Fed comes to the party…..again

So the Fed yielded to pressure and cut the discount rate. Come borrow more they say….so much for a prudent approach to banking. But really they have no choice. They will just keep flooding the market with dollars for as long as it takes.

The market rallied as expected but it’s hardly a vote of confidence in the system. There will be an expectation of a cut in the funds rate at some point if credit woes continue. The problem is that the last few weeks have been so volatile that for many the opportunity to liquidate positions has not been possible.

Flight to quality has seen the $ rally except for that old favourite $Yen which has taken a pounding.

Who would want to own $? This flight to quality argument alway amuses me given the world is awash with $ and $ assets.

The volatility in the fx markets has been extreme reminding me of the Stg ERM debacle. It just shows that the leverage in the market creates an instability in the system which causes wild swings.  The range mileage in KiwiYen on Friday was the biggest i;ve ever seen in any currency pair…22 big figures in 24 hrs….thats 27.5% in absolute terms of up and down movements.

You would need Kevlar pants to trade that pair. I’ve been trading small amounts but cannot imagine much volume getting through at any reasonable spread.

This is market dislocation. The Fed can cut rates all they want but it wont help people who are under water whether owners of houses on 100% mortgages or funds with boatloads of credit on their books.

Another wild week beckons so expect more central bank ministrations.

Credit Boom ……..Busts

The credit inspired boom of the last 15 years is now over. Markets are in severe dislocation and whilst underlying economies are very sound there is a serious problem in global banking liquidity.

On the good side we have record low unemployment and company profits are in good shape. But the driver of that has been consumption driven by an expanding money supply which has driven up asset prices and created a wave of paper wealth.

Interest rates have been hiked up to halt this boom. It’s too late. The record low rates in the US over the last 5 years created easy money that was too good to refuse. As rates were jacked up people realised they hadn’t done their sums properly.

Wave after wave of derivative offers, capital guaranteed notes and other “too good to be true” offers have come pouring forth. There is nothing so easy as making money out of money.

But mathematics will always intervene. Compound interest takes no prisoners in its tsunami like advance across personal and corporate balance sheets.

The central banks now have no option but to step in and sort this mess out. The risk of systemic crash is clearly a possibility now, not just in stock markets but banking systems.

Whether markets can recover from here is a moot point. They always do eventually whether its months or years.

If the consumer goes to sleep expect a recession plain and simple. It wont matter where you are or what you do.

The important point is that our financial systems need a serious revamp. The gross expansion of the global money supply, condoned by the global central banks, needs a full inquiry.

Nothing less will do.

The Great Lolly Scramble

For those not in New Zealand a lolly scramble comes at the end of the party when you throw heaps of sweets amongst the children and watch them go beserk. Of course once they have gorged themselves they fall in a heap as the sugar high follows by a big crash.

What we are seeing in the global markets is nothing short of a major fiasco. Banks wont lend to each other so the central banks have flooded the market with cash.

Come and get it they say. This is now starting to get silly.  They were at it again last night as well. When is it going to end?

Goldman Sachs came in with a $3bln bailout for a fund last night as well talking the deal up as a winner. Well of course there will always be distressed sellers in a credit crunch. We’ve seen it here in New Zealand with finance companies going bust with alarming regularity over the last couple of years.

The problem is that we haven’t even started to see the real pain. The real economy is quite strong globally as the spin offs from the asset price boom feeds through in consumption. But how long is that going to last. In New Zealand we are seeing housing activity level off and prices come off the top. Today we saw weak retail sales.

What I observe here is that many properties remain unsold as people will not take lower prices. This is not reflected in the data. Many properties are withdrawn unsold or just sit around in the hope some mug will pay up for them.

So at the moment we are in the distressed phase of the market sell down. People who have to sell must sell and we are starting to see that. The question is whether it slowly spirals out in the main market. We are clearly at a turning point in the economic cycle. Years of asset price increases, consumption driven higher on the back of that wealth effect, central banks with no control over the money supply, late to raise rates, now hammering rates rises home as prices peak, people locked in at high prices and high rates, wages and labour very tight………it’s a recipe for recession.

This is why the central bankers are still talking tough on inflation. They don’t want to start talking in worrying terms in case they “cause” a slowdown.

So expect the lolly scramble to continue.

But there will be a price to pay afterwards.

Currency Intervention: Kiwis don’t fly

On June 11th the RBNZ intervened in the NZ$ by selling NZ$ around the US$0.7660 level in thin markets. This was followed up by another bout or two resulting in short term sell offs to US$0.76.

This action has create a fair bit of comment most of it apoplectic in nature focusing on the poor NZ central bank against the might of global speculators. The commentary uniformly blasted the RB and trotted out the story of how George Soros buried the Bank of England back in 1992.

Well this is one time i can say “i was there” as i was actually trading Stg at the time, with the regular trader lying on a beach in the Carribean. It was a crazy time to be in the markets but when you were the focal point of action that feeling was magnified. The Bank of England phone line was running hot as we called up to sell more and more Stg. The voice on the other end of the phone was resigned to the ship going down.

It duly did. The next day i had my biggest one day loss in 12 years of trading as the market all but disappeared and every customer was looking to trade. I remember my broker took me out to dinner at the casino in Park Lane to recover. Nice.

But the main point of this story is that Stg was way overvalued and stuck in the ERM where it was required under the Maastricht Treaty to keep the Pound above a certain level which was DM2.7780.

So the Old Lady was just doing her job. She wasn’t taking on Soros or the market but just fulfilling legal obligations. Soros made a bet that the UK would have to pull out of the ERM and that was a political action and you can be sure he would have done his homework there.

So it is very different to what we see when the BOJ intervenes in the Yen at 100 or 145 where there is no legal cap but an extreme extension in rates.

The RBNZ action falls into this camp. The NZ$ is appreciating well beyond fundamentals based on the current account deficit, PPP comparisons and problems for the export sector to sell its goods. It is also suffering from carry trade side effects which are causing a huge inflow of short term investment to take advantage of high interest rates.

Its intervention is justified on those grounds. The NZ$ should be trading around US$0.60 which is just above its long term average. Of course currency rates can run way beyond what might be considered justifiable and for some period of time.

The Great Game continues in the global financial markets where the US sells it paper to trading nations such as Japan and now China in return for goods. One day this game may stop and the US$ will go into freefall.

The same could happen to the NZ$. I would say the RBNZ intervention is justified though how effective it is remains to be seen. Jeff Gamlin at the NBR is quite positive on the profit implications and it’s certainly a good long term trade to buy some foreign reserves. They should be selling as much Kiwi as possible!

As it happens intervention usually works if the intervening bank has some justification. Remember currency speculators like to make money. They don’t care whether it’s up or down.

The RBNZ is in a tight spot regardless of what Grant Spencer, the Deputy Governor , says. They will need a bit of luck to get this right and will need to continue intervening if required at higher levels like 78 and 80. I think though they will be safe there as people are starting to feel the pinch of higher rates.

Also yesterday the Japanese Minister of Finance weighed into the fray with some well placed comments. The Japanese are the experts in intervention and jawboning the currency. That shot across the bows should not be ignored.