Bernanke's Likely Weapon Of Choice

This is my prediction for Bernanke. He will raise fed funds rate very very soon. Just because of that, it does not mean that it will be bad for equity markets.

But lets go back to why it will happen very soon (by February I think). Most developed nations' central banks have been reluctant to move the low interest rates regime up because the Main Street has been showing nascent growth. What Bernanke wants to see are corporate spending on R&D and hiring - both not really evident yet. Despite the tons of liquidity being poured into markets, many banks are just sitting by idling.

The Fed has had to maintain a low fed funds rate for obvious reasons, but look at the chart, banks are earning very decent net interest margins by lending to the system, and not to clients. High ranking officials have been calling the banks to lend more aggressively, but that does not seem to be working.



Bernanke's hands are being tied a lot more now that many of the banks which received funds from the government are returning it - that means the government will have a lot less leverage to "move the banks" toward certain persuasions.

It looks like Bernanke will have little choice but to close the gap and raise fed funds rate. When net interest margins start to shrink, then the banks will have to put the money to work. The summary from all this deduction is that don't be worried when Bernanke raises fed funds rate, in fact it is a new bullish sign.

p/s photo: Erika Sawajiri

Ess'kue Me, Mister Liu!!!

During the recent APEC meeting in Singapore, Liu Mingkang, China's chief banking regulator, took a cheap shot at the US and Obama when he remarked that the US Federal Reserve is fueling speculative investments and endangering global recovery through loose monetary policy. Why I think that was a cheap shot - even my blog has been saying that for the longest time. The policies Liu was refering to were the weak USD, massive liquidity and currency printing, and low interest rates by the US. Liu basically said some standard knowledge: "The US Fed is boosting speculative investments in stock and property markets and will pose new, real and insurmountable risks to the global economy."

Mr. Liu, what do you expect the Fed or Obama to do??? Raise interest rates in the US while property prices, corporate spending and empoyment are still pretty weak??? To criticise the US is so easy. Hallo... you want to talk about bubbles, just look at China's massive expansion in dubious loans over the last 10 months - now that's a bubble as well.

Everybody do not want the financial crisis to happen but it has. How you work together to revive the global economy is more important, rather than criticising one another's policies. Every government is most concerned about saving jobs as it could derail the broader economy for a long time if left unchecked. The underlying rationale is to prevent social unrest, which could spell the end of many governments during times of crisis. Everybody has their own turf to mend first, only then can they work together to bring the global economy out of the woods.

How can the US seriously have a firm or strong USD now??? It needs to be more competitive, it needs to adjust its purchasing power in light of the massive amount of USD being printed, it needs to attract investments into its businesses and assets by having a lower USD - is that wrong? How in the hell is Obama going to justify having a firm USD in current times - yea, make it more attractive for US companies to ship jobs abroad, make US products a lot more expensive. Come on Mr. Liu, think before you speak, or rather stand in the other person's shoes before speaking. What about the massive China's stimulus program, isn't that easy money as well?

As to whether the US monetary and fiscal policies will lead to another global asset bubble, that will take some guess work. As things go, yes, we are headed for one, but we have yet to see how the major central bankers act further down the road. If they behave responsibly and keep selling bonds (buying back liquidity or soaking up liquidity) at a gradual pace, the asset bubble scenario may be averted. The flip side of it is when they do soak up liquidity, you will see asset prices correcting - I guess the strategy is to do it gently and in step with market mood swings. Mr. Liu, you think only you understand that the USD carry trade result in speculation???..., I am sure all central bankers know that, even the central bankers of Mali know that - just work together with other central bankers and stop spewing unnecessary jibes to win brownie points. You can criticise, but offer solutions lah, let's see how and what you would propose to do if your were in Bernanke's shoes.

