Monday, December 1, 2008

A day of blitz

EVENTS buffet markets as stocks drop nearly 680 points
It may have been more than markets could digest.

  • The MFG ISM drops to its eleventh lowest level since 1950.
  • The NBER finally does call it a recession and says it began in December 2007. So we have just found out its a recession and already its long - 13 months.
  • Bernanke spoke and said the economic weakness would not go away soon...
Speech, Speech!
The Fed Chairman in his speech talked of all the measures the Fed has implemented and said the Fed could buy long term bonds to try and reduce long terms rates. On this news- something that has been mentioned in the past - the bond market went nuts and drove 10-Yr note prices up by about 1 1/2 points and the 10-Yr yield down to 2.7%.

Operation TWIST
Bernanke's suggestion has been mentioned before but having the Fed Chairman say this in a speech gives it more credence. Also Bernanke has had a habit of doing some unusual things. But within the economics profession, this is not a tact that is well respected. In the early 1960s the Government tried to do something to impact long term rates and change the shape the yield curve. The attempt was called Operation Twist. It failed. In fact it failed miserably. It produced the exact opposite result from the one desired. So among economists the idea of messing with the yield curve is not something that is well regarded.

Operation Twist and Shout
So the Fed Chairman sort of alluded to this past discredited operation and in response markets drove bond prices up sharply. Well, there's a twist- so to speak. People in markets know you buy the rumor and sell the fact. In that same vein this was a successful 'open mouth' policy by the Chairman. But statistical results, even from those studies that say there is some scope for policy to affect the curve, do not leave room for hope that the Fed can use the policy to affect rates by much. Still we have the bond market rally... Of course it may not have been the impact of those remarks as much stocks falling nearly 700 points in one day.

Before the US MFG ISM was reported out, a highly similar e-Zone measure showed a sharp drop. Over the past year the EMU drop has been more severe than the drop in the US and most of that is the pace of the decline in just the past few months. Europeans are still stunned at the onset of weakness. Just today German Chancellor Merkel was talking disdainfully about other countries being in the competition for having the largest stimulus plan. The ECB and Germans in particular have been wrong. The ECB was worried about inflation far too long even with the strong euro. The Germans simply have been in denial about the weakness their economy is suffering. Those that thought China would be spared- were dead wrong. China is an exporting economy! How could severe weakness in its key export markets not hurt it? Goldman had an investment strategy based on the notion of buying US firms with weighted international sales on just this same idea that foreign growth would not slow as much. The strategy was pulled only relatively recently. Yes, even the best of the best of the best got it wrong. We are all connected. Trade has expanded greatly. Capital flows are an international staple of existence. Economies need it the same way that bodies need calories. Connectedness has its costs and tighter linkages is one of them.

1 comment:


Market always decline more sharply than they rise.