Busch: Bank Actions Will Help—After Q4

On the opening of New York trading, central banks from 6 major countries cut interest rates by 50 basis points, with Japan and Norway not participating.

Here are the banks and the rates:

  • U.S. Federal Reserve cut the Fed Funds rate from 2.0% to 1.5% and the discount rate to 1.75% from 2.25%
  • The European Central Bank cut overnight rates from 4.25% to 3.75%
  • The Swiss National Bank cut overnight target to Libor from 2.5%-3.5% to 2.0%-3.0%
  • The Bank of England cut overnight rates from 5.0% to 4.5%
  • The Bank of Canada cut overnight rates from 3.0% to 2.5%
  • The Swedish Riksbank cut overnight rates from 4.75% to 4.25%
  • The Peoples Bank of China cut rates 27 basis points on 1 year depo rates and dropped reserve requirements to 17% from 17.5%.

Here are the key lines from the Fed's statement:

"Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation."

This is another piece of the puzzle to stabilize the financial markets. I believe these central banks acted in concert to address the continued deterioration in lending and the further tightening of credit.

Prior to the announcement, there was massive deleveraging out of yen carry with one cross down 17.5% in 48 hours. Prior to the announcement, the Nikkei was down 9.38% today. Prior to the announcement, 3 month Libor to OIS spreads were 10-20 points higher from yesterday. Prior to the announcement, the TED spread was at a new high of 391.5.

This meant that there was no current, positive movement on credit from either the announced passing of the TARP program nor the Fed agreeing to buy commercial paper. Thus, action was required to stem the tide until these plans get up and running and making an impact.

The markets are in the process of significantly downshifting their outlook on economic growth and earnings. From Alcoa to SAP, companies are warning that the future is bleak due to the lack of credit and therefore dramatically reduced vendor financing. Economists are forecasting U.S. GDP to drop in Q4, Q1, and maybe be flat for Q2. Unemployment is expected to soar from 6.1% to as high as 8.0% by the end of 2009.

  • The Pros and Cons of Rate Cuts
  • Farrell: Market in a Bottoming Process
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  • Risk and You: What You Need to Know
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  • This adjustment is all occurring now and the markets have been simply brutal. I expect the direction we've taken over the last weeks to remain intense until the end of October and into November, as the frozen credit markets' negative impact show up in the economic data released in this time frame. My view is that the volatility and uncertainty are far from over and will persist well into Q4. At the minimum, we'll need a month of CP and TARP [troubled asset relief program] buying and lower rates to arrest the fall.

    As I suggested, TARP was only the beginning. Additional measures could be direct investments into U.S. banks to recapitalize them and expansion of assistance programs to consumers. Think 1930s-style programs and you'll be closer to what is possible. A new U.S. Presidential administration/Congress will be very active to expand these type of plans. All will help, all will take time.



    Andrew Busch

    Andrew B. Busch here