You can criticise the USD carry trade (borrowing in USD and speculating in foreign currencies, stocks and other assets) but that is beyond the scope of the Fed or Obama. Plus market movements or capital flows may not be long term, it may be shifting trends, you cannot simply manipulate short term monetary or fiscal policy for the sake of controlling what might reall be short term market trends. There will come a time when markets will think the USD has gone too low and the USD carry trade will unwind by itself. Do not jump around like a mad dog over normal course of events when currencies are realigning. Makes me think you not fit enough to be China's banking regulator.


p/s photos: Han Hyo Joo

Big Picture View - Equities Well Supported (Updated)

Updated:
Stocks gained on a fresh wave of M&A announcements, including a deal by Xerox to acquire Affiliated Computer Services for $6.4 billion.Abbott Laboratories gained after the company said it will buy the pharmaceutical business of Belgium's Solvay for as much as $7 billion in a deal that will expand its presence in emerging markets. Covidien will acquire brain-monitoring technology firm Aspect Medical Systems for $12 a share in cash, or a total of about $210 million, net of cash and short-term investments acquired. Johnson & Johnson says it's bought 18% of Crucell for 301.8 million euros ($440 million) -- a 30% premium to Friday's close -- and will pay development milestones and royalty payments if flu vaccines that the two firms will develop make it to the market. Among major economic news this week, the Case-Shiller housing price index and consumer confidence data are due out Tuesday morning, while GDP, ADP employment and crude inventories are slated for release on Wednesday. The above news indicate that corporations are more willing to tap the markets for the low rates. Expect more such M&A activity in the coming days. This links up nicely to the article posting below. Of course we have to bear in mind that the US$ weakness is also supporting US equity purchases.
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Every now and then, its important to reassess the big picture view. Getting the big picture correct will make for a more confident trading mindset, or reasons not to trade the market. It is clear that the developing economies are recovering more rapidly than developed nations. If you look at central banks at developed countries, they are still keen to keep rates low. This emphasised the fact that while there is some sort of recovery, it will be a long drag to becoming substantive.

By mid-2009, most central banks in advanced economies reached the trough in their rate cycles. Fed and Swiss National bank reduced the lower end of their target bands to 0%. Bank of Japan has been taking a "zero rate interest policy" 0.1% interest rate for sometime now. Sweden's reserve deposit rate is negative, and that's a useful indicator. A few central banks - Fed, BoJ, Sweden and Bank of Canada - have made explicit commitments to keep policy rates low for a long period. Australia should be the first to tighten among the G-10 central banks, as early as Q4 2009. Bank of England could be next, possibly by December/January.

Whether a central bank starts to tighten is a clear indication of how confident the central bankers are of the recovery in their country. The danger is that some could stay loose for too long, thus fomenting a bubble. That is exactly what is happening in HK, owing to its dollar peg, which resulted in very low rates, but that does not correspond with its real economy which is recovering quicker thanks to its ties to China - thus fueling its property boom.

• ECB held at 1% in June 2009 and may stay there depending on economic data.
• Federal Reserve held at 0-0.25% since December 2008 and will likely remain there all 2009 and 2010.
• Bank of Japan held at 0.1% since December 2008 and will likely remain there all 2009 and 2010.
  
• Bank of England held at 0.5% since March 2009, lowest rate since 1694.
• NZ held at 2.5% since April 2009 but may resume cutting to 1.5% later in 2009.
• RBA of Australia held at 3% in June 2009, lowest since 1960, and may hike in Q4 2009.
• Canada held at 0.25%, its lower bound, since June 2009 and may resort to quantitative easing.
• Swiss National Bank cut target range for 3mo Libor to 0-0.75% in March 2009 and may stay there until 2010.
• Norway cut 25bp to 1.25% in June 2009, its rate trough. Norway may hike in Q4 2009.
  
• Denmark cut 10bp to 1.55% in June 2009, maintaining a 55bp spread versus the ECB.
• Sweden cut repo rate 25bp to 0.25% in July 2009, committed to staying there until end-2010. In a break with the tradition of zero setting the lower bound, the deposit rate was set at -0.25%.

