By Colin Twiggs
March 13, 2008 2:00 a.m. ET (6:00 p.m. AET)
The Fed announced a new temporary lending facility that will allow banks and bond dealers to swap mortgage-backed securities, that they can't currently sell, for highly liquid Treasuries. This will increase the total amount of money that the Fed has pumped into the financial system to over $400 billion, in an attempt to sustain the flow of credit to consumers. So far the increased liquidity has not had much effect. A slow-down in credit extension would cause a sharp down-turn in the economy.
Loss of liquidity in the mortgage-backed security market is best illustrated by the chart of new issues.
During the week I spoke with fixed income specialist Neil King
of RIM Securities Limited.
His view of the Fed's bail-out plan is that it will improve
liquidity but does not address the solvency issues faced by a
number of banks.
"Repurchase agreements add short term liquidity only. But if a CDO is valued at 20c in the dollar, repos will not change this."
I also agree with Neil that the positive sentiment offers "an excellent opportunity to liquidate long positions — before people realise it is nothing more than a bull trap and the markets once again move lower."
Ten-year treasury yields are again testing support at 3.40%. The strong down-trend, however, is likely to continue. The rising yield differential is caused by falling short-term rates.
Three-month treasury bills yields are now consolidating between 1.20% and 1.50%; more than 150 points below the current fed funds target rate of 3.00%, compared to 25 to 50 points in a normal market. The market remains highly risk-averse and the strong down-trend (in short-term rates) continues.
The wide spread between treasury bill and commercial paper rates reflects investors aversion to lending in the financial markets. A further half-percent cut in the fed funds rate is expected at the March 18 FOMC meeting.
Total asset-backed commercial paper issued is holding at $800 billion, after a drop of almost $400 billion. The rise in financial commercial paper shows banks raising additional funds as they are forced to take asset-backed debt back onto their balance sheets.
While default rates remain relatively low, new issues of commercial mortgage-backed securities have also dwindled, placing downward pressure on commercial real estate prices.
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Bank credit growth is expected to fall below 10%. A sharp decline would signal a full-blown recession.
Consumer credit growth has turned down, but the position is so far not alarming compared to earlier recessions.
Employment has broken out of its up-trend. We now have to wait and see if the market consolidates, as in recent recessions, or trend downwards, which would warn of a depression.
Jonathan Wright's recession prediction model shows probability
of a recession in the next four quarters at 3 percent.
I would prefer to stop publishing the model, as I believe it failed to predict the current recession in a relatively low interest rate environment. Some readers, however, have indicated that they still find it useful; so I continue to include it — solely for their benefit.
The only things worth learning are the things you learn after
you know it all.
~ Harry S Truman.
To understand my approach, please read Technical Analysis & Predictions in About The Trading Diary.