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Banking

Bond Outlook September 26th

The Fed rate cut may have been justified, but it does not solve deep-seated problems, notably falling house prices. But at least serious rebalancing of the world's economy is underway.

Bond Outlook [by bridport & cie, September 26th 2007]

No, the Fed rate cut has not addressed the underlying problems, even if it was a necessary step to prevent immediate economic collapse. The sub-prime crisis is far from over, our own interaction with market-makers shows that liquidity has not improved significantly, and consumer confidence on both sides of the Atlantic is on the slide. Moreover, the lower Fed rate is hastening the decline of the USD and beckoning inflation in the USA .

 

Due to resets there will be major increases in interest payments in November for adjustable rate mortgages (ARMs). The interest rate on USD 350 billion of mortgages will rise typically from 7% to 10%, affecting 2.5 million borrowers. Lehman estimate that 1.5 million of them will default (actually they say 1.5 million will be foreclosed, but what are banks going to do owning 1.5 million houses?). The reason a lower Fed rate does nothing to affect this menace is that ARMs are mostly linked to Libor at six months, and that number has not declined with the overnight rate.

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