The Federal Reserve is now entering new uncharted territory. How do you drain so much liquidity without choking the economy is a key question most policy makers are grappling with. Policy blunders are what caused the devastating and continued economic declines in the 90s and 2000s Japan and 1930s US examples. And these policy blunders related to acting as if the economy were on a firm footing while in reality they were highly dependent on continued government support to offset the private sector contraction. Global central banks have a very difficult task ahead of them and it is unlikely that it will be a nice calm return to “normal times”.
Sitting on 1,200,000,000,000 US$ that was created via the Fed’s “support” of the financial system must be intimidating. These excess banking reserves as they are called have caused much speculation regarding possible inflation and the destruction of the US dollar due to money printing by the Fed. The reason CPI is negative on a year on year basis and inflation is not a problem is that banks have been buying more US Treasuries than loaning the money out it seems, which is prudent given their recent over loaning but it basically offsets the target of allowing the economy to pick up steam through credit creation. Long story short, the Fed is concerned about how to remove liquidity if need be.
Reverse repos are a new tool being tested to do just that. The reverse repurchase agreement work like this: Fed sells US Treasuries to banks, with an agreement to buy them back later at a slightly higher price. Problem is: this has never been done before by the Fed and just yesterday they did a test run with about $200 million which. This is not an indication of a change in monetary policy whatsoever,but it is an indication of the Fed being proactive in responding to threats down the road.
Archive for the ‘Monetary Policy’ Category
Quick note about reverse repo's
Friday, December 4th, 2009Bad news is good news
Monday, November 30th, 2009After the WSJ article last week that 1/4 of US homeowners have negative equity, below are some interesting facts about the surprising weakness of the US economy. What shocks me is the huge disconnect between the markets and the economy. Some of the analysis I have done recently with regards to sluggish post recession recoveries points to the fact that this disconnect can go on for years. In other words, strong financial market performance is possible even with a weak economic performance. I would argue that the 2Q and 3Q recovery in the underlying economy has two characteristics: (1) it is an anemic / sluggish recovery and (2) it is “inorganic” and highly dependent on monetary stimulus. Regarding the stimulus, note that of the full outlay presented by government authorities we have only put 30% of that capital to work. The big question is whether this will turn into a self sustaining recovery. I personally think it will but that needs to be evaluated further down the road.
With 1-year Cash yields at 24 bps, money is flowing into riskier assets. The largest factor that the market rally hinges on (for the next few months) is continued government stimulus. After that it depends on if the government – liquidity led rally, turns into a profit rally. For positioning in this environment, I have stressed that as long as the US government is flooding the economy with money (i.e. continued sluggish recovery, thus government maintains stimuli), Equity markets will be well-bid. So what is the take away from that? Bad news is good news for the Equity markets!
Regarding the “pre-Lehman” levels it is important to note that many markets have returned to October levels. In the stock and bond markets, prices and spreads are at pre-Lehman levels. But look at this tally from David Rosenberg (from Gluskin Sheff) regarding how the economy has fared since then. It is pretty shocking:
Since Lehman, we have lost 6.2 million jobs;
The unemployment rate is 10.2% now, versus 6.2% the day before Lehman collapse;
Real gross domestic product is still down 3% since the summer of 2008;
Housing starts are down 30%;
Auto sales are down 23%;
Bank credit has contracted by $500 billion, or 8%;
Household net worth is down $7 trillion;
Home prices are down an average of 10%;
Office-vacancy rates are up 3.5 percentage points, to 17.2%;
Cheap money does not cure all debt ills
Monday, November 30th, 2009The market reaction to Dubai last week seems emotionally driven and an exaggeration given the size of the problem. Concerns regarding a second round of the financial crisis due to Dubai should not be taken too seriously. Lehman for example had nearly $1 trillion in debt in its books when it collapsed.
Dubai has requested a “standstill agreement”, a likely precursor for a hoped-for debt restructuring. For weeks newspaper articles have been talking about the $80 billion debt overhang and Dubai’s inability to pay its debt that was coming due. The implied guarantee by Abu Dhabi is being tested and the lack of any support last week was surprising. This weekend’s actions by UAE fueled the reflex rally today in Asia (Hang Seng was up 3.3%, Australia was up 2.8%, even the sleepy Topix was up 3.6%). Good summary article from the FT about the UAE’s actions, but long story short the central bank is setting up an emergency liquidity facility (sound familiar?) to provide banks with fresh liquidity to offset fleeing capital after the shock of Nakheel (the real estate arm of Dubai World). Sadly this sounds too familiar, given the real estate bubble in Dubai, and the over-reliance on construction and real estate as a driver of their economy.
Pressure will definitely mount to not allow Dubai to default. The United Arab Emirates is comprised of seven emirates, the largest and richest of which is Abu Dhabi, the “senior partner” in the group, controlling 90% of UAE’s vast oil reserves. Not to mention that Abu Dhabi has the largest sovereign wealth fund at a little over $650 billion. It seems that Dubai’s problems can be solved by a check from its bigger brother, even though the bigger brother claims a blank check is not going to happen. There has clearly been a global central bank push to lower rates, which has encouraged a massive refinance wave to extend maturities. I agree that sufficient debt write downs are lacking, and the Dubai news highlights that cheap money does not cure all debt ills.
In conclusion, I don’t think this Nakheel issue poses a serious threat to derail the market rally. However it is evident how “spooked” the market can get (Shanghai A shares were down 7% last week), a sign that many market participants are skittish. As John Mauldin put it recently: “when anything as relative small as Dubai spooks the market, it should serve as a warning sign.”
Article from the Financial Times:
http://www.ft.com/cms/s/0/e9334100-dca8-11de-ad60-00144feabdc0.html
Tags: Dubai, investment strategy, market commentary, Nakheel
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