Prieur Perspective: Busy Week For Fed
Signs point to U.S. economy contraction.
What a tumultuous week! Once again, the fall-out of the subprime mess had a lot to do with it. For some variety, however, it was not only financials that were in the limelight but also commodities, which corrected sharply.
Unrelated to St Patrick's Day, the week started off with a sense of fear for a market meltdown after it had been announced over the weekend that the Federal Reserve of New York facilitated the sale of Bear Stearns (BSC) to JPMorgan Chase (JPM) for the princely sum of $2.00 per share.
Stock Trader's Almanac succinctly reminded us of the words of Norwegian playwright Henrik Ibsen, who opined over a century ago: "Those heroes of finance are like beads on a string. When one slips off, the rest follow." With faith in the U.S. financial system fragile, pundits questioned whether Bear would be the only casualty. However, better-than-expected earnings reports by Morgan Stanley (MS), Goldman Sachs (GS) and Lehman Brothers (LEH) allayed some of the market's concerns about the shape of the financial sector.
In the Federal Reserve's first weekend action in more than 25 years, it announced a 25 basis-point cut in the discount rate to 3.25% and created a new lending facility to provide financing to participants in securitization markets. "You only cut on a Sunday if you're trying to avert all-out panic on a Monday," said John Hussman of Hussman Funds.
Two days later the Federal Open Market Committee (FOMC) cut the Fed funds rate by 75 basis points to 2.25% and the discount rate by another 75 basis points to 2.50%. Although the FOMC's statement noted increased uncertainty surrounding the inflation outlook, it still believed inflation would moderate. However, the downside risk to growth remained the Fed's main concern and it was implied that it was ready to cut rates again if necessary.
The Office of Federal Housing Enterprise Oversight (OFHEO) announced that it was relaxing the excess capital requirement for Fannie Mae (FNM) and Freddie Mac (FRE) in an effort to increase liquidity in the U.S. mortgage market by as much as $200 billion .
Capping a busy week, the Fed also announced that it was planning to expand the list of eligible collateral for next week's Term Securities Lending Facility to include difficult-to-trade securities.
Before highlighting some thought-provoking news items and quotes from market commentators, let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.
In addition to the Fed's interest rate announcements and other actions mentioned above, the past week's U.S. economic reports included industrial production showing a steep decline; higher-than-expected jobless claims pointing to a weakening labor market; the Philadelphia Fed manufacturing survey, showing contraction for the fourth consecutive month; and a current account deficit narrowing in the fourth quarter from 5.1% to 4.9% of GDP, partly as a result of the weak dollar.
The U.S. Producer Price Index carried mixed news with total PPI up less than expected, but core-PPI, which excludes food and energy, exceeding the consensus number. On a year-to-year basis, total PPI was 6.4%, marking the fifth monthly reading in excess of 6.0%.
On balance, there appears to be a growing list of economic indicators that are signaling contraction in the U.S. economy. This was also reflected by the Index of Leading Indicators, showing the biggest drop in the current cycle (on a quarterly basis) – consistent with readings seen in past recessions.
Elsewhere in the world, the Bank of England's minutes showed the BoE balancing strong inflationary pressures with slower economic growth. February retail sales surprised on the upside, but also suggested that U.K. consumers were continuing to drive themselves deeper into debt to fund purchases.
Here are this week's economic reports, courtesy of Yahoo Finance, as of March 21, 2008.
The next week's economic highlights, courtesy of Northern Trust, include the following:
1) Existing Home Sales (March 24): Sales of existing homes are predicted to have declined in February. Existing home sales have dropped 31.5% from their peak in September 2005. Sales of existing homes have fallen 22.4% from a year ago in January. Consensus: 4.85 million versus 4.89 million in January.
2) New Home Sales (March 26): Sales of new homes are expected to have fallen in February. Purchases of new homes have fallen 57.9% from their peak in July 2005. Sales of new homes have declined 34.9% from a year ago. Consensus: 575,000 versus 588,000 in January.
3) Durable Goods Orders (March 26): Durable goods orders (+0.5%) are predicted to reverse a part of the sharp 5.1% decline seen in January. Orders of aircraft and defense may have risen following a big drop in January. Consensus: 0.7% versus -5.1% in January.
4) Real GDP (March 27): The downward revision of retail sales in December and a smaller trade gap in December could result in no change in the headline GDP from the preliminary estimate of a 0.6% annualized increase. Consensus: 0.6%.
5) Personal Income and Spending (March 28): The earnings and payroll numbers for February suggest only a small gain in personal income (+0.1%). Auto sales were nearly flat in February and non-auto retail sales were noticeably weak, which points to likely drop in consumer spending (-0.1%). Consensus: personal income +0.3%; consumer spending 0.1%.
6) Other reports: Consumer Confidence (March 25).
The performance chart obtained from The Wall Street Journal Online shows how different global markets fared during the past week.
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