• Home ::
• Fundamental ::
• Market View ::
• Morning Report

• Send
• Print
• Add To
• Rss

Morning Report

3761c7f7-7aa8-42e5-8ce0-9ab856e3e616

0

0

The Fed responded to the carnage in global equity and credit markets

Wed, Jan 23 2008, 06:06 GMT
by Westpac Institutional Bank Team

Westpac Institutional Bank

News and views

The Fed responded to the carnage in global equity and credit markets by cutting its key policy rate by 75bp. Rumours of an emergency rate cut have been circulating for some time, even with a scheduled review just a week away, but the size of the move – the largest in the low-inflation era – surprised everyone. The Fed said the cut was delivered due to rising economic risks, noting a deepening housing contraction and a softer labour market. They also noted that while short-term funding pressures may have eased, broader financial conditions have deteriorated and credit has tightened for households and businesses.

The accompanying statement leaves the door open for further action should the market not respond in a positive way, and in fact the money market is still pricing in another 50bp cut at next week’s review. There will no doubt be plenty of speculation as to whether the timing of the cut signals panic within the Fed about the deterioration of the US economy – justifying further steep rate cuts – or was intended to break the vicious cycle of pessimism in financial markets, which could cause more damage to the real economy if left to continue.

US equities were down for the day, after playing catch-up with the sharp declines seen elsewhere during the Martin Luther King Day holiday. European indices are a better gauge of the market reaction – the UK market ended up 2.9% and the broad Euro Stoxx 50 rose by 1.37%.

The New Zealand dollar raced higher overnight, and was easily the strongest of the major currencies. The slump in Asian equities dragged the NZD to a three-month low just below 0.7400 yesterday evening, but a more positive tone in European markets saw it recover quickly, and the surprise Fed rate cut sent the currency back to 0.7650 this morning. The 2.7% gain for the day was the second-largest since the LTCM crisis in October 1998, topped only by the 2.8% gain after the Fed’s first rate cut last September.

Most of the other majors also gained against the US dollar and the yen, but the moves were surprisingly muted. The Australian dollar gained by around 1%, as enthusiasm was dampened by the sense that the RBA will find it difficult to justify further rate hikes in this environment, even if today’s CPI figures turn out strong. As a result the NZD/AUD cross rose to 0.8800, reversing all of the last week’s losses. The euro and pound each gained around 1% for the day, while the yen reversed its post-Fed losses and ended down 0.5% against the US dollar.

Outlook

We noted earlier in the week that a ‘circuit breaker’ was needed to snap the market out of its extreme pessimism. The Fed’s unscheduled rate cut clearly fits the bill, though it remains to be seen if it will have a sustained effect, given the sense of panic that it seems to suggest. Equity markets, and the New Zealand dollar, could bounce further in the short term as short positions are squeezed out, but we suspect some upside surprises in the economic data will be needed to sustain the improvment in market sentiment.

Today’s Australian CPI figures will be watched closely, though there is less confidence now that a strong number will lead the RBA to raise rates in February. We expect the core measures, which the RBA follows more closely, to rise 0.9% for the quarter, bringing the annual rate to 3.4%, well outside the RBA’s comfort zone.

Locally, the main event this week is tomorrow’s OCR review. We expect the RBNZ to remain on hold, but to maintain a hawkish tone. Inflation pressures are mounting, but housing is correcting a touch faster than anticipated and there is greater uncertainty around the global outlook.

• Download Full Morning Report

Published on  Wed, Jan 23 2008, 06:09 GMT