Weekly Economic and Financial Commentary

Stimulus is Working, So is it Time to Take it Away?

Mon, Aug 24 2009, 07:26 GMT
by Wachovia Research Team - Wells Fargo Investments, LLC | View company's profile

Vote:

Vote up:9
Vote down:0

U.S. Review

Stimulus is Working, So is it Time to Take it Away?

The economy and financial markets continue to benefit from the flood of monetary and fiscal stimulus put in place over the past year.
The Fed’s purchases of Treasury bonds and asset-backed securities have reduced mortgage rates, helped cut credit spreads, and set off a huge stock market rally.
The federal government’s cash-for-clunkers program and tax credit for first time home buyers has also helped spark activity in these two cyclically important but incredibly depressed sectors.

It May be Time to Take One of the Punch Bowls Away

With the economy on the mend, the Fed has been openly contemplating its exit strategy. More and more economic indicators are improving with each passing week and most forecasters inside and outside the Fed now believe a recovery is underway. The challenge for the Fed will be to remove stimulus from where it is no longer needed without crippling the recovery. Fortunately, this is not a case of whether or not to take the punch bowl away. The Fed has put so many programs and facilities in place that they effectively have ten punch bowls out there. The decision they face today is whether they can shut some of these down without putting the budding economic recovery at risk.

The Fed’s actions have produced tangible results for the financial markets and the economy. The interbank lending market has returned to levels that existed before the onset of the financial crisis and other short-term funding markets are also functioning much more normally. In addition, a growing number of companies have been able to tap the equity and debt markets, allowing them to fortify their balance sheets. The improvement in financial conditions paves the way for a sustainable recovery. The Fed and many private forecasters expect the recovery to be slow at first and to gradually build momentum. Under that scenario, we would expect the Fed to gradually wind down and end many of the programs enacted during the last year, effectively removing one punchbowl at a time.

A good place for the Fed to start would likely be the lending programs aimed at short term funding, including the programs aimed at restarting the commercial paper and short-term asset-backed paper lending markets. The Fed has also announced plans to wind down its purchase of Treasury securities. They will probably need to leave programs designed to reinvigorate long-term funding in place longer, including the Fed’s purchases of mortgage-back and asset-backed loans and the Term Asset Lending Facility, which is designed to strengthen private sector demand for these assets. The Fed will also likely leave the federal funds rate alone until the middle of next year but we believe they will raise short-term interest rates in 2010 and will move quickly to bring the federal funds rate back to a neutral level.

Fiscal stimulus is also making its mark. The widely reported cash-for-clunkers program is coming to an end this Monday and is reported to have helped fund the purchase of close to half a million vehicles. The increase in motor vehicle sales has been strong enough that Ford and General Motors announced plans to slightly increase their production later this year. The rise in auto sales will boost overall retail sales in August and lift overall growth for the quarter. There may be a payback later this year, however, as some sales were pulled forward and many of the folks trading in clunkers now have car payments to meet each month and less to spend on everything else.

The $8000 tax credit for first-time homebuyers is also producing some tangible benefits. Single-family housing starts have now risen for five straight months and sales of existing single-family homes have risen for four months in a row.

Global Review

Mexican Economy Will Lag The Rest of the Region

The Mexican economy continued to plunge into its worst crisis in decades during the second quarter of this year, even surpassing the effects of the Tequila Crisis back in 1994-1995.
With 90 percent of Mexican exports destined for the United States, the recession north of the border took a toll on Mexican exports. Another way the slowdown in the United States is hurting the Mexican economy is a drop in remittances, or transfer payments back home from Mexican workers in America.

As expected, the Mexican economy continued its plunge in the second quarter, even surpassing the effects of the Tequila Crisis back in 1994-1995. Mexican real GDP declined by 10.3 percent in the second quarter compared to the same period last year. (chart on front page)

On a seasonally-adjusted quarter-over-quarter basis, GDP dropped by 1.12 percent in the second quarter. INEGI noted that the Easter week was in April of this year, not March, and this has negatively affected the second quarter results.

The only sector posting a positive quarter was the agricultural sector, up 1.1 percent. The industrial sector plunged by 11.5 percent and the service sector dropped by 10.4 percent. However, the fine print shows the plunge in the Mexican economy is due to its dependence on the U.S. economy (middle chart). This becomes even clearer when we observe the manufacturing sector. While manufacturing GDP dropped a severe 16.4 percent year-over-year, the production of transportation equipment fell off a precipice, down by an astonishing 44.5 percent year-over-year.

The Mexican economy during the last several decades has been specializing to provide the U.S. auto manufacturing sector a relatively cheap way of producing North American cars. Furthermore, U.S. auto manufacturers in Mexico have been producing mainly SUVs for the U.S. market for more than a decade.

Because of the focus on producing vehicles aimed for the U.S. market, when the crisis hit this time, the auto manufacturing sector in Mexico completely collapsed. However, the most serious issue is that this reduction in demand for SUVs in the U.S. pre-dates the financial crisis and will probably continue after the crisis is over. This is bad news for the Mexican automobile production complex in particular and for the Mexican economy in general. In fact, this trend actually started with the surge in the price of petroleum. The financial crisis was just what pushed the sector off the cliff.

But the Mexican economy’s problems are much broader. Almost 90 percent of total Mexican exports go to the U.S. market. With the weak prospects for U.S. consumption in the short to medium term, the prospects for the Mexican economy are not good, especially if it is not able to diversify its export markets. Furthermore, the only sector that posted positive economic growth (the agricultural sector) is probably going to go under during the third and fourth quarters due to the severe drought affecting the country.

Meanwhile, the domestic economy is also suffering from a large drop in remittances from Mexicans living in the U.S., down 12 percent during the first half of 2009 compared to the same period a year earlier. The number of jobs in the U.S. will need to actually increase and not merely decrease at a slower rate before remittances pick up in a substantive way. We expect remittances to remain weak, which will also weigh on the Mexican economy for the foreseeable future.

Download Full Weekly Economic and Financial Commentary

Published On Mon, Aug 24 2009, 07:40 GMT

About this Report

Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

More Reports from this Contributor

Archive

The Moderate Economic Recovery is Still Underway
Fri, Feb 10 2012, 19:23 GMT
Off to a Good Start for the Year in US; Europe Agrees on Fiscal Pact; Manufacturing Improves
Fri, Feb 3 2012, 20:08 GMT
Less Strength Than Meets The Eye
Mon, Jan 30 2012, 05:24 GMT
Good News on Manufacturing, Inflation and Housing
Fri, Jan 20 2012, 20:12 GMT
Week Two Brings a Little Less Enthusiasm
Mon, Jan 16 2012, 06:17 GMT

Older Posts:

Advertisement

Legal disclaimer and risk disclosure

Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.