ANALYSIS-Y2K fears seep into world markets at last 09:16 a.m. Aug 17, 1999 Eastern By James Saft

LONDON, Aug 17 (Reuters) - A slew of financial market distortions and anomalies in recent weeks have at last provided hard evidence that international investors are moving to price in the risks surrounding the Y2K problem.

Years of hand-wringing by pundits and politicians about millennium computer problems have until recently caused only slight and arcane moves in market prices.

But recent sharp increases in bond market credit spreads, a fresh selloff in emerging markets and the gloomy interest rate horizon implied by short-term futures market have all been at least partly spurred by the Y2K effect, analysts said.

``There is an avoidance of risk and a preference for liquidity,'' said Giles Keating, Credit Suisse First Boston chief economist.

``There has been a lot of discussion about Y2K over the last six months but nobody quite foresaw swap spreads, for example, being driven to such extreme levels.''

In the last two weeks, U.S. swap spreads have soared to their highest levels in a decade.

Benchmark 10-year dollar swap spreads now stand at 100 basis points, having touched 114 earlier in the month.

U.S. swap spreads reflect the interest rate premium a double-A-rated borrower would have to pay over U.S. Treasuries and are a key barometer of investors' overall appetite for risk.

Ballooning swap spreads are being driven in part by a glut of issuance by corporate borrowers eager to nail down financing before an expected Y2K-related year-end market shutdown.

The Y2K or millennium bug problem arises because many computers were allocated just the last two digits for the year in dates. Unless amended or replaced, computers may misread the year 2000 as 1900 or simply fail to work.

There is also evidence debt markets are increasingly anticipating a yearend scramble for cash as insurance against any potential millennium disruptions -- with investors steering clear of all bonds with coupons due in the first weeks of 2000.

A so-called ``millennium butterfly'' trade, under which investors buy December futures contracts while selling September and March, shows that Eurodollar markets are offering a 40 basis point premium to those willing to lend out money over the turn of the year, according to Steve Major of ING Barings.

On Euribor markets the premium available is 49 basis points.

Both figures are substantially higher than they were in May and have the potential to go higher, Major said.

``We are entering a surreal environment and as bankers we are paid to be prudent,'' Major said.

``Given that it is only August and we had this amount of dislocation, I would say would say the spread would go up.''

Other measures of bond investor concern around the millennium, such as a preference for more liquid ``on the run'' government bond issues, have so far shown only modest effects.

An overall measure of bond market Y2K sensitivity devised by ING shows investors are now only half as nervous as they were at the height of the Russia and Long Term Capital Management crises of late 1998, when euro conversion nerves added to uncertainty.

``We are at 50 percent of last years' peak in risk aversion, we think that it may get worse before it gets better.''

The steep central bank interest rate rises that are being discounted over the next six months in eurodollar and sterling interest rate futures contracts are also seen as at least partly a Y2K-rleated anomaly. Analysts said the strips are substantially driven by a demand for cash around the millennium rather than a prediction of central bank policy.

A selloff in emerging markets in recent weeks is also at least partly attributable to fears lesser developed areas will have difficulty hurdling yearend technical challenges and as investors who made money in these assets turn risk averse.

The MSCI-EMF benchmark emerging markets index is now about 10 percent below its recent peak and some Brady bonds have underperformed.

Even the recent run-up in oil prices has been partly explained by some as a dash to build up inventories ahead of any yearend logjams. Others say the recent surge of Japan's yen is related to a scramble for cash and the resultant repatriation of capital by the world's largest creditor.

Keating at CSFB said that the lower profile of hedge fund and bank proprietary desks after last years' LTCM fiasco has allowed price anomalies to grow.

``There is a more limited amount of arbitrage capital and that is perhaps removing the capital which would otherwise help to arbitrage the market,'' he said.

