November looks set to prove another tough month for hedge fund managers and bank prop trading desks. The optimism of some pundits following a market rally in September that global credit markets and the bank funding system was shrugging off mispricing of the risk premium in the past several years proved short-lived.
Volatility moves in November resembled those seen in August, and the omens do not augur well for the short term. There is a severe decoupling between the troubled credit and funding markets and the buoyant equity markets. The spread between three-month US Treasuries and Libor has reached levels not even seen in 1997/1998, when the Asian financial crisis, coupled with the near-default of hedge fund Long Term Capital Management, sent shivers through the financial markets. But equities aren't far off all-time highs - both in Asia and the US.
Most local senior executives in Asia believe the region is significantly isolated from the troubles in Europe and the US. Given strong corporate earnings in the region - and in the Europe and the US - the buoyancy of equity markets does not immediately come as a surprise. But there are concerns this may be a short-lived phenomenon. Asian inter-regional consumption is growing fast. But if the US goes into recession, the region's exporters will face significant problems.
Clearly, something has to break - either liquidity returns to the credit and funding markets or equities are due for a major tumble, even in Asia. And this seems to centre on whether US supervisory action will work to ease funding issues.
For a change, the most critical action may not stem from the Federal Reserve Boards' easing of the Federal funds rates. US treasury secretary Henry Paulson appears to be driving actions aimed at curtailing problems in financial markets.
His efforts to create a 'super-Siv' seem to have floundered. Asia's 'old hand', HSBC, partly scuppered these efforts by bringing $45 billion of its special investment vehicle commitments on balance sheet. Japanese interest also looks to be waning - and it's unclear why Japan's banks should bail out the overindulgence that took place in the US, unless, of course, they are more involved than they have let on.
Paulson appears to be using Asian tactics to delay the implementation of realistic mortgage interest rates following the end of US teaser promotions.
Whether these coordinated efforts will work or not is still open to question. And it's unlikely to become clear until the release of end-of-year audited results - accompanied by Sarbanes-Oxley-era potential jail time for senior executives that understate their problems.