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Unprecedented coordinated rate cut by six major central banks

Thu, Oct 9 2008, 07:25 GMT
by John Hardy

Saxo Bank

British rescue plan wins critical praise - but not from the market as GBP tumbles. Week to end with big CDS settlement.

LATEST HEADLINES

• Japan Aug. Machine Orders out at -14.5% vs. -2.8% expected

• Australia Sep. Employment Change out at 2.2k vs. 0.0k expected

• Australia Sep. Unemployment Rate out at 4.3% as expected

• Germany Sep. Wholesale Price Index out at -0.6% as expected

• Germany Aug. Trade Balance out at 7.3B vs. 9.0B expected

• Japan Sep. preliminary Machine Tool Orders out at -20.7% YoY vs. -13.9% in Aug.

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• Sweden Sep. CPI (0730)

• UK Sep. HBOS House Prices (0800)

• UK Aug. Visible Trade Balance (0830)

• Switzerland SNB to publish quarterly bulletin (0900)

• US Weekly Initial Jobless Claims (1230)

• US Fed's Stern to Speak (1730)

• US Sep. ICSC Chain Store Sales (no time given)

• US Fed's Rosengren to Speak (2200)

• EuroZone ECB's Trichet to speak in Washington (2300)

• Japan BoJ Minutes for Sep. Meeting (2350)

Market Comments

The most over-used word in financial markets in these black swan time is "unprecedented", an expression we probably ought to shelve for a while, as something unprecedented seems to happen every day lately. Yesterday, major central banks, including the US Fed, Bank of Canada, Bank of England, ECB, and Sweden's Riksbank, all cut rates by 50 basis points and the SNB cut their target by 25 bps. The central banks also issued a joint statement aimed at calming markets with the Bank of Japan indicating that it strongly supported the move. The rate cuts sparked an extremely sharp rally in equity markets and equivalent short term mayhem in the FX crosses correlated most heavily with equity markets - like anything with a JPY or an AUD. AUDJPY rose something like 8% in the space of about two hours before erasing most of those gains and then rising back to new post-cut highs overnight. We think it is interesting that, while equities have not managed to keep much of their gains off the lows yesterday, that the risk barometers like AUDJPY are considerably higher from their lows - a sign of divergence that bears noting. Part of the reason for this difference may be found in the fixed income market, where bonds have sold off heavily through support (yields rising) and gold has also come well off its highs from yesterday - signs that outright panic across the board is fading somewhat. These signs two-way traffic are early indicators that we either have or will very soon put in a low in risk sentiment for this part of the cycle.

And if we are to look for an actual event risk that could mark the end of this "endless vortex of declines" part of the cycle, we should possibly look to this Friday's enormous settlement of Lehman and other defaulted CDS, where the pay-outs are expected to amount to up to $400 Billion, according to an article in the FT. Banks have apparently been hoarding cash as this date approaches and the idea here could be that money markets and interbank lending may thaw somewhat once this huge settlement is behind us. The authorities are still trying to set up a central exchange for the over the counter CDS market, where the implications of defaults like Lehman's and the US GSE's are now painfully evident.

EURUSD got less of a bounce than we would have anticipated off the back of the Fed's new facility for buying up commercial paper, as the Libor-OIS spread - a measure of funds available in the US money markets - actually increased yesterday rather than falling.
This spread needs to come in for EURUSD to rally; something we think is likely soon as the generalized panic has to ease soon - possibly with the help of the authorities. More on that below.

The UK's new plan for dealing with the banking crisis has won wide praise for its direct injection of capital into the banks, but the market completely rejected GBP, with EURGBP to our surprise rising strongly through the 0.7800 area resistance and back into the old range rather than continuing to slide due to the inept response of the EuroZone framework to this crisis.

The next step in the Global Credit Bubble Unwind Damage Control Department? We will need to see a coordinated response to the crisis in interbank lending, not just in the rate cut department, which was dramatic and needed, but not enough. And there are already signs that the US is looking for this, judging from Paulson's rhetoric yesterday, and the coordinated rate cut is also likely a harbinger of the necessary further joint efforts to come. This weekend's G-7 meeting is well timed for the creation of some kind of coordinated response and we should have another interesting weekend of developments coming up.

Specifically for the US, Paulson was out yesterday hinting that the government is possibly looking at taking direct ownerships stakes in banks (unimaginable only a couple of months ago due to the US aversion to words like "nationalization") as a way to get capital into the banks, something that was already much talked about . Clearly, the TARP package is allowing for significant dynamism in policy response beyond simply "buying toxic assets" that will be important for keeping the ball rolling while the legislative arm shuts down for election season. It's fortunate, that Mr. Bush is not up for re-election, as his lame duck status allows his team to try to solve problems rather than worry about the political spin on all of this.

On the real economy front, we note that the huge increase in US pending home sales yesterday is not necessarily a bullish sign for the US housing market - it is due to the number of foreclosures and forced auctions out there that are attracting bargain hunters.
Also, the previous day's US consumer credit number for Aug. showed a sharp drop for the first time in recent memory. We can only imagine what the September number will be. The US economy is all about consumer activity and this data shows that a sharp braking in consumer activity is already well under way. Extremely poor preliminary US same store sales data for September out yesterday also underlined this.

Chart: EURCHF

Most moves in the FX market are occurring along the axis of risk appetite, with EURCHF no exception. We have reached interesting levels for the pair down around 1.5300 yesterday as the action has gone completely parabolic. Note how the pair bounced last time around after this kind of price action developed. We are likely to see a repeat of this style of technical action once we get a temporary bottom in risk sentiment.

Published on  Thu, Oct 9 2008, 07:29 GMT