The Federal Reserves Triple Pronged Barrage
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Trading Features / Strategies from Simon Denham of Capital Spreads.
As the US Federal Reserve does its impersonation of some sheriff in a Glen Ford western riding to the rescue of all that capitalism stands for there are some slightly worrying things that still remain to be answered.
The Sub Prime problem arrived in an economy growing at over 3%, it is disturbing to speculate on what on earth is going to happen to the already weakened banks if there actually is a recession and the vast bulk of medium rated mortgage risk and possibly even the huge Junk bond market comes under not just the current valuation problems but also pressure from actual defaults.
Added to this, the Fed has cut rates to 2.25% in an attempt to loosen up the liquidity of the cash markets but this has not had the desired effect yet and even overnight lending between the banks is at 3%. I am also slightly bemused as to the logic of cutting rates to encourage people to lend money. If I was sitting on my pile of dosh I would hardly be encouraged to lend it at the same risk for less return.
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The final brick in their wall has been the 'bail out' of Bear Stearns. An indication of their willingness to be the creditor of final resort to an implosion of not just the domestic banks but also the investment banks. The problem with this is that it is all very well when all you are doing is 'guaranteeing' the paper involved as has been the case with the vast majority of the $30bn promised to JP Morgan (ie they are just insuring it). But if this does not work and further whispers start to impact the financial credibility of another investment player and then another what do we do then. There has already been a significant deterioration in foreign participation in the US T-bond auctions, the prospect of vast new calls for cash would make the current dollar weakness seem like a picnic.
There is little more that the Fed can do. Its armoury is almost depleted so the triple pronged barrage must be successful. We may well stagger on through this crisis but the structural problems of too much debt and huge public and trade imbalances are unlikely to go away. The asset values of much of the collateral that props up this debt has also been severely impacted with equity, property and currency falls all weakening one side of the equation whilst the other only has the Fed rate cuts to help it along.
The steady stream of financial crises over the past 10 to 15 years seems to show no signs of abating and each one raises increasing prospects of a complete financial meltdown. Trust in institutions is the corner stone of the financial wellbeing of the entire globe. It is this trust that the central banks are striving to maintain.
The above comments do not constitute investment advice and neither Capital Spreads nor Clean Financial accept any responsibility for any use that may be made of them.
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'The Federal Reserves Triple Pronged Barrage' edited by DB, updated 03-Apr-08
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