Monthly Archives: December 2008

How will the Fed exit this strategy?

The only real surprise today was that the Fed cut its rate by 0.75% instead of 0.5%. US interest rates are now in a range of 0% – 0.25%.

Predictably equity markets rallied strongly and the Dollar got hammered, but the major question has to be whether or not the strategy of 2008 stands a hope of working.

In a year of unprecedented action, today’s decision amounts to the last throw of the monetary dice. With the TARP half-spent and only 0.25% of possible rate cuts left, the Fed has little options open to it now other than to invite US citizens to turn up to their printing presses with wheelbarrows, to cart off piles of worthless paper.

When we come back to look on 2008 I think it is going to be difficult to draw any other conclusion than the policy measures have not worked. Whether or not they have lessened the impact of the Credit Crisis remains to be seen, but each and every rally in equities post-rate cut this year has failed and the trend has reverted. Economic fundamentals have worsened and the declines have even accelerated.

However judging by the reactions of the talking heads on CNBC and Bloomberg tonight, today’s decision was “exactly the right things to do” (by the way also don’t worry things will be better by the second half of next year!).

I am not so sure. To my mind the financial system has failed. The Madoff scandal (more of this tomorrow) is just the latest symptom of this. The culmination of complicated and murky financial instruments and institutions, driven by short-term greed in extremely lax regulatory environments, will have to result in a whole new system for the international management of money.

No Government or Central Bank has faced up to this reality yet. If anything policy reactions have been knee-jerk, un-coordinated and have not addressed the structural imbalances which have caused the system to collapse.

Remember that Libor falling was meant to herald the beginning of the end. In the last 6 weeks Libor has fallen from above 4% to below 2%. Let’s see if the banks start lending again.

In the past I have pinned a lot of hope on Obama’s team putting together the modern New Deal. The only optimism I can cling onto at the moment is that they are going to pull something spectacular out of the hat. They are going to have to.

December Are people waking up to our situation? And is it too late?

Hearing that the German Finance Minister, Peer Steinbrück, had called our Government’s plan for stimulating the economy “crass” was both surprising and hilarious. I can’t remember the last time a senior member of a G7 Government criticised the financial policies of another in such a way, but when the consensus-loving Germans feel it necessary to break ranks, then things must be serious!

Given David Cameron’s calls for an early General Election, earlier in the week, and the publicity that attracted, there seems to be genuine unease at the measures proposed in the Pre Budget Report. As job losses increase and Sterling collapses, the staggering levels of proposed debt have clearly had an extremely unsettling effect on the already debt-laden public. Genuine fear for the country’s economic prospects has permeated the nation’s consciousness and monopolises headlines and conversations up and down the land.

However I fear that this awakening has come too late.

The Government’s spending plans look certain to go ahead and the indications are from the Bank of England that they are about to fire up the printing presses and start reeling off vast quantities of paper money. This all can only end one way – the wanton destruction of the Pound and the decimation of our economy.

Perhaps Peer Steinbrück made his comments because he felt safe in the knowledge that it will not be long before no one from the UK is going to be able to afford to travel to Germany to take issue with him!

Surprising reaction to US payrolls and can British Banks afford to pass on the 1%?

Friday saw yet more confounding action on the US market. In case you missed the numbers, the US economy 533,000 jobs in November, with large downward revisions for September and October. The unemployment rate jumped to 6.7%. By any measure, these numbers were awful. What is worse was that the pace of declines is actually accelerating.

Why on Earth then would anyone buy stocks against such a backdrop?!

I have spent a lot of the weekend pondering this question, but the ticker provides its own, crystal-clear story. 8,000 on the Dow is clearly a significant base.

Not only was Friday’s rally extremely surprising, it even appeared to have some significant weight behind it, based on the day’s volume data. A clear pattern has been forming over the last few months, in which the Dow has vacillated between 8,000 and 9,500. Friday’s rally was more evidence of a market finding its feet. I am still extremely bearish, but markets do rally in bear markets and we are due some positive moves after 6 months of carnage. I know talking about Obama’s inauguration is a tired topic, but it is extremely significant and is only 8 weeks away now.

I have stayed out of the market since September, but I think I will be tempted in again if the Dow hits 8,000. It just seems that no matter how negative the newsflow is at the moment, it is not able to sink US equities below their recent lows.

In the UK the situation looks a lot bleaker. Thursday’s “shock” 1% drop in Interest Rates was not at all surprising, nor was the reaction of retail banks.

A major row is now brewing, as politicians and journalists round on the banks, demanding that they pass on the full reduction to consumers. I generally have very little sympathy for banks, especially in light of the huge bailouts they have required from taxpayers.

However in this instance I am on their side and think they are actually doing the right thing.

When Japanese Rates hit 0% in the early 1990′s this proved to be the catalyst for economic stagnation, which the country only recently seemed to be breaking out of. Much has been made recently of the dangers of the “Japanese example”, but very few seem to have grasped what the fundamental problem was.

