My Diary 496 --- 17Dec2008: Xmas Pony from Daddy

December 17, 2008 --- Xmas Pony from Daddy

Wall Street has a solid gain (+5%) after Fed surprised the markets with an unexpected move, despite dismal reports on CPI, housing starts and a big 3Q loss from Goldman. The VIX fear gauge fell 10.2% to 50.98. This is interesting as it seems that part of the markets view that risk in equities isn’t as high as the risk of earning nothing. Based on the overnight X-asset classes’ observation, I would say equities reacted like kids asking for a Christmas pony from their daddy. But we have to be careful to our wishes as somebody has to clean up the mess afterward. I still want to remind us that S&P 500 is poised for its worst year since the Great Depression after losses and writedowns at global financials reached almost $1trn and earnings at US companies dropped for 5Qs, matching the longest streak on record.

Back to the Big Daddy, overnight FOMC succeeded in surprising the markets by slashing 75 bps, moved to a target range (0-0.25%) instead of a single rate and also were perhaps more explanative about QE than the markets anticipated. Indeed not only did the Fed reinforce that they will buy GSE and MBS but they also said that they were willing to expand those purchases. In other words the Fed is giving notice to our traders/investors that we can either trade for ST profit or for HTM if we are LT investors… But all these explicit gestures signalled by Fed mean that US is deeply into the unknown world of QE – where rates don’t matter as much as the quantity of available money. The bears will argue that the FED has now delivered its last bullet – Zero interest rate policy with QE as a side shot. The bull will say that the FED is ahead of the global deflation fears. 

One other question in my mind is that is the move another mess for USD, as EUR has jumped from 1.37 to 1.41, while DXY has crashed from 82.30 to a low of 79.80 (3% intra-day).  I think FX traders see this dangerous game – with USD fully 2% weaker after FOMC cut. It looks clear that one of the other bullets FED may use -- USD devaluation, or bigger B/S and more government debt. My key watch today is how RMB will react to the O/N dollar depreciation.

Economic wise, deflation may truly be closer than we think as the US CPI (-1.7% MoM) drop was the worst since 1982 and the flat core (0% MoM) shows a world dangerously close to a change in the consumer behaviour – where lower prices don’t spark larger demand. The correlations of price to demand aren’t the only ones being questioned now as the EUR and oil and SPX correlation breaks down. It seems to me that commodity and consumers did not buy the call. The OPEC cuts (2mn bbl) as we expected to meet global demand drops and USD competitive devaluation doesn’t spur any inflation fears but merely a shift into Gold and EUR. 

Lastly, this looks like our year-end solution for Debt deflation before we go for Christmas Dinner --- US borrowing $2trn in 2009, Equity down 40% yoy, 30yr debt yield below 2.80%, Core inflation at 2% yoy, USD losing 3% in a day…Cheers or not, today Hong Kong is at least up 500pts, I guess.

Oversea Markets Review

Overnight US markets rallied in response to the Fed’s actions. S&P500 finished the day up +5%. Outside the US, equities posted moderate gains with +0.8% in EU and 0.7% in UK, but down 1.1% in Japan. UST rose after Fed cut, pushing 2yr down 8bp to 0.65% and 10yr lower 25bp to 2.26%. Accordingly, USD weakened, dipping 0.7% on TW basis, losing +2% against EUR to $1.40, and declining ~2% vs. YEN to 89—a fresh 13 year low.