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Thursday, 19 October 2017

What's that smell? Is it a building money-market crisis?

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Forgive me if I suggest that we briefly forget the Eurozone crisis and also the United States debt ceiling issue for a moment, stick our nose into the air and try to ascertain whether there is another, more worrying, smell of trouble abroad. There is a whiff but as yet not a stench. It is something we should recognise but something we probably would like to forget. There is quite clearly a sense of something troublesome brewing in the money markets.

The events of summer 2007 – I mentioned them last week – which led to the credit crisis began with a seizing up of the interbank money markets in the aftermath of BNP’s announcements surrounding the asset quality of one of its structured credit funds. Although everyone remembers the fall of the House of Lehman, it should not be forgotten that Bear Sterns was wiped off the map along the way and had Bank of America not stepped up at two minutes to midnight, Merrill Lynch would have been for the high jump too. The cause was a fear of assets which were reported to be a lot better than anyone was honestly prepared to accept.

I have the pleasure of being acquainted with a hedge fund manager attached to a family office who in previous incarnations has acted as head of European credit research for a number of large and reputable investment banks. When chatting last week, he was expressing his concern over a presentation he had just attended in which one investment firm was proudly offering a supposedly low risk money market fund which was returning Libor plus 80bp. Was this not where the so-called “credit crunch” began? Is there not something inherently wrong and deeply, deeply scary in a “risk-free” fund which is returning 80bp? The funds must, in order to be showing that kind of spread, be holding paper from some of the banks in the most troubled regions of the Eurozone. Any assumption that these are low risk smacks to me of near criminal negligence.

However, my little spies in the short-term funding markets confirm that refinancing unsecured short term debt is becoming progressively more difficult and I have had confirmed that interbank lending for anything more than a month at a time is getting tricky. It is of course far too early to extrapolate that we are building up to another late summer crisis in the money markets but I would like spin something of an original thought.

Back in 2007 and 2008 there were many, many fights between finance directors and their corporate treasury departments. Treasurers were prepared to pay above the odds for bond issues in order to have large cash reserves and so as not to be dependent on banks for liquidity. This money was not cheap but the comfort of being self-sustaining was deemed worth it. Although expensive cash was painful, FDs seemed prepared to give the treasurers their head. Since things have eased up in the past two years, equity geeks have been eyeing up the cash piles and have been getting increasingly excited about the prospect of them being used for acquisition purposes or, much more to their short-termist taste, for share buy-backs. This is not what those war chests were created for. The aim was for companies to retain financial independence. I wonder if the stock jockeys who are calling for the cash to be returned to shareholders also cancel their health insurance if they haven’t been sick for two years or leave their house unlocked because they haven’t recently been burgled.

We know that markets aren’t happy. We know that many of the assumptions which were being priced into assets at the beginning of 2011 have not come to pass but we have not yet seen any alternative macro outcome being half-way coherently and properly discounted. I am still comfortable with the way most major companies dealt with the banking crisis and how they have adapted to a changing world. The current reporting season in the US has confirmed this and there is little doubt that the European one will broadly demonstrate the same kind of resilience to the lack of notable underlying growth in GDP. However, although there is plenty of good news to be expected on the corporate front, the economy remains perched on a fiscal and monetary fault line where the banking system acts as the seismograph – and it looks to be picking up first little tremors. Banks, especially Hispanic ones, have a wall of refinancing coming up and if the markets were continue to show disdain for them and for the Spanish government’s attempts to stabilise the situation – the Bankia IPO looks to have been driven by more arm-twisting that by natural confidence and enthusiasm – those tremors could develop into serious quakes.

“Chapeau!” to the corporate treasurers who have hung on to their cash and “Boo, hiss!” to the analysts who want them to give it all away again.

Anthony Peters is a strategist with SwissInvest

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