The Credit to Equity Tie

Includes: DIA, IVV, SPY, UDN, UUP
by: Jim Delaney

You read this piece, every day I hope, to find out what is happening in the relationship between the credit markets and equities. From time to time however we take a step up and look at a macro factor that is affecting all markets. Sometimes this occurs in grandiose fashion and inter-market correlations jump to 1 and stay there until the markets figure things out. Sometimes it happens without a lot of people noticing.

Faith Popcorn, yes that’s her real name, wrote a book some years back called Megatrends. In it she made the observation that trends start out in the rural parts of the country and migrate towards the city centers while fads start in the cities and resonate out like shockwaves from a bomb blast.

On Monday of this week, for the first time in 16 years, it became easier to borrow a Dollar in the foreign exchange market than to borrow a yen. “Easier” in this case means cheaper which further translates into 3-month LIBOR was lower than 3-month YIBOR. The exact rates were 0.37188% and 0.38813% respectively so we’re not talking some huge differential here but a relationship that lasts for 16 years is something to be noted, especially when it breaks up and you don’t need lawyers.

On July 7th there was talk that the Administration was considering a second stimulus package. The reaction, everywhere but the most left leaning parts of Congress was very much less than enthusiastic. With barely 20% of the first ¾+ trillion package barely out the repercussions, both political and economic, seemed more than the traffic would bear.

This week President Obama renominated Ben Bernanke to head the Federal Reserve. Ben or Helicopter Ben as the media was so quick to call him before the credit crisis gave them something real to write about is a student of the Great Depression and vowed that GDII would not happen under his watch. Along with a host of other measures Ben took the Fed Funds rate to zero some time back and has, at every opportunity afforded him, made it extremely clear that they’re not moving off that mark for the foreseeable future and probably a bit beyond that.

We have also read much lately regarding the effects of China’s stimulus package and the possibility that it could be creating bubbles in the equity and property markets in that county, bonds being left out only because there is no such market in the country. The cause for these worries is the expansion of credit and the surfeit liquidity it is creating.

Lest you think today’s piece is a bunch of unrelated bullet points, here’s the thread. With Ben Bernanke’s confirmation for a second term Barak Obama will have his 2nd stimulus plan in place. No congressional wrangling, little to no media hype, just quietly, like those trends Ms. Popcorn discovered emanating from the hinterlands to form powerful forces.

Need evidence? You already got it. I repeat: “On Monday of this week, for the first time in 16 years it became easier to borrow a Dollar in the foreign exchange market than to borrow a yen.”

The rate markets are about quantifying how much more to charge as maturities extend and credit worsens. Absolute zero in that market is the Fed Funds rate. Ben has said that is staying at zero.

The world is focused on the excess liquidity and the problems it might cause in China. Ben is working hard to keep his foot off the bubble peddle but at the same time he’s got the accelerator floored.

The stock market is at its highs for the year because there’s a lot of liquidity around.

There’s your credit to equity tie in for today.

Enjoy the weekend.