How Lower U.S. Rates Affect Asian Markets

Notes from Dr. Enzio von Pfeil's recent performance on CNBC Cash Flow:

U.S. Federal Reserve surprise rate cut - what are your thoughts behind that move?

• We were as surprised as everyone else was
• Yes, along with everyone else we expected them to cut rates at the Fed meeting next Wednesday;
• However, we did not think at all of an interim cut – the first one since 1984, according to the Financial Times!

Your expectation from the next FOMC meeting and the outlook for U.S. interest rates

• Down, down, down
• But, this is really NOT where the action is!
• We suggested earlier to our subscribers that the big difference this time around who - to use the parlance of The Economic Clock™ -is creating an "excess demand for money"? This time around, it is private sector banks don’t want to lend. So markets have to wait until they are in a lending mood. This is a far cry from the more normal occurrence of a Central Bank not wanting to lend.

1. While the private sector is driven by business considerations (well, maybe not if we reflect on the sub-prime carnage, inflated bonuses and huge market losses) Central Banks are driven by policy considerations.

2. In each instance, the decision-making process is totally different one. Clearly, Central Banks can change policy at will; however, private sector banks cannot: they have to await the business opportunity.

3. So with The Economic Time™ clearly worsening in America – we have been flagging stagflation there since May 2006, i.e. for about two years – don’t expect banks to lend. And if they don’t lend forget growth.

• Thus, it is not the price of money that matters. It is the perception of private sector banks that matters. And they won’t lend for a long time. Germany went through this and got stuck in recession for two and a half years!
• Besides, don't expect Bush's recent $140 billion dollar bailout proposal to do any good, either.

Several regional central bank will be meeting next week - your expectations there?

• Key has to be their currency concerns
• Unoriginally, we’ll grudgingly go with the herd and expect Fed Funds to slither down to around two percent or so. Well, that hardly makes the US dollar an attractive investment vehicle, right?
• We must emphasize that American consumption is going to shrink by about $350 billion - that represents nearly twice the level of exports that China sold to America in 2006! So who on earth can talk of "de-coupling" or that "things are different this time"?

Federal Reserve's cut benchmark interest rate by three quarters of a percentage point - which Asian countries are likely to follow suit?

• So Central banks out here will be seeking to balance the risk of their currencies being dragged-down too much in the wake of an ever-weaker dollar.

o Hong Kong has no choice: thank God that the peg stays

o China probably will stay the course; interest rates play no role in determining the exchange rate, anyway.

o You could find the exotics like the Malaysian Ringgitt, Baht or Korean or indeed NT dollar rising, if their yields are favorable. So their Central Banks probably will leave interest rates alone; if the currency rises too much, of course they will cut interest rates.

o The Singapore Dollar can “manage” easily in that the Monetary Authority presumably can alter the currency composition of the underlying basket against which the S$ is managed.

Impact of interest rate differential on investment flows

Please see next.

Any topics you would like discussed?

- First, we have brayed-on for nearly two years about stagflation hitting America. With the dollar’s attractiveness waning, it will keep trudging down hill, fueling higher import prices and thus more cost-push inflation. That is going to put the Fed in a bind.

- Secondly, with the unwinding of the carry trade, expect the yen to keep strengthening. Not because people believe in this corpse called Japan, but because their greed has been replaced by fear. So expect Japan to slump even more: a stronger yen will hurt her exports AND fuel imported deflation in Japan!