a rate cut and has been for some time now

 
 

Jim Caron

·          "Renormalization thesis" - liquidity was cheap and it was easy to attain leverage, which fueled asset inflation

·         Now we're finding the exact opposite, as liquidity has become more costly

·         This will have the greatest impact on the assets with the highest dependency on liquidity and leverage - especially Financials

·         Key with the Fed is to figure out how to address increased liquidity costs without cutting rates so much that it spills over into the broader economy

·         Market of Many trade: re-pricing of risky assets with high dependence on liquidity and leverage = breakdown of correlation across different asset classes

·         Fed is doing 45 day RP's to get us over the year-end hump, after which liquidity typically becomes more available

·         Fed is trying to keep liquidity up over the next 4-6 weeks until we get past this rough patch

·         The problem is that this seems to be a recurring theme and it doesn't seem to be just a rough patch

·         The Fed is trying to allow the re-pricing to happen, but wants to slow the pace of it

·         Jim thinks the yield curve will steepen quite a bit, out to 150-200 bps by the end of 2008

·         If LIBOR/Fed spread continues to widen further, he'd expect a 50bps cut in December - thinks the fed would have no choice but to cut funds much more aggressively

·         If your view is that the Fed will need to cut aggressively, he recommends putting on his "curve steepener" trade

 
 

Greg Peters

• Expects a short-covering rally but is still negative
  
• Policy makers and central banks do seem to have moved into an "action phase"- which is a good start but we have a long way to go
  
• What's important about the Citigroup news is that it separates big fish from little fish - for the contrast, look at ABK continuing to weaken
  
• Knock-on effects on economy should continue to play out
  
• Started with homebuilders, then into financials, then consumer discretionary, and the next leg will likely be cyclicals
  
• Recommending long position in AAA ABX - dealers and banks still have onerous positions which they've hedged out with ABX, which has depressed values beyond where they should be
  

 
 

Abhijit Chakrabortti

• Behavior of the yield curve is important to Financials; we've seen LIBOR rates go up and treasury rates falling
  
• In mid-89, fed started cutting rates and the YC was inverted-fed cut from 9.5% to 7% in a slow, sedate manner and the yield curve didn't move much (from 100 bps inverted to flat), while S&P financials fell 45%
  
• Only after the Fed finally started to cut aggressively did the rally take place
  
• Since the fed has cut this year, by 75 bps, Libor rates have come down by less than the Fed (65 bps) and the yield curve is virtually unchanged
  
• So he thinks this provisioning cycle will be far worse than 1990
  
• The unchanged YC will be devastating for NIM and overall earnings for Financials
  
• For a sustained rally to be mounted in financials, the curve has to steepen with treasury yield going UP and MM/Libor rates falling, telling us that liquidity concerns have eased
  
• Magic words the market is seeking is not that the balance is "roughly equal," but that the balance of risks has shifted decisively toward growth and that they will aggressively cut as much as is necessary to address the problem
  
• In the July sell-off, MO and CL went flat, but this time they have rallied - this is a sign that the focus should be on - the market internals
  
• Fed needs to shift from the denial phase at least to the recognition phase (not even the action phase)
  
• Everyone keeps telling him the bearish view of Financials is such a consensus position - but everyone at Palmetto was bullish on Financials
  
• Who thinks Financials could fall another 20%?  That is the real contrarian view
  
  • Finding out what is non-consensus is just as important as being contrarian