Link

-- It's a sign (of@the.times), August 17, 1999

Answers

A glut of corporate paper issuance ahead of "...an expected Y2K year-end market shutdown?" Huh? Which corporate CFOs are expecting such an event? Is this simply another expression of the 'doomer' mentality? There seems to be a liquidity crunch brewing, or what may more accurately be called a 'confidence' crunch.

-- Spidey (in@jam.commie), August 17, 1999.

Is it illegal to yell Y2k in a crowded Schwab office?

-- Safer (Buggedoutof@lanta.net), August 17, 1999.

It's a sign,

A good timely posting. Thank you very much. London reports seem to lead us by a few weeks or a month. Now, when CNN and/or the business channel starts talking about this the same way, then the public will notice.

-- Gordon (gpconnolly@aol.com), August 17, 1999.

Safer,

ROTFLMAO! Great one!

-- (cannot-say@this.time), August 17, 1999.

Safer,

No, not illegal, but definitely not being a "team player" and it will get you booted out of there real quick, as an enemy-of-the-people. LOL

-- Gordon (gpconnolly@aol.com), August 17, 1999.

Safer,Gordon,

As Mr. Burns from the "Simpsons" would say: "Excellent".

-- CygnusXI (noburnt@toast.net), August 17, 1999.

Of course LOndon leads us--not as much thought control there.

-- Mara Wayne (MaraWayne@aol.com), August 17, 1999.

Yen rise seen fuelled by Y2K-related risk aversion

10:34 a.m. Aug 17, 1999 Eastern By Swaha Pattanaik

LONDON, Aug 17 (Reuters) - Mounting risk aversion among global investors, not least because of jitters before the millennium, could create a headache for Japan which is already confronted with a recovery-threatening rally in the yen.

The premium that investors are demanding to hold anything but top- rated government debt has risen above levels hit after last year's Russian default while concern about the havoc Y2K could wreak on the world's markets is boosting demand for cash.

Although investors around the world are taking money home or looking for safer places to park it, Japanese capital repatriation is seen dominating and unleashing a fresh bout of yen strength given Japan is the world's largest creditor nation.

A wash of money returning home to Japan would therefore drive the yen above all-time highs it has already hit against the single currency on Tuesday and beyond the six-month peaks it hit against the dollar earlier this month, analysts said. ``Bond markets are pricing in more problems than the equity market, and the risk is that the equity market, which is semi-professional because of the large amount of public participation, is behind the curve,'' said Shahab Jalinoos, senior currency analyst at Commerzbank Asset Management.

``If there is a major correction in equity markets, the dollar would suffer against the yen given the U.S.'s role as a major importer of capital while the yen will benefit as a capital exporter, and this will be independent of what is happening in Japan.''

``People are also expecting to see the long end suffer and cash outperform because of millennium fears.''

Japan's current account surplus totalled nearly $55 billion in the first half of 1999. As long as this money flows abroad via the capital account the yen's tendency to appreciate against the currencies of Japan's trading partners is kept in check.

As soon as Japanese investors become less inclined to take their money abroad, the yen begins to rise.

This tendency becomes even more pronounced when money starts flowing home, or investors who have used cheap yen rates to fund leveraged bets start unwinding such bets, called carry trades.

``Many indicators of risk aversion have been going up recently, not just in emerging markets but also in the U.S, and in this environment, the currencies which higher current account balances are the ones most likely to benefit,'' said Alfonso Prat-Gay, global head of foreign exchange strategy at JP Morgan in London.

``Risk aversion is also associated with unwinding of carry trades and repaying loans in funding currencies and the yen is the funding currency of the world and should benefit.''

Prat-Gay said he is expecting the yen to appreciate to 113 per dollar within the next month.

While currencies like the euro and the Swiss franc are also backed by current account surpluses, they are less likely to advance against the dollar on this basis for the time being, analysts said.

``This argument does not hold water with the euro zone given its current account surplus with the U.S. is much smaller than the Japan's and smaller than the capital flows,'' said Tony Norfield, global head of foreign exchange at ABN Amro in London.

