Daily Market Reports | Jan 29 2009
By Greg Peel
The Dow gained a further 200 points or 2.5% but the S&P posted a solid 3.4% gain and the Nasdaq 3.6%.
The rise marks a very rare (in the new world) four-day rally in which the two big sectors of financials and commodities are trying to come back from the brink. For the most part, the materials sector is taking its lead from activity in the all important financial sector. Only last week financials crapped out again as worries continued over the capacity of big names such as Citi to merely keep trading, despite government injections to date. But the mood has turned this week – so far.
The market was positive from the outset last night as Wall Street focused on the new idea of “good bank – bad bank” as flagged by Citigroup. Citgroup has suggested it might split into two entities – one of traditional commercial banking called Citicorp (the good bank) and one of merchant banking and broking called Citi Holdings (bad bank). It is in the latter where all the toxic securities will lie, as well as all the heightened risk. This model is now being looked at as a possible template in the financial sector.
And it has piqued the attention of the Obama Administration, which has now resurrected the idea of the government stepping in to buy those toxic (bad bank) assets. Readers may remember that this was Paulson and Bernanke’s original idea for the TARP back last September but it was subsequently dismissed by the Bush Administration. The TARP has now mutated and evolved so fast that heads on the Beagle would be spinning. We still don’t know exactly how remaining funds will be deployed.
The resurrection of the idea has meant renewed cries of “privatised profits – socialised losses” but given the government will also be invested in the “good banks” via the previous TARP injections, it is covered on both sides. The good banks should be free to perform a lot better without the burden of the bad banks, but it is still another step towards nationalization in most eyes.
Nevertheless, the concept seems to have sat well with Wall Street and as such the market remained positive all the way up to 2.15pm – the time at which the Fed released its rate decision and policy statement.
There was no change to the 0-0.25% cash rate range, which is hardly surprising. The only way to go would be to zero full stop, or to go up of course but that was never going to happen. Indeed, not only did the Fed statement acknowledge that economic conditions had worsened yet again since December, for the first time it completely dropped any idea of inflation risk and switched to disinflation risk:
“The Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term”.
Moreover, while the Fed suggested there had been some improvement in credit conditions at the banking level as a result of the myriad of rescue measures, it noted credit problems still dog the corporate and household levels. It is still looking for gradual economic recovery later this year, but suggested “the downside risks to that outlook are significant”.
Wall Street was thus heartened that the Fed insisted the current cash rate range will remain in place “for some time”, but then that’s what it said in December anyway.
Probably the most interesting part of the January Fed statement was its length. Most Fed statements are short and sharp but this one might have been penned by Tolstoy. One long paragraph was devoted to what the Fed intends to do beyond simple cash rate management measures, and it is best considered in full (my emphasis):
“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee’s policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve’s balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve’s balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.”
Taken as a whole, this paragraph suggests the Fed will keep doing what it’s doing, and maybe more. It will do whatever it can. Maintaining the balance sheet “at a high level” means it is happy to stand in the middle of the financial market and ensure corporate paper can be rolled over in order to keep the daily economy functioning. The policy of buying mortgage securities has to date been heralded as a success in lowering mortgage rates for distressed homeowners or potential buyers and the Fed will throw more at it if necessary. Last month the Fed said it might buy Treasury securities, this month it “is prepared”. This will ensure credit rates are kept at lower levels. The plan to assist the smaller end of the market via the TALF “will be” implemented, as opposed to suggested, and all up the Fed will constantly assess whether “expansions” to policy are required.
In other words the Fed will do whatever needs to be done. That’s not really different from anything it has said for over twelve months, but this particular statement seems that much more emphatic than those preceding. Wall Street felt comfort in the words, and despite a bit of a stumble in the last hour, closed on a positive note.
The US dollar reaction was mixed, as it might be given nothing much new was announced. Gold thus slipped a bit further given little fresh impetus. It fell another US$8.10 to US$887.50/oz. The Aussie trod water at US$0.6609.
Oil jumped US54c to US$42.12/bbl as while crude inventories increased last week by about twice what was expected, gasoline inventories shocked by falling for the first time in months. It appears that the policy of refiners to continue paring back production capacity is now having an effect.
Base metals weren’t sure what to do, so they just sat tight.
The SPI Overnight rallied 63 points.
One point of interest last night was that the VIX volatility index closed at 40.63. The VIX had a go at dropping back into the 30s at the end of December but failed. If it can drop definitively this time it will be the first time since September – when the world imploded – that the index has been as low. The implication is that put option protection is being sold back, suggesting risk appetite is cautiously returning. The high in the VIX was 90 in October.
