Preview from Europe: Fed Steps in with Guns Blazing

Shock and awe are back in vogue. Yesterday was a landmark day in this crisis with the Fed going all-in (see below) after flip flopping about on the merits of quantitative easing (QE). But now it’s all hands to the electronic printing presses as they clearly don’t believe that Geithner’s TALF could do the heavy lifting required. Stocks rallied as VIX declined back to 40 (the floor of its recent range). But is QE a sign of desperation? It is a serious negative for the EUR/USD, which kissed 1.3536 overnight. Gold of course bounced as the textbooks say this will ultimately be inflationary. But it beats living in caves.

Today’s Market Moving Stories

• In overnight economic news Japan’s Tankan manufacturer sentiment fell 4 points in March to -78, hitting a record low. Japan is planning emergency employment measures worth $15.6bn to soften the impact on the job market of the deepening recession. The Bank of Japan said economic conditions have deteriorated significantly and are likely to keep worsening. As an aside, it goes without saying that any pronounced period of Dollar weakness (due to US QE) will of course have fairly dire consequences for the already hard pressed big exporter name stocks on the Nikkei.
• China sets new rules on bank asset sales, following complaints that domestic state-owned banks sold stakes to foreign investors and employees too cheaply. The new rules, which take effect May 1, require state-owned shares of listed financial companies be sold openly through stock exchanges and prices should be no lower than the ratified assessment of the company’s asset value.
• Lord Turner, chairman of UK’s FSA, has laid out recommendations for a “profound” overhaul of banking supervision. Also in action is Germany’s finance ministry who have drafted a bill to give greater power to the country’s financial supervisor BaFin to control banks.
• Disappointingly, but all too predictably, ECB President Trichet has signalled a clear preference for boosting the Eurozone economy by pumping emergency liquidity into banks instead of unveiling special quantitative easing measures. He said the greater role played by banks, rather than capital markets, in the Eurozone compared with the UK and US “has important explanatory power” when it came to interpreting the ECB’s actions.
• Big investment-grade companies appear to be hoarding cash in the face of economic uncertainty as they raise record amounts of debt in the bond markets while cutting dividends, share buybacks and capital expenditure. Companies globally have already raised $353bn worth of bonds, which is $224bn more than they are due to repay by the end of Q1.
• Meanwhile, in the real world, some scenes from the recession.
• There are too many jokers for my liking in this pack of cards.

The Fed Delivers A Major Electroshock To The Market
The Fed fireworks continue. The Fed announced more aggressive quantitative easing initiatives than expected, worth an extra $1.15 trillion. The new developments include:

1. An extra $750bn of agency MBS purchases over the rest of 2009
2. $300bn in longer-term Treasuries to be bought over the next six months
3. An extra $100bn of agency debt over the rest of this year.

The impact has been immediate, with 10Year US Treasury yields dropping by about 45bp (their biggest move in 50 years) and a sharp one-shot move in EUR/USD to over 1.35 from 1.31. The Fed has now really stepped in all guns blazing, showing its unequivocal determination to do all it takes to stabilise the economy and the financial sector, and fend off risks of deflation. It should make the Chinese vendor financing of the US a bit more secure also.

With these new initiatives, we could eventually be looking at a Fed balance sheet of $5 trillion, or nearly six times its normal pre-crisis level. If this happened, it would take the Fed’s balance sheet to 36% of GDP. Overall, the Fed is once again showing its intent in going to extremes in its ‘once-in-a-century’ policy response to this once-in-a-century crisis. Whether it ends up boosting spending or saving remains to be seen, but these actions raise the already rising probability that Q2 GDP could be a positive print.

This move makes the ECB look very much the odd man out as we now have the Bank of England, Bank of Japan, Swiss National Bank and the Fed engaging in explicit QE. This move heaps pressure on Trichet and Co who find themselves miles behind the curve and totally out of touch with reality.

An Irish Toxic Debt Company?
The Irish Government has been advised to set up a toxic debt company to take over billions of euro of bad property loans according to the Irish Independent. The “bad” asset management company would be set up to absorb loans weighing on bank balance sheets. This would free up banks' capacity to lend, stave off nationalisation and send a message to the international markets that the Government is actively managing the situation.

However, it appears that the problem which has faced the US TARP program needs to be resolved if the plan is to proceed - what level of write offs do the banks absorb on the assets before transfer into the “toxic asset” company? The “toxic asset” company could fund itself through the issuance of government bonds to the Irish banks in return for the assets. The Department of Finance had declined to comment, but government sources said that the proposals were “tentative”.

