FYI | Dec 13 2007
By Greg Peel
The Dow traded in a 383 point range last night, one day after having fallen nigh on 300 points. The index opened up 272 points, fell most of the day to be down 111 points, before rallying in the last hour to be up 41 points, or 0.3%, at the close. Similar rollercoasters were experienced in the S&P (up 0.6%) and the Nasdaq (up 0.7%). You’d think that as we approached the holidays we might have expected some ease-off of volatility, but noooo.
Volatility had dropped dramatically last week after the Bush Administration announced its subprime rescue plan, but Tuesday’s 25/25 rate cut was a big disappointment and last night’s new rescue announcement was – well – confusing. It took a while for the market to think it through.
The announcement was ostensibly this:
The US Federal Reserve has coordinated a plan in cooperation with the European Central Bank and the Swiss National Bank, and to some extent with the Bank of England and the Bank of Canada. What it amounts to is the biggest globally coordinated injection of liquidity into the world’s financial system since 9/11. What it involves is a series of auctions of funds to qualifying banks aimed at unfreezing the credit market.
On December 17, US$20bn will be auctioned by the Fed. A further US$20bn will be auctioned on December 20. Further auctions will be held on January 14 and 28, the size of which will be later determined. At the same time, temporary swap arrangements will be established with the ECB (US$20bn) and the Swiss central bank (US$4bn). Apparently the BoE and BoC were included in discussions.
At first glance, it looks as if the Fed sat watching the Dow fall effectively 350 points on Tuesday in response to its 25/25 rate cut and decided to unleash the beast it had been holding back just in case. Not so, said the Fed. Apparently this plan has been in formulation for some time and was always going to be implemented.
So why on earth did they not announce it yesterday, alongside the rate cuts? Wall Street financial traders are livid, and it’s not just in the stock market – a more severe whiplash occurred in the US Treasury market which no doubt left copious pools of blood on the floor of the Chicago Mercantile Exchange and in dealing rooms around the globe. Apparently the Europeans weren’t available yesterday, or something.
Plan B does, however, put yesterday’s very disappointing cut of only 25 points to the Fed discount rate into perspective. It was only half the story. The Fed obviously knew that you can lead a horse to water but you can’t make it drink, and has seen that cuts to the “target” rate have proven largely meaningless in the frozen credit markets and that the discount “window” is not something many banks have been prepared to approach due to the stigma attached. By holding auctions, the Fed can offer funds at whatever becomes the market rate for legitimate hand-outs. The whole problem to date is that the real interbank funding rate – Libor – had risen, not fallen, as the Fed kept cutting. These auctions bypass Libor and as such that rate finally fell last night.
And as such the spread from US Treasuries to Libor sprang back. Having dropped sharply on Tuesday in yet another flight to safety, US Treasury yields completely reversed those moves last night in a second day of extraordinary magnitude. Twos finished back at 3.08%, tens at 4.05% and the thirties (mortgage base) at 4.5%. Had the Fed announced the liquidity injection on Tuesday, Treasury markets would have been calm.
There was little time to think on the stock markets last night. It looked like another market-saving rescue package – one that should appease the financial sector and reverse some of Tuesday’s fall. The Dow shot up nearly 300 points in anticipation but soon the realisation sank in that the financial sector was actually not biting at all. Is this a good package? Or does this simply indicate the credit market situation is a lot more dire than even the sceptics were suggesting?
By mid-session it didn’t really matter that much, for Bank of America was always going to preview its fourth quarter earnings last night, and the news was bad. BA has only written down US$3bn of credit security valuations to date, but the CEO said there would be more to come in the fourth quarter, amount yet unknown. A profit would still likely be made, but it would be disappointing. Lehman Bros reports tonight, and then we have Morgan Stanley, Goldmans et al to follow next week.
Ahead of those announcements, Merrill Lynch last night downgraded JP Morgan Chase and BA to Neutral and Wachovia to Sell. Morgan Stanley came out and declared Citigroup “the best Sell of 2008”. All the financial stocks, which hadn’t really moved on the Fed news, were trashed yet again. Citi finished the day down 7%. Ben Bernanke must be wondering what on earth it is he can do.
The announcement of further massive liquidity injections (all of which come straight off the printing press) sent the US dollar tumbling once more against the major currencies of the euro and pound, while the carry currencies of the yen and Swissie were sold down as carry traders decided this was a new green light (dollar up). This added up to another US1c up in the Aussie to US$0.8831. Aussie forex traders will be feeling just as giddy as everyone else.
There was only one way for gold to go, and that was back up – US$15.50 to US$813.00/oz. Apart from the falling US dollar and the inflationary implications of liquidity injections, gold responded to a big night up in oil.
It was all happening in oil last night. Firstly, the Fed injections supposedly ward off a recession, which is bullish. Then the inventory numbers came out for the week, dropping yet again. Then there was a big oil spill in Norway, some sort of fire at an Exxon facility, and there are storms about where they’re not welcome. All this added up to an extraordinary 5% up-move in crude – US$4.37 to US$94.39/bbl. Whatever happened to heading into the mid 80s? We’re looking at 100 yet again.
Base metals were all over the place. One minute the Dow’s up, the next it’s down. One minute the Fed rescue package looks good, the next minute it implies serious problems. The US dollar was down. The biggest reaction was in copper, which fell heavily at first but came back to post about a 2.5% loss. The others were mixed.
And where would you close the SPI Overnight? Lord only knows. Up 4 points was the final, confused outcome.
Tune in tomorrow to see what will happen in the next episode of “I’m a Financial Trader – Get Me Out of Here!”.
