During his speech last night, Ben Bernanke was cystal clear - the Fed are ready to cut rates. The stock market rallied all of thirty seconds before beginning its decline on the way to a 5% down move. Asian stock markets are down a similar magnitude, and I suspect Europe will be down more still. The dollar is flat while commodities are mixed. Energy is lower, metals (especially gold up 1%) and grains are slightly higher ...
... Bernanke might be criticised for yielding one of his most potent weapons against the market - the element of surprise. But this would be very harsh indeed. The market is going to go where it's going to go. It feels that the only thing preventing all out collapse at the moment is the prospect of some sort rate cut. Soon even that prospect will be exhausted and one feels there will then be nothing holding up the market.
Every policy responce has so far been sold heavily. Yesterday the Fed announced measures to unblock the CP markets by setting up an SPV with Treasury money to buy 3-month unsecured and asset backed CP directly from issuers. The Treasury will make a special deposit at the Fed to support the facility, and the Fed will lend to SPV at the Fed Funds rate making it neutral to monetary policy.
This is a crucial intervention as non-financial and blue chip issuers (like AT&T, Boeing and Deere) and even states like California and Massechusetts had recently been locked out of anything beyond overnight liquidity. After LEH went down and ... forget its name - money market fund ... broke the buck, there has been a collapse in demand for any short term money which isn't issued by the government by the money market funds. These states and companies rely on this liquidity to make payroll and pay suppliers. Moreover, the freeze is hurting financial institutions, not only because financials are the biggest issuers, but because the companies are now drawing on credit lines in the absence of any alternative. These had often been agreed years ago when spreads were in single digit bps and used as a loss leader to get advisory business ... seems like a long time ago now ... anyway, the effect in the credit markets looked good. GE CP spreads came in around 100bps on the announcement. Yet the stock market, after a sharp 3% move higher, soon fell back and began its long descent lower throughout the day.
Its kinda funny though ... some commentators, mostly those with a more libertarian leaning have suggested that rate cuts are the last thing develped market economies need right now, as though it's "like giving a junkie another shot of heroin". Since low interest rates caused the mess we're in why are we looking to low interest rates to get us out of it? I wonder what those people will say now that the Treasury has got the Fed to run a SIV to buy commercial paper?!
Will it work? Once again, it is a step in the right direction. But what's going to happen if the credit markets are still frozen when longer maturity debt falls due, impairing the ability of the companies to fund themselves at economic rates?
This is how to unfreeze the credit markets - create a centralised exchange for interbank lending. It looks as though we're moving in that direction in the CDS derivatives market already - why not do the same for interbank lending? If I buy an SPX future on the CME or a copper future on the LME, I don't care who took the other side of my trade. The only counterparty risk I have is with the exchange which effectively insures me against counterparty default by charging me a fee which I pay for with membership of the exchange. There should be a similar mechanism in place initially provided for by the governments, for interbank loans. Effectively, the fear of counterparty default would be removed and banks would once again be in a position to lend to one another.
On March 6th, 1933 facing the prospect of a run on the banking system and on the country's gold reserves, Roosevelt declared a bank holiday to commence four days. In those days Congress hurriedly passed the Emergency Banking Act (By March 9th Henry B. Steagall, Chairman of the Committee on Banking and Currency, apparently had the only copy of the bill in the House. Waving the copy over his head, he entered the House chamber reportedly shouting, “Here’s the bill. Let’s pass it!" They did so in 40mins and a few hours later the House approved it.) Among other things, the Act allowed the RTC to take equity stakes in private sector banks and set up the FDIC deposit insurance scheme. I say we do the same thing right now - we all get a week to recover, the policy makers get a week to set up a centralised clearing exchange for interbank lending and recapitalise our banks.
Central banks should also be cutting rates though and at long last it now looks as though they're finally about to. So far, the unconventional measures don't appear to have meaningfully narrowed any risk spreads. Rate cuts won't either but at least they'd lower the ultimate cost of capital for those able to get finance. All this delay has felt like we've been watching the house burn down but are scared to turn the hose because we're worried about the water bill ... better late than never I guess, but there isn't much of a house left ...
But here's another problem - who the hell is going to finance the US current account deficit? The cash-rich surplus economies currently doing the financing aren't looking to clever at the moment and any sudden withdrawal of capital by them could introduce another black swan in a sky filled with them.
For example, illustration of the confusion over the seriousness of the situation in the Chinese real estate markt was provided by Morgan Stanley. One of their economists - Mr. Wang - predicted that "A substantial improvement in the inflation outlook should help ease the lingering concerns about the inflationary consequences of an expansionary macroeconomic policy,'' and that he " ... expects a decisive policy shift toward boosting growth in the coming weeks and months." All sounds sensible enough. Except that the main risk to his forecast was a "meltdown'' in the property sector across the country which "would lead to a massive collapse in real-estate investment". Wang said the consequences of this could be so serious as too offset any pro-growth policies the authorities might attempt, but put such a probability at a comforting 25%.
Last month, Jerry Lou, one of their strategist said the likelihood of a meltdown was high. Annecdotally, white elephants can be found all over China - empty hotels, shopping malls and sports facilities. And those white elephants are collateral on banks balance sheets somewhere. Also, its nearly always wrong to trust an economist's view, especially if he's a good one. So I'm even more worried that Mr Jerry Lou might be right. If he is, the Chinese will join the Koreans who are already repatriating their dollar holdings to shore up domestic liquidity shortages ...
Meanwhile, Russian President Dmitry Medvedev pledged $36 billion of loans to the country's banks for five years to help unfreeze credit markets. That takes the total Russian lending to banks and companies via loans, cash auctions and tax cuts to $190bn in an effort to maintain a decade-long economic boom. And just in case a quick glance at the stock market didn't tell you how bad things were (down 65% since late May) Russia's big four oil companies have asked the government for loans to refinance debt. Gazprom, Lukoil, Rosneft and TNK-BP are all struggling to raise liquidity at economic rates and so are tapping government reserves ...
... and in the UAE, the central bank also injected $16bn dollars into their banking system to relieve liquidity shortages there. Nevertheless, Dubai plans to build a 350 billion dirham ($95 billion) development, Jumeirah Gardens, that will be home to up to 60,000 people. It will include offices, retail, residential buildings, two hotels as well as a high-end shopping area andis expected to be complete by the fourth quarter of 2013. Apparently, they think the real estate boom has nothing to do with the recently high but now falling oil price, even though the UAE were shut out of credit markets in 1999 ... if it wasn't so tragic it'd be funny ...
Speaking of oil ... have the Saudis already pulled back in the 500k bpd they they sold into the mkt after oil hit $147? OPEC members pumped an average 32.19 million barrels a day last month, down 425,000 barrels a day from August, according to the survey of oil companies, producers and analysts. As Goldmans back away from their uber bullish forecast, now saying a rise to $120 was unlikely any time soon, Libya called for OPEC production cuts. The president of OPEC Chakib Khelil said the group would take "appropriate measures" to stabilise markets ... bring back the evil speculators maybe?
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