Equities

• Sony (SNE) said it would freeze workers’ salaries this year as the company tried to recover from a record loss, and its rivals may follow in the face of a global sales slump.
• Abu Dhabi and US bidders are said to be on the short list for Barclays’ (BCS) iShares. A $6bn price tag rumoured. Selling off the crown jewels to remain independent may prove a pyrrhic victory.
• UK insurance giant Prudential (PRU) results were very good across the board with the exception of a whopping hit from unrealised losses on the US corporate bond portfolio. Other surprise news is that CEO Tucker is to quit at the end of September. I suspect the reason is that he was very much in favour of acquiring AIA from AIG which Prudential said it couldn’t meet its ‘strict financial criteria’. Stock is up 9%. Indeed the whole sector seems to be getting a shot in the arm this morning with Legal & General up 6.4% and Aegon (AEG) gaining 5.5%.
• Luxury goods maker Hermes (HESAF.PK) is up 6% to €76.17. The company reported 2008 net income of €290.2M compared with an average street estimates of €287.5M.
• Irish Continental stated in a press release that it intends asking the Irish Takeover Panel to impose a deadline on the Moonduster consortium to make a bid for the company.

Disclosures: None

Comments

[prudentinve...:]

Shock and Awe indeed. Next we'll see "Mission Accomplished".

Mar 19 08:47 AM

[aarc:]

What an irony of your linked pictures.

The objective: A home for every Amercian.

The result: Lots of and lots of empty expensive houses foreclosed or abandoned. Increasing number of jobless and homeless Americans with tent cities sprouting all over the place.

That is the result of an economic agenda that focuses on providing housing while neglecting business.

America and Europe embarked on this mega-housing project while throwing away their profit-making businesses to China, India and other developing countries and practically turning their noses from the Tech Industry after the dotcom fiasco. Technology companies are supposed to suppliment the manufacturing industry which was suffering from high labor costs and cannot compete to cheap labor from the developing countries. This two-pronged (mis)approach resulted with less than adequate sources of income needed to sustain a vastly increased amount of expensive assets such as mcMansions many Americans gorge themselves into.

Plus... a never-ending unproductive and vastly expensive "little" wars in Iraq and Afganistan - perfect additional ingredient for an economic paralysis. More tonnage of bombs dropped into Iraq than the whole WWII? Plus all those aircraft carriers, long-range bombers, seek-and-destroy helicopters, robocop soldiers, etc. looking for a handful of terrorists. Too expensive, is it not?

Just trying to point out which is more important. Housing or business entrepreneurship? Fancy house with no income does not match as we now know. As soon as the potential complete meltdown of the economy got arrested and stop gap measures are implemented to prevent joblessness from getting worse; it is time to have a hard look again at Technology since manufacturing can't possibly compete yet with cheap or rather "getting cheaper now!" labor from China and India. America needs a "new" source of income aside from the (now dysfunctional) financials and retail in order to pay up for the excessive depts being incurred now.

The sooner business entrepreneurship becomes the primary focus of national economic recovery; the faster new jobs will be created that will be needed for an effective or self-sustaining economic recovery.

How about war on terrorism? Is it really needed to keep the bombs (soldiers) vs. terrorists or use the less expensive but maybe more effective intelligence (police) vs. terrorists? The more money re-directed back into the economy, the better off the economy can recover. The military won't mind helping the country recover from this economic crisis by drastically reducing hardware expenses without risking defence by involving the military personel more on in-expensive training rather than actual combat, will they? The military has more than enough hardware capability to fight the Whole Wide World if that is what becomes necessary in a MAD+MAD scenario. How many enemies does America has right now and might have in the next 10 or 20 years time?

Mar 19 09:13 AM

[@TexasER:]

Maybe you should explain this line, "It should make the Chinese vendor financing of the US a bit more secure also."

This move increases the likelihood that China will walk away from future treasury auctions. That's a good thing in my opinion, because it will force the dollar down even more. But I think you are suggesting the opposite?

Mar 19 11:49 AM

[carey_jim:]

United States government spending as a percentage of GDP is about 40%. www.usgovernmentspendi...

Government spending as a percentage of GDP of several other major countries:

Sweden: 55% www.heritage.org/index...

France: 53% www.heritage.org/index...

Great Britain: 45% www.heritage.org/Index...

Japan: 36% www.heritage.org/index...

China: 30% www.heritage.org/index...

Russia: 30% www.heritage.org/index...

No other country spends as much for defense as the United States. If you subtract defense spending, the percentage of U.S. government spending is closer to that of Japan, Russia and China.

Mar 19 04:59 PM