Rakesh Saxena's  Instablog

In March, price-makers in the credit default swap market were demanding an upfront premium, over and above a 450-525 basis points spread, to cover default risk on GE Capital, the finance arm of General Electric (GE). This week, GE Capital’s CDS prices are in the 200-220 bps range, and no cash payments are being demanded or offered. A prominent issuer of daily CDS bulletins clarified that the sharp decline in perceptions of GE Capital risk “is a direct result of GE pre-funding 90% of its long term debt through 2010 and extending its commitment to its finance unit to five years from three.”

 

But in a debt market struggling to rationalize credit spreads, traders were wondering whether the entire CDS matrix was simply following the optimistic leads emanating from the equity markets? “How else can you justify 100-300% shifts in risk premium over a 6-month period?” a Wall Street bond specialist asked rhetorically in a recent CNBC interview. “Should we be ignoring CDS quotes altogether?”

Given the restrictive nature of financial instruments in the emerging markets, the Wisdom Tree Emerging Currency Fund (CEW) stands out in its ability to capture broad and sudden shifts in investor sentiment; the ETF is mandated to access “non-deliverable” forward exchange (NDF) contracts quoted by a number of seasoned market-makers. To the extent that the leading candidates in the emerging markets spectrum are responding to global developments in their own unique manner, the ETF is thoughtfully diversified. Moreover, since this ETF’s policy is to hold securities which are rated (upper two tiers, short term), it is well-positioned to weather a major meltdown.

 

At first glance, the Emergency Currency Fund may only appear to be of interest to traders seeking to make bets on a basket of emerging market currencies. However, a closer scrutiny throws up many other reasons to engage this ETF.

The bulls are back in full force on the networks during the weekend. “As more third quarter results are scrutinized this week, we are going to go well past 10,000 (Dow), this time decisively,” a prominent CNBC contributor insisted. And, quite clearly, the overwhelming majority of Wall Street analysts are convinced that the worst is behind us.

 

But what is being scrutinized is corporate performance in the midst of an environment which is heavily loaded with government intervention. In fact, what is behind us is the first round of stimulus plans, bailouts and rescue packages. What the future holds is the continuation of this massive trial-and-error programme targeting the elimination of systemic risk in the financial, housing and consumer sectors, in no particular order. The International Monetary Fund is predicting that governments will begin unwinding intervention-related commitments by mid-2010; the fundamentals, however, point unequivocally in a contrary direction.

Some on Wall Street call it a “sensible” approach. “The more you disclose, the more you get Washington’s lawmakers excited, and there is more talk of regulation,” a Geneva-based hedge fund manager told his partners at a conference last week. “Without trades in over-the-counter currency forwards, interest rate swaps, commodity swaps, structured products and equity puts, the share-price outlook for all major banks will remain subdued, recovery regardless.” Senior risk managers from Credit Suisse (CS) and Union Bank of Switzerland (UBS) who were attending the conference were in complete agreement.

 

According to Bloomberg (October 16, 2009), “the top five U.S. commercial banks, including JP Morgan (JPM), Goldman Sachs (GS) and Bank of America (BAC), were on track through the second quarter to earn more than $35 billion this year trading unregulated derivative contracts, according to a review of company filings with the Federal Reserve and people familiar with the banks’ income sources.” In other words, income from OTC derivatives is an integral and influential component of bank performance, particularly in an environment where the adequacy of loan delinquency provisions is still being debated.

Shortly after JPMorgan Chase (JPM) announced an impressive $3.9 billion profit for the third quarter, an entire series of Wall Street analysts began spreading the message of hope on the popular networks: despite problems in the broader economy, banks have entered a new era of prosperity. In reality, on closer scrutiny, JPM’s performance raises two fundamental questions which traders need to answer before they make short or long calls on Wall Street’s majors:

 

(1) Can the revenues achieved in JPM’s investment banking business, particularly fixed-income trading, be sustained and enhanced in the forthcoming quarters?

The shock waves from India’s Red Corridor failed to dampen bullish sentiment as the Indian stock market began celebrating key year-on-year data yesterday. Maoist guerrillas blew up railway tracks, burnt down train stations and destroyed transmission towers across the states of Bihar, Jharkhand, Orissa and Chattisgarh.  But the Sensex index still surged past the 17,000 mark on impressive industrial production numbers.

 

Industrial output grew by 10.4% in August (year-on-year) as stimulus money revived demand for household goods and cars. “Foreign institutions have invested more than $12 billion in the Indian stock market during the first nine months of this year based on valuations,” said a senior officer responsible for foreign accounts at Citibank, Mumbai. “With blue chips yielding as much a 17% return for the third-quarter period, we expect sentiment to remain positive well into 2010.”