Taken at face value, 0% rates appear to de-risk the lending system. The thinking goes that the overhead of lending money is removed so this should encourage more risk taking, increase lending and stimulate more economic activity. This was certainly behind Greenspan’s aggressive rate policies in the late 1990′s and early 2000′s.

I think a lot of confusion in the media has been an inability to square the apparently contrasting results of similar policies in Japan and the US. Why did Japanese rate cuts in the early 1990′s fail, whereas Greenspan’s “worked”?

The first part of this answer is that the US rate cuts at the turn of the Century clearly didn’t work. All they succeeded in doing was to fuel a massive credit-driven boom, which we are now all facing the consequences of.

The second part of the answer is less clear, but I think (and hope) is behind UK banks not passing on the full cuts.

0% rates actually do not de-risk lending. Banks have substantial fixed overheads to cover to enable them to lend money as well as to carry the risk of borrowers’ failing to repay loans. If banks were required to pass on all base rate cuts then the further rates fall, the less viable it is for banks to function as businesses. In a traditionally conservative country, such as Japan, this proved to be a killer blow as the incentives for risk taking were inadvertently removed and capital markets dried up, starving entrepreneurs and corporations of the lifeblood they needed for growth.

Moving back to the present day, the outlook is so bleak that the likelihood is the next wave of losses to hit the banking industry will be those traditionally associated with recession. Traditional banking prudence, the likes of which has been absent in the past decade, is now being forced on senior management. I do hope that they remain steadfast in not passing on all rate cuts to consumers. By staying strong, they will be doing what is in our best interests in the long run, albeit painful in the short term.

If we are to claw our way out of a recession then a strong banking sector is going to be a necessity. A strong banking sector requires strong balance sheets and the ability to operate sustainable, profitable business models. Although this is galling to most of us, after the years’ of excess that have precipitated the worst economic conditions in three generations, but we really have to support measures, which are going to help us out of this mess faster.

Counter signals in bond and equity markets

If I’ve learnt nothing else this year it is not to be too blinkered in a view of the market and be open to counter signals. Had I paid heed to this, then Q3 would have been brilliant, rather than the personal disaster I suffered along with the rest of the World.Anyway, I have been keeping an eye on two market movements in the last few days.

First the bond market, especially UK Gilts, has been surprisingly strong. On Monday UK Government-issued debt yields hit 3.5%; a level not seen since the mid 1960′s. According to reports prices had been driven this low as investors sought a safe haven.

Second equity markets have rallied again off what look like key levels. For the FTSE 100 this is 3950 and for the Dow 8000. Of course both indices are at 5 year lows, but bounces off these levels, indicate a possible base being formed.

Traditionally it would be quite normal for bond yields to peak as equities plummet and level out. Some might argue that this is the beginning of a bottom or even, dare I say it, a bullish signal.

However such are the characteristics and risks of the current crisis, I am not so certain that we can use historical trends as a model for the future. The Credit Contraction is well and truly established now and will surely only worsen over the coming months. This will continue to drag on economic activity at all levels, which can only be bad for share prices and tax revenues. Why, therefore, would anything rally at the moment?

I think the only thing I can do is stay out of the market for now.

Also on Monday the National Bureau of Economic Research came out with a report, stating that the US recession started in December 2007. Regular readers will remember that I cast doubt on official US GDP figures at the time of their last release. Part of the recent strength of the Greenback can be attributed to the fact that the US has not entered an “official” recession (two consecutive quarters of GDP declines). Watch out for substantial downward revisions in next January’s quarterly announcement and for US Dollar to take another pummeling

Fiscal stimuli cannot solve this crisis alone

I attracted a fair bit of criticism last week, for a very bleak assessment of our Government’s attempt to avert the tide of economic misery which is enveloping us. The point was made (several times) that it is all well and good being critical of a set of policies, but what would I do differently.These comments got me thinking, hence the lack of blog writing (I’ve never been that good at multitasking!). The more I thought about what I would have done differently, the more I realised that Governments and Central Banks have been trying to solve the wrong problem.

Their efforts have been almost universally aimed at propping up the “system”. What doesn’t seem to have dawned on policy makers yet, is that these efforts can only fail. Anyone who has picked up a newspaper or turned on a television this year can see that the “system” is broken. Greed, self-interest and historic levels of debt have corrupted free markets to such an extent that confidence has been shattered in their effectiveness.

It is no wonder that all the fiscal stimuli have yielded no discernible success. In fact their failure to avert the crisis can surely only be interpreted as collective recognition that we are in desperate need of a new economic system, which can support and sustain society’s progress.

I am certainly not about to adopt the neo-Marxist viewpoint, as I do believe there is still a future for free markets, but I believe their essence has to change, through better regulation, laws and increased personal responsibility.

I talked about the need for Obama’s “Grand Plan” when he takes office. For confidence of a prosperous future to return, we need this more than ever.