Economic indicators can be sluggish and yet stock prices can rally, there is nothing wrong with that. The equity markets collapsed a few months before the subprime implosion took over. The recent G20 meeting reinforced the view that they will plan to leave the emergency stimulus in place even though there are signs of some recovery. The G20 basically did not want to pull the brakes too soon. That can only mean one thing, higher equity prices. Yes, there will be bouts of minor correction, but these are just bumps. You have very low interest rates, some signs of recovery, an easy monetary policy, a much lower risk aversion attitude, where can you place your bets ... bonds??? ... of course its equities.

Even when stocks rake in just 5% or 6% return, that is still powerful compared to the prevailing interest rates of 2%, and the differentials are substantive enough for people to put their money to work. Asset managers will have to reduce their cash holdings and put them to work in order not to under perform. The very low rates are not designed to prop up the stock markets per se... its really to boost corporate borrowing and corporate lending, which is a much bigger concern, all of the G20 are grappling with unemployment and needs the corporate side to borrow and spend more. The stock markets are just a bystander beneficiary to that objective. Good till year end.


p/s photo: Zhang Xin Yu

Critical, The New Treasury Secretary

The most important appointment Obama will make over the next few days will be the Treasury Secretary. The person to replace Henry Paulson. As economics is the most difficult and pressing matter facing Obama, it is imperative that he make the right choice. Markets will rise and fall depending on who he selects.

The contenders:

a) Lawrence Summers - A renowned Harvard economist who won the John Bates Clark medal for economists under 40 in 1993, and was the Treasury Secretary under Clinton's administration. Has done it before, but under Clinton, no big financial or economic turmoil. Still an OK selection, but better than Robert Rubin definitely. His strong grasp of economics comes in handy. Summers could provide an economic lift, such as improving health care, reducing dependence on foreign energy sources and changing the tax code. He says focusing on those areas will help the economy by creating jobs and preventing families from cutting spending. Summers was among the first economists to call for a second round of economic stimulus based on infrastructure investment, which he says would help create jobs, bolster the construction industry and provide a cash infusion to municipalities. Markets to move up if he is appointed.

b) Timothy Geithner - President of New York Federal Reserve Bank. Though not well know, he should be viewed as a good selection as he was one of the early and more aggressive proponents of action to stem the crisis. Geithner would come in with an even more interventionist approach, which is what the market seems to be looking for, to solve the mess. He pushed for quicker action on Fannie & Freddie, and help strategise the bailouts of Bear Stearns and AIG. Market savvy and well regarded by Wall Street. Markets will go up slightly if he is selected.

c) Robert Rubin - another former Treasury Secretary under Clinton, ex top dog at Goldman Sachs and now a director for Citigroup. Impressive resume but largely seen as ineffective over the last 5 years. Did not forsee the crisis or counselled Citigroup properly. Was not entirely effective as Treasury Secretary. It would be a poor choice for Obama to select him. Markets will fall of Rubin is selected. Rubin is a trader, not a good economics strategist.

d) Paul Volcker - Your favourite and mine as well. Possibly the best Federal Reserve chairman ever. In his 80s, is a towering figure in U.S. monetary policy, famous for vanquishing inflation as former chairman of the Federal Reserve. Age might stop him from taking up the post. I would even just ask him to take up the post for 2 years to help guide the US through the economic landmines ahead for Obama. You can expect a sharp rally if Volcker was selected. His reputation from the 70s was unmatched. He dealth with the OPEC crisis, was brave and committed to tackle issues swiftly. Not prone to do popular stuff but effective measures. Markets will rally the strongest if Volcker is selected.

Others being mentioned include: Jon Corzine, another ex-Goldman Sachs top dog, now the Governor of New Jersey and Jamie Dimon of the unscathed JP Morgan.

p/s photos: Top, Paul Volcker with Obama Baby. Bottom, left to right, Summers, Corzine, Geithner