The world has gone ex another inflation fighting central bank after China cut rates by 27bp to 7.20% and also lowered reserve requirements yesterday. The Australians have already cut and everyone else will soon follow as the cycliacal peak in inflation has clearly been seen. As recently as early August, Bernanke suggested the Fed's next move would be up not down. In 2006 the same man - who spends his entire working life observing and analysing the health of the US economy - said under oath that there was no problem in the US housing market.
AIG were downgraded overnight and this morning their CDSs imply about a 60% chance of bankruptcy. The FT reports they needed to take a $20bn hit on their bond insurance exposure, while a downgrade requires them to post another $20bn in collatral. But its getting out of control. Yesterday they wanted a $40bn bridging loand from the Fed, presumably adding up those two numbers, but were allowed only to bend the rules so as to give themselves a $20bn bridging loan using otherwise ringfenced holding company assets as collateral. Today, in a Zimbabwesque inflationary leap, they need $75bn.
It seems as though Goldmans and JPM are setting up to lend them that $75bn. Not that either of those banks have anything like that sort of money to lend. But they do have access to the Fed. In March the Fed used JPM as its vehicle to bail out Bear, which at the time as an investment bank had no access to the Fed's lending. It feels like JPM and GS will be used similarly here with AIG.
Will they cut today? I had doubted it. The liquidity response to the panic in the stock market has been comprehensive with the Fed now taking eqities as eligible collateral (wonder if that includes LEH and AIG?) ... more likely was an admission that they're now thinking about it. But BB has shown himself easily paniced by stock market declines so a cut wouldn't surprise me ...in fact, the Fed Fund futures are now pricing in action with greater than 50% probablility from virtually zero a week ago ... the Chinese monetary response hasn't done much in Asia this morning though, where indices are down roughly 5% following on from the US last night. Chinese property prices also rose by 5.3% YoY in August, the lowest gain in 18months.
As spectacular as the stock drop is that of oil, which is trading down 4% to below $92 this morning. MEND attacked a flow station in a third day of attacks and claim that Alakiri flow has been completely destroyed after what sounds pretty much like all out war, with the military launching air and marine offensives against MEND positions. Shell already announced force majeur on Bonny light deliveries in July and have now extended that.
Meanwhile, the IAEA said yesterday that Iran had produced 480kg of low enriched uranium and were consistently refusing to answer questions concerning allegations of nuclear weapon making activity. What are the Iranians playing at? Who knows. It seems as though the mullahs are playing a game of brinkmanship with Amadinejad as their pawn-cum-rotweiller. The economy would certainly benefit enormously from a lifting of the sanctions the West is talking about and one would expect that to be the end game. But the Iranians seem to want more than what's on offer.
Rationally, war is in no one's interest. The biggest weapon the Iranian's have (until, crucially, they get nuclear weapons) is to block the Straits of Hormuz. But that's not actually especially useful as a long term strategy. By preventing the export of their own oil it would harm themselves as much as anyone else. Moreover, their own feeble navy consisting of a couple of dingies and a rowing boat couldn't hope to last more than a few days against the might of the US navy, destroyers and aircraft carriers and all in such an event. And such action would have widespread international support to the extent it lowered world oil prices. And in any battle for public support the Iranian's could only use such a tactic credibly if they could claim to be using it in self-defence defence. That means they need some sort of provocation and that's what the nuclear antagonism is all about.
The Israelis cannot tolerate a nuclear Iran. They view it as an existential threat (Amadinejad has openly called for Israel to be wiped off the map) and have threatened to take out any Iranian facilites in the same way they did with those in Osirak in Iraq in the early 1980s, and in Syria last year. But an Iranian operation, being much further away and with targets spread out over the country, would be much more complex than either of those operations. It would require Iraqi (US?) permission to use airspace and/or US aircraft carriers. But the US don't want another foreign adventure and would be unlikely to sanction an Israeli attack unless there was no other option. The Israeli noises so far, that they are about to bomb Iran and have conducted training exercises, have largely been bluffs (you don't telegraph to your opponent what your next move is going to be). But that's not to say they have to be remain bluffs.
So where does that leave us? A nuclear Iran is such a game changer in Iran's favour that they want far more compensation than what's on offer for forgoing it. More posturing by both sidesis therefore likely until some sort of diplomatic solution is reached. Losing Russia over Georgia has probably upped the price the West will now have to pay. But this is a dangerous game indeed because there are euphemistic "hawks" on all sides - Iranian, Israeli and US - who want conflict.
The grain markets are also being swamped by the panic in stocks right now and the associated strength in the dollar, but the Australians said this morning that they expected to haverst 5% less wheat than they'd forecast because of dry weather. That puts the current forecast at 22.5m tons, still materially higher than last year's measly 13m tonnes ... but we're still early in the season down there ...
... meanwhile, the fundamentals in the sugar market are looking better than they have done in a while with various factors coming into play. As sugar prices have been flat comparered to those of othe crops the Indians have switched production leading to an output drop of 16% according to the ISO. This would lead to a drop in exports of 86%, basically removing India from the export market. Meanwhile in Europe, the WTo ruling on EU dumping of excess sugar supply on world export markets comes into effect on Oct 1st. This outrageous and pernicious EU legislation currently subsidised EU farmers in the production of sugar, causing them to over produce for their domestic market, but allows them to dump that excess production on world markets. That game is now up and there will be a consequent decline in world sugar supplies to the tune of 14m tonnes according to F.O. Licht in Germany. Allowing ethanol importation from Brazil into the US is increasingly gaining traction with McCain on record as saying he would remove the current prohibitive tarrif which corn based ethanol relies on to compete. Any move in that direction would see a huge diversion of the Brazilian crop towards ethanol and away from sugar ... interesting ... need to check on the inventory position before I get frothily bullish
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