Daily Market Reports | Mar 19 2009
By Greg Peel
The Dow closed up 90 points or 1.2% but the S&P added 2.1% and the Nasdaq 2%.
“To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.”
Just like that.
Ben Bernanke caught Wall Street off-guard last night by suddenly announcing following the FOMC meeting another US$1 trillion of liquidity injection, which is the total of the pledges above. It was a surprise because commentators had assumed Bernanke had been looking to back off on such drastic measures, particularly given his suggestion on Sixty Minutes last Sunday that stimulus measures were working and that the US economy could well pull itself out of recession by the end of the year. Commentators had begun to back down from the expectation that the Fed would commence quantitative easing, but that’s exactly what the US$300 billion of long term Treasuries is all about. Bernanke suggested possible quantitative easing four months ago but had not yet made any move.
The Fed has nowhere to go on the cash rate, given it is now set in a range of zero to 0.25%. But as the Fed noted in its statement, “Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract”. To that end it has decided to take the dangerous step of providing the US economy with a shot of adrenalin by buying US bonds with printed money, which is highly inflationary. Such solutions can only be short term before they become potentially fatal.
Bernanke feels comfortable in doing so, nevertheless, given ongoing disinflation in the global market place:
“In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, 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. In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.”
The principle is that you can provide such inflationary adrenalin shots when deflation remains as a risk. It is simply a counter measure. But history has shown that economies can move from deflation to hyperinflation on a heartbeat if the balance is not carefully maintained.
The other aspects of the latest plan include a further US$750 billion to buy mortgage-backed securities (which effectively means buying the other side of mortgages) and another US$100 billion to buy agency (Fannie/Freddie) debt. This is the second direct mortgage market injection. When the Fed made its first move into this market last year, mortgage rates dropped around 0.5% immediately. But a rush by homeowners to refinance at the lower rates has forced the mortgage rate back up again. Struggling lenders have been trying to pick up extra profits. It remains to be seen what happens this time.
As well as the extra trillion, the Fed also announced it had “launched” the Term Asset Loan Facility (TALF) – long ago announced – and expanded the range of collateral it will accept in return. The TALF targets consumer-level car loans and credit cards etc and loans to small business.
The stock market loved it. The Dow had been down as much as 138 points early in the session after rallying for a few days and was still down 55 just ahead of the Fed release at 2.15pm. On the release, the Dow shot up to reach a peak of up 176 points before profit takers moved in again. A battle ensued before a close of up 90 was resolved. The stock market loved it because the Fed is indeed employing all its tools to stabilise the economy, and Wall Street was already in a more upbeat mood.
The numbers on the S&P 500 were more telling (and really, we shouldn’t be paying much attention to the Dow these days). The S&P peaked at 803 before the sellers moved in. The 800 mark provided a support level in January and was only briefly breached back in November, so it makes sense that it should now be a resistance level. But more importantly, 800 is 20% up from 666 – the intraday low. A 20% move often marks the end of a bear market rally.
But it doesn’t have to. We could see the Dow back at 10,000 and still only have completed a typical 50% bear market retracement of the drop from high to low.
While the stock market was a winner, so too were commodities. Oil closed up US24c at US$49.40/bbl, but that marked a turnaround following a drop to US$46.92 earlier in the session. Weekly inventory data showed an increase in both crude and gasoline supplies. Base metals also suffered from increased inventory notifications but also turned around late in the session, with copper and aluminium finishing 2% higher.
But the big winner on the night was gold, which leapt US$28.70 to US$943.70/oz. Why? Because the US dollar tanked.
The US dollar index collapsed 3% last night immediately after the Fed statement was released. That is a very big one-day move and and the greenback was lower against all major currencies. The Aussie shot up 1.7 US cents to US$0.6783.
Gold has been wavering of late given its safe haven role. As some confidence has returned to the equity market, investors have not felt as much need to hold gold. But gold is ultimately the store of wealth, and the Fed’s move to quantitative easing brings the potential for hyperinflation one step closer. The dollar fall came despite a big jump in the prices of US Treasuries. Usually a rise in bond prices (fall in yields) indicates safe haven buying and is positive for the greenback, however this time it was simply a rapid price adjustment. The ten-year bond plunged an astonishing 0.5% to 2.52% – the biggest one-day move since the Crash of ’87. That’s what a US$300bn injection can do (even if the Fed has not yet physically bought a bond).
The question now is: Is this the beginning of the end for the world’s reserve currency? Will the greenback keep sliding from here?
The answer is not a clear one, as it basically involves a race to the bottom. It is appreciated that the economies of the UK, Europe and Japan are in as bad, if not worse, states as the US economy. The UK had already moved to quantitative easing and has nationalised its banks to a significant extent. The EU is holding off so far but looking at its options. Both the UK and EU have significant loans to Eastern Europe which remain a danger. Who can boast the world’s worst economy?
For whomever has the worst economy will also have the worst exchange rate. The UK and EU had caught up with the US, such that the US dollar had been well supported up to last night. From here we may see the greenback settle back into strength after this initial shock, or perhaps this truly is the start of a fading US dollar, just as most predict it must ultimately do.
The SPI Overnight rose 31 points or 0.9%.
