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Bernanke Warns of Ominous Outlook


More rate cuts expected from Fed.

Reviewing the past week's market action I couldn't help but recall the words of Claudius in Shakespeare's Hamlet: "When sorrows come, they come not single spies, but in battalions." A laundry list of ominous economic reports, continuing worries about the credit insurers, more news of mortgage-related write-downs and talk of hedge funds facing margin calls served up the perfect storm of investor anxiety.

Fed Chairman Ben Bernanke was in the spotlight on Wednesday and Thursday when he delivered his semi-annual testimony on the economy and monetary policy to the House and Senate banking committees. Testifying after inflation readings for January showed rising prices, he admitted that inflation risks have increased, but emphasized the Fed's view that growth risks remained the greater threat to the economy right now.

Bernanke acknowledged that tumbling house prices could set off a second phase of the credit crisis. He said: "Financial markets continue to be under considerable stress," and also warned of possible small bank failures in the U.S.

The take-away from Bernanke's testimony was that the Fed will be cutting rates again at the March 18 FOMC meeting, with the Fed funds futures now seeing a 100% chance of a 50 basis point cut and a 62% chance of a 75 basis point cut.

John Mauldin, author of the Thoughts from the Frontline newsletter, said: "Bernanke practically promised more rate cuts ... The Fed is going to cut and cut again ... I think it likely they will go below 2%. They may stay there longer than we now think if I am right about a protracted and slow muddle-through recovery."

Let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.


A number of important U.S. economic reports were released last week, causing considerable angst among investors that a combination of slowing growth and increasing inflation could result in 1970s-style stagflation.

In addition to Bernanke's downbeat Congressional testimony, several economic numbers came in worse than expected, namely tumbling house prices, falling consumer confidence, consumer spending close to zero, falling orders for durable goods, a recession-like manufacturing survey, flat GDP growth and signs of a weakening labor market.

Importantly, producer prices rose by 7.4% in January from a year ago, coming on the heels of the news last week that the CPI rate jumped to the highest year-on-year rate in decades.

Research from UBS suggested that total losses for financial firms related to the sub-prime meltdown would reach at least $600 billion against the $160 billion of write-downs so far disclosed.

On the positive side, the Office of Federal Housing Enterprise Oversight announced that it would be removing the portfolio caps on Fannie Mae (FNM) and Freddie Mac (FRE), thereby hoping to improve liquidity in the secondary mortgage market to promote increased lending. Also, Standard & Poor's affirmed the triple-A ratings for MBIA (MBI) and Ambac (ABK), but this was negated by news that the bailout of the latter had hit a problem.

Here are this week's economic reports, courtesy of Yahoo! Finance.

In addition to the Fed releasing its Beige Book on Wednesday, the next week's economic highlights, courtesy of Northern Trust, include the following:

1. ISM Manufacturing Survey (March 3): The consensus for the manufacturing ISM composite index is 48.1, after a 50.7 reading in December. Several reports of the factory sector have sent a message of a contracting manufacturing sector. Consensus: 48.1 from 50.7 in January

2. Employment Situation (March 7): Payroll employment in February is predicted to have barely risen (+10 000). Payroll employment dropped by 17,000 in January. The jobless rate is predicted to have risen to 5.0% from 4.9% in January. Consensus: Payrolls – +25 000 versus -17 000 in December, unemployment rate -5.0%

3. Other reports: Construction spending, auto sales (March 3), Pending Home Sales (March 6), Productivity and Costs, ISM Non-manufacturing Survey, Factory Orders (March 6).


The performance chart obtained from The Wall Street Journal Online shows how different global markets fared during the past week.

Source: Wall Street Journal Online, March 3, 2008.


Global stock markets closed the week higher, with the MSCI World Index gaining 0.6%. If not for emerging markets (+1.5%) and the Japanese Nikkei 225 Average (+0.8%) the global index would have been underwater.

A sharp sell-off on Friday (driven by a host of negative news regarding financial stocks) resulted in declines for the U.S. indexes for the week, as follows: S&P 500 Index (-1.7%), Nasdaq Composite Index (-1.4%) and Dow Jones Industrial Index (-0.9%). Gold and silver stocks (+3.5%) were the strongest performers for the week, whereas banks (-6.4%) and brokers (-5.5%) were on the receiving end of the selling orders.

The major U.S. indexes all recorded declines (ranging from 3% to 5%) for February, resulting in a fourth consecutive month in the red – the biggest losing streak since 2002.


Mounting economic concerns caused government bond yields across the globe to decline sharply as nervous investors piled into government debt as a perceived safe-haven asset class.

The entire maturity spectrum recorded double-digit yield declines in the U.S., with the yield on the two-year Treasury note falling by 34 basis points to 1.64% and the 10-year yield dropping by 27 basis points to 3.52%. Capital markets in the rest of the world behaved similarly.


The past week saw the U.S. dollar plunging to lifetime lows on a trade-weighted basis and against the euro as market participants focused on weaker U.S. economic growth leading to further rate cuts by the Fed. "The last time the dollar was this low, Jimi Hendrix was on tour," said Barry Ritholtz of The Big Picture.

The U.S. dollar dropped by 2.3% against the euro based on the view that the European Central Bank would keep interest rates on hold for a while longer. Losses against other major currencies were: Swiss franc (-3.7%), Japanese yen (-2.3%) and British pound (-0.9%). Concerns about the UK economy and slowing house prices impacted negatively on sterling.


The Reuters/Jeffries CRB Index (+3.8%) continued its record-breaking ride during the past week on the back of a slumping dollar and increased investor inflows (as also evidenced in an announcement by Calpers to commit large additional assets to commodities). Crude oil (+3.1%), gold (+2.9%), platinum (+1.2%), industrial metals (+4.7%) and agricultural commodities (+4.0 %) all reached record levels.

Inflation concerns and negative real short-term interest rates pushed gold bullion to a record $975.90 en route to the $1 000 level. Silver continues to play catch-up within the precious metal complex, surging by 10.4% to breach $20 before minor profit-taking set in. A trader remarked: "Silver is in huge short supply, and the shortage is getting worse by the day; the silver inventories which depressed the price for more than 60 years are gone."

West Texas Intermediate oil hit an all-time high of $103.50 as a result of supply disruptions, but eased by the end of the weak as economic worries got the better of supply concerns.

Agricultural commodities and base metals again experienced a strong week.

With the ISM Manufacturing Survey out on Monday and February's payroll numbers on Friday, another key week for financial markets lies ahead.

The U.S. Economy – That Recessionary Feeling

Source: Tom Toles, Yahoo News (via Barry Ritholtz's The Big Picture).

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