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Weekly Market Commentary

The Federal Reserve trimmed its Fed Funds target by 25 basis points to 4.50%

Fri, Nov 2 2007, 15:17 GMT
by Nicole Elliott

Mizuho Corporate Bank  |  View company's profile

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Overview

The fall-out from the sub-prime mortgage debacle, and the ‘carry trade’ in all its myriad guises, sees problems coming home to roost. Banks’ share prices have been slashed, being the first in line to take a hit, and this has now spread to specialist bond insurers. Most stock indices sold off, some after setting new highs. Amazingly Mumbai’s Sensex index managed to set a new record high at 20,238 although it closed below 20,000 and Egypt’s Hermes index closed at a record high of 84,441. The beleaguered US dollar suffered again, loosing a whopping 2.15% to its Canadian counterpart this week alone. At C$0.9320, or USD 1.0730, it is stronger than it has been since the currencies floated. The pound also did well, rallying to 2.0875 (highest since May 1981) and the Swiss franc dropped to CHF 1.1490 to the greenback, stronger than it has been in eighteen months. Yet another new all-time high for the Euro at 1.4526 and plenty of rumours that countries are considering abandoning their USD currency peg. As has been the case for some months now, many commodities made new highs, most eye-catching Nymex Crude Oil at $96.24 per barrel and spot Gold at $799.30 per ounce. Freight rate futures have retreated from record highs on fears that diesel shortages in China will slow the manufacturing sector. Fixed income yields reversed an initial rally, many testing pivotal chart levels, and index-linkers yield around 1.80%, the lowest since early 2006.

Political and Economic Developments

Interest rate moves left right and centre. The Federal Reserve trimmed its Fed Funds target by 25 basis points to 4.50%. This had no effect on money market rates where two and three-month Libor remain at 4.85%, so yesterday the Fed the did a total of $41B worth of repos, the biggest cash injection since September 2001. Iceland surprised with a 25 basis point increase to a record 13.75%, Governor David Oddsson obviously not one to mince his words saying, ‘the outlook for inflation is much worse than we expected…we will not start to cut rates until 2009’. The Swedish Riksbank increased theirs by 45 basis points thereby matching the ECB’s 4.00%. The Reserve Bank of India raised its Cash Reserve Ratio by 50 basis points to 7.50%. This is the ratio to be deposited with the central bank, draining liquidity because capital inflows have seen money supply grow unacceptably fast. Saudi Arabia also increased their reserve requirements, the first time in 27 years, from 7% to 9% as inflation touched a seven-year high of 4.40%.

US October Non-Farm Payrolls were a better-than-expected +166K, business services adding 65K and leisure and hospitality another 56K jobs. These numbers probably do not as yet include those laid off in the financial services industry, nor Merrill Lynch boss Stan O’Neal who ‘retired’ with a $160 million payoff after $8.4B write-offs in Q3.

Underlying Themes

Many are of the opinion that the worst of the summer’s credit crunch is over, including the Fed whose Wednesday statement said financial strains ‘have eased somewhat on balance’. Pointing to the fact that interbank offered rates are lower than September’s peak, and that Fed easing will do the rest, their positive spin on it all is delightfully Panglossian. We beg to differ and point out that the money markets are still very if not totally seized up; many rates are merely indicative; quantities available and traded are minimal. Add to this the looming year-end, where traditionally a brief scramble for cash takes place, and rose-tinted spectacles are of no use. Historically high energy prices, keeping in mind that many countries subsidise the retail cost of fuel, so things are likely to get worse rather than better. There is little policy-makers and central bankers can do to ‘fix’ things as interest rate changes are a blunt instrument especially when faith in the financial system evaporates.

What to watch for next week

Sunday 4thNovember the clocks go back one hour in Canada and the US. Monday Minutes of the Bank of Japan’s September meeting, UK October Official Reserves and Industrial Production, Eurozone November Sentix Index and US Non-Manufacturing ISM. Tuesday Japan September Leading and Coincident Indices, EZ13 PPI and Retail Sales, German Factory Orders, UK October BRC Retail Sales Monitor and Services PMI’s for several European countries. At 22:30 GMT the Reserve Bank of Australia decides on rates. Despite the drought strong economic numbers last month mean there is a chance they might raise their Cash Rate target from 6.50%. Wednesday UK October Nationwide Consumer Confidence, BRC Shop Prices, German September Industrial Production, US Wholesale Inventories and Consumer Credit, plus US Q3 Non-Farm Productivity and Unit Labour Costs. Thursday early Japan September Machine Orders, October Money Supply, Machine Tool Orders and Economy Watchers Survey, then German September Trade Balance. Both the Bank of England and the ECB decide on rates (expected unchanged at 5.75% and 4.00% respectively). Friday just UK and US September Trade Balances and November University of Michigan Confidence Survey.

Positioning and Technical Analysis

A stalled/malfunctioning credit market will of course impact the ‘real economy’ and in a global world few will not suffer from the fallout. Stock indices are likely to slide further. As contagion spreads business conditions will become harder and get really tough when jobs are axed. Some will benefit from a weak US dollar, at least temporarily, but this will exacerbate existing problems especially if we see chronic rather than steady weakening. Commodities may not keep pace with currency moves, proving they are a poor ‘hedging’ instrument. Treasury yields look set to break lower in what may become a mad scramble.

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Published on  Fri, Nov 2 2007, 15:26 GMT

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