Stock Markets Soar as Fed ZIRP Makes Money Free

By: PaddyPowerTrader

So ZIRP(idée doo dah) as the Fed heads into uncharted waters by cutting rates by ¾% to only 0.25%. They will now buy Treasuries (i.e. quantitative easing) to help. So rates at zero for as long as it takes with the promise that they will buy MBS, ABS, GSE paper and any old iron if it helps counter this historic deflationary depression. Sanity clause has prevailed and we may not need to start learning Japanese. But more seriously and crucially, confidence has been (temporarily) instilled as ZIRP eases debt burdens, makes financing and refinancing cheaper and hopefully reflates assets prices.

Today's Market Moving Stories

• The downside of the quantitative easing measures the Fed are about to embark upon is that it causes the yield curve to flatten i.e. there is little difference between short and long term interest rates. As banks “traditionally” made money by lending long term and borrowing short term funds, the narrowing of this gap crimps profit margins.
• For more about the US rate cut, see the piece I wrote on quantitative easing yesterday. And for those who did read it, my prediction that Bernanke wouldn't say too much was off. However my suggestions about what they would announce and the impact it would have on the dollar were spot on.
• BoE Governor King admitted yesterday that whilst inflation is currently above target, at some point next year, it will fall below target. So there is nothing stopping the Bank cutting rates further. I think that the Base rate will be cut to 0.5% by the start of Q2 2009. Who would have thought but a few short months ago that Mervyn King would be scribbling his monthly “Dear Darling” letter to the U.K. Chancellor of the Exchequer explaining an inflation undershoot!
• A man sure to enjoy his retirement at his Long Island mansion, Henry Paulson, said yesterday on CNBC that “automakers will get their money as quickly as we can prudently do it”. However, measures that included TARP funds would be temporary bridge loans. He also predicted that no other MAJOR financial institution would fail.
• The Yen has surged to a 13-year high versus the Dollar.

Bank Funding Costs To Go Up Even More?
Very important news from Deutsche Bank this morning that has far reaching consequences for bank funding and the rest of the sector. As we all know, banks issue bonds (IOU's), like governments do. Traditionally these bonds had call options i.e. the right for the bank issuing to repay the debt and refinance. These calls were nearly ALWAYS exercised. So investors PRICED the bond accordingly. Say Deutsche Bank issued a bond in 2004, maturing in 2014, but with a call in 2009. Investors would price it as a 5 year bond rather than a more expensive 10 year issue. But now Deutsche have declined to call this bond in 2009 as they can't refinance economically. So going forward, investors will start pricing callable bonds to maturity rather than to the call date. This will increase funding costs for banks.

Implications Of The Fed Cut For The Muppet Show In The ECB

1. The Fed's bold market friendly move last night again demonstrates that the ECB is miles behind the curve and events. They have been far too slow to lower rates and have been hamstrung by their inept rate hike in July. This move should ignite some hope that they may see the light at their January meeting despite recent rhetoric of a lunatic pause in the rate cutting cycle. They have said they need to wait a while to see the effects of past cuts ebb through. Trouble is lads, we don't have this luxury.
2. With the Euro zooming north against the Dollar and Sterling at a disorderly rate it will impart a further disinflationary pressure on the Eurozone and hurt exports (Germany in particular).
3. The ECB's own staff economic forecasts for 2009 and 2010, although only two weeks old, now look wildly out of date and overly optimistic.
4. Crossing the Rubicon towards quantitative easing will be far harder to achieve for the ECB than the Federal Reserve because of the very different national philosophical approaches the various member states have.
5. Bottom line is that the ECB have shown themselves to be inflexible and utterly unable to act proactively to the unfolding abyss into which we are now starring. Their rear view mirror school of central banking with no contingency planning has met its Waterloo.

Data Today
The Bank of England will be in the spotlight today the release of the December minutes at 09.30. The report is likely to show a unanimous vote for a 100bp cut, with that arch (and sadly outgoing) dove Blanchflower wanting a bolder move. The statement will be analysed for any clues as to how much lower the policy rate can go and as to whether there was any discussion about “non conventional” policy measures, although I expect there wasn't (yet).

UK Labour data is also released at 09.30 and is set to show the ILO unemployment rate at its highest since July 1999. Average earnings growth is expected to be under control.

Equities And Earnings

• The key equity news today will come from former U.S. investment banking powerhouse Morgan Stanley who report at around noon. Bloomberg estimates showing a smallish $244m Q4 loss and $3.6bn profit for the full year. But after the Goldman miss, a bigger loss probably won't come as a shock.
• Nike is estimated to report a profit of 78 cents a share in the fiscal second quarter.
• Honda slashed its full year profit forecast by 62% reflecting plummeting car sales in Europe and the US.
• French banking giant BNP just reported a disappointing €710 mln pretax loss in the first 11 months of the year.
• Mining giant Anglo-American is also showing signs of the global strains, halving its capital expenditure .

And Finally… Some Visual Thoughts On The Auto Bailout

Disclosures = None

By The Mole
PaddyPowerTrader.com

The Mole is a man in the know. I don’t trade for a living, but instead work for a well-known Irish institution, heading a desk that regularly trades over €100 million a day. I aim to provide top quality, up-to-date and relevant market news and data, so that traders can make more informed decisions”.

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