Busch: Arresting Developments
The weekend was extremely busy in the world of finance. Starting in South Korea, this nation cut its overnight interest rates by 75 basis points to 4.25%. Genuflecting at the altar of low rates/high liquidity, the Bank of Korea cut rates for the 2nd time this month and by the most ever in one move as the country is experiencing drastically lower growth (0.6% GDP) and a shut off of lending to smaller firms.
They also announced an increase in the amount of money available to lend to small companies from KRW 2.5 trillion to KRW 9 trillion. More rate cuts are likely at the next BOK meeting on November 7th.
Next up, we had the G7 issue an unusual announcement on Sunday. "We reaffirm our shared interest in a strong and stable international financial system. We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability.
We continue to monitor markets closely, and cooperate as appropriate." Normally, a direct statement on a specific currency would cause a major spasm of activity in the foreign exchange markets in the direction that the G7 wanted. This happened as the markets sold yen and bought US dollars...but it didn't last long.
This certainly is a tact I have recommended to the US Treasury. Why? We're in the midst of an unvirtuous cycle that goes like this: hedge funds have used the yen carry trade as not only an investment strategy, but also a method of cheap funding for investments in equities. As equities head lower, this means they have to sell their positions. Also as equities head lower, this means they are forced to sell profitable positions as well like yen carry. As redemptions requests rise, this puts more pressure to sell both equity positions and yen carry. Thus the cycle gets reinforced. If you can arrest or stabilize one of these, then you can get the other to potentially stabilize as well. Since the US Treasury and Federal Reserve can't directly intervene in the equity markets, direct intervention in the currency markets appears to be a viable alternative.
Where the Dynamic Duo of Tsy and Fed can act is where they are already acting: in the US money markets. Today, we get the start up of the Fed's commercial paper program where they are making loans to American corporations to ensure companies have access to short term funding. From Morgan Stanley to FordMotor Credit, companies have signed up to sell debt that will carry rates between 2-4%. (Asset backed paper will be 300 bp on top of OIS and unsecured CP will pay 200 bp on top of OIS.)
The program can buy up to $1.3 trillion worth of the paper. This is expected to have a spill-over effect of encouraging money market managers to purchase CP as well and help thaw this area of the lending markets. As I wrote last week, the volume of CP has dropped around 20% from a combo of uncertainty over the crisis and over the announcement of this program. Let's see what these numbers look like in a week.
One other area of assistance by the US Treasury is the direct capital injection program. The first batch went out in a chunk of $125 billion and banks have until November 14th to apply for the other $125 billion. From Interim Assistant Secretary for Financial Stability Neel Kashkari testimony to the Senate, check out the list of aid they are working on .
Lastly, did anyone notice existing home sales went up last week? The massive 7.7% increase to 5.18 mio helped reduced the monthly inventory of unsold homes from 10.6 to 9.9. This is exactly what I was predicting back in March of this year. Also, today we had new home sales increase 2.7% in a surprise move. Inventories of unsold new homes dropped from 11.4 mths to 10.4 mths. Low prices have started to generate sales and this is very good news. The problem is that we need to see about 6-7 months of 7.7% increases to reduce the inventories down to levels where prices should stabilize. We have begun the process, it's a question of how long it takes...and this is true for all of the above.