FYI | Aug 30 2007
By Greg Peel
It’s probably easiest just to pretend that Tuesday and Wednesday never happened on Wall Street. Wise heads have suggested they’re simply not interested in playing in a market with such light volume. This week is the last of the summer vacation period and weary traders are on the beach, not the bourse.
The second quarter house price numbers released on Tuesday were real, but hardly a shock. Nor should the consumer confidence number be gobsmacking and in fact it was not quite as bad as analysts had predicted. The Merrill Lynch downgrades were real, but the real folly of Tuesday was the reaction to the August 7 FOMC minutes, as noted in yesterday’s overnight report. Well, they were at it again last night.
New York Democratic Senator Charles Schumer has been fairly vocal throughout the credit crisis, and last night it was made public that Fed chairman Ben Bernanke had written Mr Schumer a letter on Monday in which he stated “The Fed is closely monitoring developments in financial markets” and “is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets”.
Omigod! That means Bernanke is going to cut rates after all!
Having decided on Tuesday the Fed wasn’t going to cut rates, based on the outdated minutes of the August 7 FOMC meeting, Wall Street sold off stocks heavily. This news last night saw Wall Street buy them all back again. Well here, again, is an excerpt from Bernanke’s August 17 statement:
“The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.”
Can you spot the difference? Nor can I.
No wonder the wise heads are staying out of this ridiculous market. Those wise heads are also fully aware that Bernanke will make a statement on Friday from the Fed’s Jackson Hole retreat that will supersede all others. Fridays are usually fun days on Wall Street.
Suffice to say, with respect to the rest of the markets, that everything that went one way on Tuesday went the other way last night. The US dollar fell against the euro and rallied against the yen. The Aussie rallied. US ten-year bond yields ticked up. Gold rallied. Base metals largely rallied. Let’s just say everything went roughly back to where we were on Monday.
The SPI Overnight rallied 96 points.
What we really have here now – ahead of whatever Bernanke’s going to say on Friday – is a conundrum. Uncertainty is operating on two levels. There is the short term level of the ongoing liquidity crisis which is still seeing corporate paper unable to be rolled over despite ongoing injections of liquidity into the system. That money is still heading into Treasuries. And there is the long term level that suggests the housing/mortgage crisis will slow down the US economy, perhaps even into recession. On both counts, the market wants to see the Fed cut the cash rate. Firstly to relieve the credit crisis and secondly to stimulate the economy. But the conundrum is that the Fed is only “prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets”.
In other words, the Fed will cut rates if it sees a continuing problem. That would be a continuing lack of liquidity in credit markets and/or bad economic data. The liquidity crisis is just not going away, and every time there are some bad economic data the market panics and sells. But every time the market thinks the Fed will cut rates it panics and buys.
Let’s say tomorrow’s second quarter GDP number is strong. What do you do? Do you buy because it means a recession is less likely or do you sell because a rate cut (or a least a substantial rate cut) is also less likely? Let’s say Bear Stearns announces a significant profit downgrade. Do you sell because this is the bad news we were all fearing or do you buy because this might encourage the Fed to cut rates?
We still have a way to go.