Meanwhile, there are already signs that investors are beginning to batten down the hatches in preparation for possible computer glitches at the end of the year.

``Some people are already getting out of stocks and bonds and moving into cash as they don't want to revalue and deal with volatility before Y2K,'' said a dealer at a U.S. bank in London.

``Rather than revaluing, they are taking profits, sticking their money into cash, and sitting tight.''

Link

-- It's a sign (of@the.times), August 17, 1999.

Uh - what the heck is a swap spread?

Sounds dang kinky to me.

No, but seriously, what are they talking about?

-- R (riversoma@aol.com), August 17, 1999.

Favorite quote from that Reuters article:

``We are entering a surreal environment and as bankers we are paid to be prudent,'' Major said.

There are a number of Dali paintings that capture the essence of that quote wonderfully.

-- Mac (sneak@lurk.hid), August 17, 1999.

That surreal painting of Dali's that comes to mind is his "Atmospheric Skull Sodomizing a Grand Piano." I interpret the Skull to be the bankers, and the piano is "we the people" (meaning investors).

-- gilda (jess@listbot.com), August 17, 1999.

"Atmospheric Skull Sodomizing a Grand Piano."

I didn't know Elton John was in on this.

-- Forrest Covington (theforrest@mindspring.com), August 17, 1999.

You asked R, so I'll give it a try.

What is a swap spread?

I am not terribly familiar with the European money markets (although I do know that LIBOR stands for London Inter Bank Offer Rates), but interest rates I know.

Let's start with what a spread is and how it relates to risk assessment.

Suppose you have two bonds paying $1,000 each on January 31, 2000. One is a U.S. government bond, the other is a corporate bond from Intel. In the absence of the Y2K problems, you would expect the yield (the current rate of return for holding the bond) of the Intel bond to be slightly higher than the rate for government bonds. This difference in yields or interest rates is usually called a RISK PREMIUM because the U.S. taxpayers are less likely to default on their loan than Intel. This difference in interest rates is also referred to as a spread which can be measured in "basis" points. 100 basis points equals a difference of 1% between interest rates.

In addition to default risk, there is also inflation risk over time and the "price" charged in the form of interest for borrowing this money over time. The spread between bonds which mature or pay out on different dates reflects the cost of borrowing money and the inflation risk. The spread over time can therefore be used as a measure of what lenders and borrowers think will happen in the future with respect to the risk of inflation.

Now, the spread that is being referred to in the article is a swap spread. Swaps are usually electronic transactions in the form of bonds and cash between large financial institutions like banks and brokerage houses. If you are a bank that runs into a liquidity problem today, there is usually a bank with excess cash which will lend to you temporarily for the going swap rate, even if it's just for overnight. Typically, you swap government bonds which mature in the future for cash for a very short time. At the end of the swap you give back the cash and receive your bonds back.

What they are seeing is that the spread between bonds which are maturing in September, the bonds that don't mature until December, and the bonds which mature in March are exhibiting an abnormal pattern. Normally, you would expect a gradually increasing spread over time which produces a smooth yield curve. Instead, they are seeing a dip in December with increases in interest rates for September and March. This indicates that people want to borrow in September, but to stay away from December. The interest rates are even higher for March because fewer people want to be creditors over the rollover.

The spreads are indicating that the supply and demand for loanable funds in the next several months are being impacted by people's fears about Y2K. In economics we call this uncertainty. Markets hate it. Banks fear it. There's going to be a lot of it in the next few months. There's nothing that the Fed or the Treasury or the UN or the Bilderbergers, or you or I can do about it.

Except to prepare of course.

-- nothere nothere (notherethere@hotmail.com), August 17, 1999.

"Y2K fears seep into world markets at last 09:16 a.m. Aug 17, 1999"

Well American investors seem to be as leak proof as ever to Y2K seepage. One more day at least. Dow closed at 11,117.08 and Nasdaq composit up 25.94 points.

-- Chris (%$^&^@pond.com), August 17, 1999.