“Fed Cuts, Stock Fall”
That is not a headline we read; it’s one we wrote – neatly summarising yesterday’s market action. When we looked, stocks were down more than 290 points, measured by the Dow. This followed the Fed’s announcement of another quarter-point rate cute, bringing the key rate down to 4.25%.
Apparently, investors had hoped for an even bigger boost – a cut of 50 basis points. But the Bernanke Fed seems to have decided to play it safe – give Wall Street a cut, so they won’t complain…but don’t shoot the dollar in the head.
Otherwise, oil headed back up, to over US$90…and US Treasuries had their best day in years.
A rate cut was, of course, universally expected. Last month, housing prices fell 1.5%. Next month, they will probably fall even more. Falling house prices come as a shock to many homeowners. They thought buying a place to live was a sure thing; they thought they couldn’t go wrong…even those who didn’t go down the risky mortgage path are getting a rude awakening. Their house is worth less than they thought – and it’s happening more and more.
Alas, the financial marketplace is a lot less forgiving than it was a couple years ago. Now, marginal homeowners are being squeezed by higher prices and higher mortgage payments. And marginal investors – even those with billions to throw around – are being squeezed by falling asset prices.
The word ‘credit’ comes from the old Latin word – credere – which means ‘to believe’. Investors – at the bottom and at the top – were nothing if not True Believers. They believed in the New Zoo Capitalism – in which everything is always under control…and the dangerous beasts are all behind bars. They thought the credit boom would never end…that house prices would always go up…that financial engineering could turn junk loans into triple AAA investible credits…and that the people running the zoo would always make sure the animals had enough to eat.
But now, it appears that the old capitalism – red in tooth and claw – is coming back.
And here’s an interesting comment…interesting because it sounds like something we might have written:
Ramachandra Bhagavatula, a managing director at New York hedge fund writes:
“What is happening is that household net worth is not growing by leaps and bounds — if anything it is going down — [which means] people actually have to start saving out of their current income. That has negative effects on spending growth. In many ways, I think the next five years in this economy could look like Japan after 1990. The big [growth] you got in variety of asset classes — financed by borrowing because of extraordinarily low rates — will come out. When you look at the economic landscape, stock prices are too high, house prices are too high, and you put all the pieces together and the size of the adjustment needed seems reasonably large. How many years does it take? Who knows? It doesn’t necessarily mean we have five years of recession — maybe just 3-4 quarters of recession.”
Our currency counsellor Chuck Butler also gave us his reflections on the interest rate cut:
“The Fed finished the year with those three rate cuts I called for back in May. And just to refresh your memories, I’ve also said that the Fed will continue to cut rates in 2008, until rates get to 3-3.25%. That’s at least another 100 BPS, folks…think we’ll be getting foreigners to line up at the door for our 3% yielding assets? Ooooh…the thought of it is giving me goose bumps!
“Yesterday, I also said that we might see the Fed change their wording of ‘balanced growth’. They didn’t go so far, but they did say, ‘Economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks.’
“Hmmm…doesn’t sound as if growth is balanced with risk/inflation, does it? So why didn’t they just drop the bias? Because, they know that it could ‘spook’ foreign investors. And when foreign investors get spooked, they don’t buy our assets, and when they don’t buy our assets, the current account doesn’t get financed, and when the current account doesn’t get financed…the dollar gets weaker!”
Markets and Money