C.M.O. 3.20.2009

Credit Market Overview
March 20, 2009

There were some dramatic reactions to the Fed announcement of its planned purchase of treasuries and additional assets in mortgage backed securities. The bond market reacted immediately with the 30yr Bond contract settling up 5 2/32 on the day on Wednesday after establishing an 8 27/32 range for the day. To put this perspective the Bond contract’s range on March 18th eclipsed all of the price action going back to January 22nd. The stock market had a good day too albeit achieving a smaller net gain within a smaller daily range.

Moving outside these two markets Gold reversed a down move that had peaked on 2/20/2009 and looked set to close lower than all prices since that date before the Fed’s announcement. Afterwards it did a 180 and made a $64 move higher before settling ~$40 higher on the day. The U.S. Dollar, as measured by the DXY contract lost ~2.30 within a half hour of the announcement and traded as low as 82.63 or ~3.85 lower by 11:30 yesterday morning.

The price of a barrel of oil also moved higher as a result of the Fed’s action on Wednesday. Having made its lows for the session around 11:30 that morning (similar to the Dollar) and closed at its highs for the day afterwards. It, like the Dollar and Gold continued their moves yesterday as the market digested the Fed’s actions.

The interesting question here is what is the market digesting? The final round of G-20 talks occurs this weekend with all of the big machers heading to London. In the first two episodes of this mini-drama 3rd level and then 2nd level potentates met so that there would be no surprises when the big guns showed up. The U.S. has been pushing for globally coordinated round of stimulus while the Eurozoners have wanted to shift the effort towards increasing financial regulation.

Does the Fed’s action on Wednesday show that the U.S. is ready to put their money (literally) where there mouth is and inject liquidity into the system at all costs? Does the U.S. think this will help persuade the other nations to take complimentary actions?

It could be argued that the U.S. has the most at stake as the single super power left with more of its debt held by foreign nations than any other country and its currency considered the world’s reserve exchange mechanism. There are those too that see the current crisis as one stamped “Made in U.S.A.” on the bottom and as such expect Uncle Sam to clean up his own mess. Given the interconnectedness of the World economy, can this still be considered a rational approach?

The other question to be asked regarding Ben’s move on Wednesday is whether it will produce confidence that we are on the road to recovery or, like the drowning man, are we simply acting out of desperation? How this is seen is important here at home but isn’t it equally if not more important to consider how it will be viewed by the World whose nations represent our investors and trading partners?

The other set of questions that need to be considered are those of inflation expectation. Last year oil traded up to $147bbl and the media was howling that the government was focusing on the ex-food and energy component of CPI when the 95% of the people the President is redistributing wealth to spend a disproportionate amount of their income on filling up the car and putting food on the table. Will the Fed’s move on Wednesday bring back last year’s weak dollar strong oil environment? If so, is this what an economy struggling to its feet really needs?

Inflation also plays into the current budget projections. Without getting into whether Christina Romer’s projections for a 23% increase in U.S. economic output over the next 4 years is too optimistic when the compared to the 17% increase projected from the summary of private economists that make up the Blue Chip Consensus. Inflation, should it rear its ugly head in a meaningful way, could change the current budget projection for 70% of the 23% coming from real growth while 30% is the result of inflation.

A decrease in purchasing power brought on by inflation will help erase the massive debt load this country now carries and is projected to carry more of, but will it help the work-a-day folks that have dutifully paid their mortgages while they watched their retirement accounts lose 40% of their value?

This crisis, from its genesis in reduced lending standards by FNM and FRE, has produced a long line of unintended consequences. Most of these have come from the people we have entrusted not asking a simple question: What if?

Let us all cross our fingers and hope beyond hope that someone somewhere is asking that question now.

Enjoy the weekend.

Jim Delaney