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Prieur Perspective: Fight for Confidence


A leaky ship, a shortage of plugs.

I was bargaining on a quiet week as there were only a handful of economic releases and no major earnings reports. But credit and liquidity issues ravaged the financial markets and resulted in plenty of white knuckles and shaky knees, climaxing on a particularly sour note on Friday and not quite delivering the birthday present I was hoping for.

Struggling to contain a crisis of confidence in credit markets, the Federal Reserve announced a new Term Securities Lending Facility, or TSFL. The Fed will lend up to $200 billion of Treasury securities to primary dealers for a term of 28 days (rather than overnight) against collateral including federal agency debt, mortgage-backed securities of Fannie Mae (FNM) and Freddie Mac (FRE) and private AAA-rated residential mortgage-backed securities.

This program essentially aims to improve liquidity by allowing more thinly-traded securities to be used as collateral to borrow highly-traded Treasury securities. "...looks to me like the nationalization of duff loans, although the Fed has not actually purchased the mortgage securities," remarked London-based David Fuller, author of the Fullermoney newsletter.

The auctions will take place on a weekly basis, commencing on March 27, and participating central banks include the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank.

Wobbling on the brink of collapse from a lack of cash, Bear Stearns (BSC) received emergency funding on Friday from the Federal Reserve of New York and JP Morgan (JPM) in the largest government bailout of a U.S. securities firm. The rescue action failed to restore confidence among Bear's customers and shareholders, who slaughtered the stock price by 47% and sent stock markets tumbling.

The Fed's board unanimously approved the JP Morgan Chase and Bear Stearns arrangement and issued a press release stating that it was "monitoring market developments closely and will continue to provide liquidity as needed".


The world's major central banks' efforts to inject liquidity into the financial system did little to quell investors' fears as recession concerns remained elevated.

Economic data were mixed, although the reports did not have much impact on financial markets due to credit worries taking center stage. February retail sales fell by 0.6%, which was short of the expected 0.2% rise. On the positive side, however, the inflation numbers were better than expected as February CPI and CPI excluding food and energy came in flat. CPI is now up 4.0% year on year, and core CPI is up 2.3% year on year.

The better-than-expected inflation reading, together with the reeling stock market, caused pundits to up their expectations of the size of the FOMC's March 18 rate cut. Fed funds futures now suggest a 64% chance (up from only 6% a week ago) of a 100 basis point cut, with the rest of the bets on a 75 basis point cut.

Last week's economic reports are detailed below, courtesy of Yahoo! Finance.

Click to enlarge image

In addition to the FOMC's interest rate announcement on March 18, the next week's economic highlights, courtesy of Northern Trust, include the following:

1. Industrial production (March 17): The 0.5% drop in the manufacturing man-hours index in February suggests a 0.3% decline in industrial production. The operating rate is projected to have dropped to 81.2 in February. Consensus: -0.1%; Capacity Utilization: 81.3 vs. 81.5 in January.

2. Producer Price Index (March 18): The Producer Price Index for Finished Goods is expected to have risen by 0.3% in February, reflecting higher food and energy prices. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in January. Consensus: +0.4%, core PPI +0.2%.

3. Housing Starts (March 18): Permit extensions for new homes fell by 1.8% in January, inclusive of a 3.0% drop in permits issued for single-family homes. The weakness in permits is indicative of fewer housing starts in February (970,000 versus 1.012 million in January). Consensus: 990,000.

4. Leading Indicators (March 20): Interest rate spread and money supply are the only two components likely to make a positive contribution in February. Stock prices, initial jobless claims, consumer expectations, vendor deliveries, and building permits are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defense capital goods are used in the initial estimate. The manufacturing workweek held steady in February. The net impact is a 0.4% drop in the leading index during February. If our forecast is accurate, this would be the fifth monthly decline in the index, which reinforces expectations of a recession. Consensus: -0.3%

Other reports: Current Account (Q4), NAHB Survey (March 17, Philadelphia Fed Survey (March 20).

Stock Markets

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

Click to enlarge image


International equity markets were again on the receiving end of credit market woes, including the Bear Stearns bailout. Global stock markets closed the week lower, with the MSCI World Index declining by 0.5%.

As was the case during the previous week, the Japanese Nikkei 225 Average and emerging markets again came under strong selling pressure and lost 4.2% and 2.2% respectively. China's Shanghai Stock Exchange Composite Index (-7.9%) was at the forefront of selling pressure, having lost 35.0% since its peak in October 2007.

The major U.S. indexes experienced a mixed week, with the S&P 500 Index losing 0.4%, the Nasdaq Composite Index closing unchanged and the Dow Jones Industrial Index gaining 0.5%. Gold and silver stocks (+5.0%) and oil services stocks (+1.2%) performed well, whereas brokers (-7.2%) were again dumped by nervous investors.


The prices of U.S. government bonds were pushed higher as investors sought the perceived safe haven of government debt. The yield on the 10-year U.S. Treasury Note fell by 12 basis points during the week to 3.42%.

Elsewhere in the world, bond yields declined in Germany, edged up in the U.K. and were mixed in Japan.


The past week saw the U.S. dollar yet again recording lifetime lows on a trade-weighted basis (-0.9%), as well as against the euro (-2.1%) and Swiss franc ( 2.5%). As larger-than-previous Fed funds rate cut expectations weighed on the greenback, it also hit a 12-year low against the Japanese yen (-3.0%).

The dollar's record-breaking slide prompted complaints from Jean-Claude Trichet, European Central Bank President, and Fukushiro Nukaga, Japanese Finance Minister. Henry Paulson, U.S. Treasury Secretary, also re-emphasized that he was backing a "strong dollar".

"We're on an intervention watch," Stephen Jen, Morgan Stanley's London-based head of foreign-exchange research, said. "While I don't think we have reached the threshold yet, the argument in favor of it is gradually becoming compelling."


The weak dollar aided a 0.5% rise in the Dow Jones-AIG Commodity Index. Gold bullion rose by 2.7% and hit an all-time intraday peak of $1,009.0 an ounce. At the same time crude oil surged by 4.8% and registered a record intraday high of $111.00 a barrel.

Crude's advance occurred even though the U.S. government's weekly energy report showed stockpiles had increased by a much larger than expected amount, but possible supply interruptions in Nigeria caused concerns.

Gold jumped by $16 on the news of the Bear Stearns rescue operation, and was also helped by negative real interest rates in the U.S., the plunging dollar and the strengthening oil price.

As far as other commodities were concerned, agricultural commodities scaled new peaks, but industrial metals experienced some profit-taking.

Political decisions on money flows, labor and technology are "substantially constraining supply growth" of commodities, Goldman analysts including Jeffrey Currie in London wrote in a recent report. "This will likely support the ongoing structural bull market in commodities until these policy-driven investment constraints are removed and/or demand is adjusted."

However, other analysts are beginning to question the sustainability of the commodities rally. Albert Edwards, global strategist at Société Générale, said: "The unfolding U.S. consumer recession is likely to suck liquidity away from the Emerging Market, EM, region as the U.S. current account deficit declines and EM accumulation of foreign exchange reserves slows sharply. As EM asset prices slide and decoupling arguments evaporate, commodity prices will react sharply as recent speculative 'safe haven' froth unwinds.
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