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Living history

Mon, Sep 22 2008, 10:47 GMT
by Westpac Institutional Bank Team

Westpac Institutional Bank

The extraordinary developments in the global financial markets last week will encourage the RBNZ to continue to ‘front-load’ their easing cycle. Q2 GDP to confirm NZ recession.

Eyes have been wide open, jaws dropped, and fingers crossed as everybody watched in disbelief at world financial developments last week.
Dysfunctional credit markets have generated widespread fear. The US have now nationalised the world’s biggest insurance company, global investment banks have fallen over or been sold in fire sales and the US government has taken responsibility for the bulk of mortgages in the US. Global equity markets were smashed and central banks pumped copious amounts of liquidity into financial systems as interbank lending markets seized. These developments are simply mind-boggling. One gets a strong feeling of living history.

By the end of last week, the US Treasury responded to the melt-down in financial markets with an ambitious $700bn plan to buy up distressed assets from US financial institutions. Such an enormous bailout is required to stem the rot that has beset financial markets. While this measure will avert the Armageddon scenario (total financial system failure), the credit crunch will be ongoing. As the US economy slows and unemployment rises further, defaults are likely to rise in consumer and business debt. But at least the financial system will then be dealing with a standard cyclical credit cycle, rather than the self-fulfilling contagion of the past couple of weeks.
None-the-less, credit creation is likely to be constrained for a number of years.
Also, the sheer size of the US bailout (and the increase in US debt it entails) may result in upward pressure on US long term interest rates and a weakened US dollar.

Despite the prospect of the mother of all bailouts, events of the past few weeks are likely to: raise bank funding costs; increase risk aversion, slow credit creation, and hence reduce global growth; slow NZ export growth and lower commodity prices. The RBNZ will seek to offset these effects through enhanced liquidity (last week the RBNZ improved liquidity via broadening the range of assets eligible as collateral and extending lending terms) and a lower OCR.

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Published on  Mon, Sep 22 2008, 10:51 GMT