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The Fed is getting very good at turning round sentiment for equity markets, but our scepticism remains as to whether the latest cut in the Fed rate, together with opening the discount window to non-banks, addresses the basic problems of a deficit economy, falling house prices and overuse of leverage. In fact, nothing has changed: the US authorities have decided to return to their old standby of cheap money, while paying no more than lip service to inflation. Most other economies have central banks which are still serious about inflation and will delay taking the path of the Fed for as long as possible. Even the BoE, which has presided over a GBP falling almost as much as the USD, is announcing that “holding down inflation is the absolute key”. There is only one way to control inflation with a weak currency: keep interest rates high and accept an economic slowdown. The alternative of lowering the rates can only accelerate a currency’s fall and associated inflation. Yet that is precisely the Fed policy! |
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We have recommended long maturities in USD and EUR on the grounds that recessionary pressures, including low short-term yield (which tend to keep long-term yields down), outweigh inflationary pressures (which push them up). So far so good, but the situation could change suddenly, at least for the USD. In a sense another bubble has been created – this time for commodities. Obviously supply and demand imbalances (all that extra demand from China) explain much of the rise in prices. However, the extent to which speculative money has inflated the bubble was signalled when commodity prices fell because of margin calls (before the latest Fed move) took money back out of commodities (see Focus). We are far from saying the commodities boom is over, but signs are appearing that this is the next bubble to burst. |
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The bond market is still very illiquid, although the Fed action and a certain relief over the results of US banks (not so bad as feared, but still bad), have slightly helped. We would like it to last, but would not count on it. Many of our clients are still moving to as near to absolute safety as they can, i.e. only government bonds and bills. Even the real and rouble (which we have recommended) are no longer so attractive to many fixed-income investors. |
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While the US policy makers had best focus on avoiding system collapse, many commentators in both sides of the Atlantic are asking how the mess was created in the first place. We reckon to have put our finger on the problem at least three years ago when we first christened Alan Greenspan “Greenscam” because of his use of cheap money at the slightest sign of a slowdown or fall in equities, a view which is gaining momentum. At least he has had the honesty to admit that the current crisis is the worst since WW2, even if he blames mathematical models rather than his own policies! |
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More recently the moral hazard of securitisation, with the rupture between mortgage issuer and risk taker, has been widely recognised. What we did not realise until this week was that mortgage loans are tied to the property rather than the borrower (as in Europe). In Europe, if you walk away from a property with negative equity, the debt goes with you – apparently not in the USA. What a way to run a country; no wonder negative equity holders cannot resist the temptation of leaving the key under the mat! |
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The tight linkage between financial markets in the USA and the rest of the world has been confirmed again this week. Yet the hope of a degree of decoupling between the US economy and the real economy elsewhere persists. The Economist expressed this hope eloquently by stressing the growing demand for infrastructure and consumer goods in countries which now have “the cash in hand” to pay for them: China, Russia, Brazil, India and the oil exporters. Europe is harder to call: European industry, led by Germany, has excellent export strength, but the strong EUR is a burden. Rumours are growing that central banks are planning a joint intervention to support the USD. |
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Focus |
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(!) Banks: massive job cuts are being announced by some banks (e.g. 8,000 UBS, 7,000 Northern Rock), similar numbers for Bear Stearns under new ownership |
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(+) US T-Bonds: the 10-year yield has dropped to 3.34%, a level last seen in mid-2003 and at 25 bps from the lowest in 50 years |
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(?) Commodities: it is mainly the non-industrial commodities that have been so volatile lately |
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(–) Iceland: fall of the ISK against USD of 20% in two weeks |
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(–) Inflation: France has joined the UK in announcing increasing inflation in February (2.8 resp. 2.9% per annum) |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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