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Wednesday,
September 12, 2007
Chart Presentation:
To Ease or Not to Ease
According to Goldman Sachs
on Monday the odds of a 50 basis point reduction in the Fed funds
rate next week were 97%. Following the October Fed meeting the odds
were 99% that the funds rate would either be at 4.75% or 4.50%. In
other words... the powers that be in the investment banking business
are fairly confident that the Fed is ready and prepared to come to
the aid of American home owners who, for one reason or another,
purchased one or more properties that they evidently couldn’t
afford.
A cynic, of course, might argue that this has more to do
with supporting hedge fund returns and year-end investment banking
bonuses for those who likely will never be in the position of
defaulting on a mortgage... which brings to mind a line recently
used by BMO Financial Group’s Don Coxe that ‘Capitalism without
punishment is like religion without Hell’. At right is a comparison
between platinum futures, gold futures, gasoline futures, and crude
oil futures.
Each of these commodities
reached price peaks in 2006 and each has taken a hard run at the
highs during 2007. We mentioned in passing recently that we wouldn’t
be surprised if gold futures jumped back to the 720 level just to
make things interesting. Platinum took three good
runs at the 2006 highs during the year only to fail on each occasion
and earlier this year gasoline futures used the summer driving
season and the never ending spate of unplanned maintenance shutdowns
by refineries to lever back to just under 2.50. Now we find crude
oil futures hammering at the highs even as OPEC members bicker about
whether it makes sense to actually sell more oil at a higher price.
We wish we had that problem.
In the spirit of the old
line that it is a slow down if your neighbor is laid off, a
recession when you become unemployed, and a depression when your
spouse loses his or her job... we wonder whether the fervency with
which Wall Street is arguing for easier credit conditions has to do
with the fact that the problems are much closer to home this time
around. The intriguing thing about the chart comparison at right is
that energy and metals prices- which typically are the key driver
behind the trend for short-term interest rates- are currently lined
up in a most threatening manner.
Consider the Fed’s dilemma with regard to monetary policy if saving
the banks, brokers, and hedge fund gazillionaires provides the spark
that sends these major commodities to new highs next week.
Equity/Bond Markets
The chart at right compares
the stock price of Bear Stearns (BSC) with that of Japan’s
Mitsubishi UFJ (MTU).
The Nikkei began to under perform the
SPX in the spring of 2006 while MTU’s stock price turned lower.
Both trends are consistent with an underlying trend that favors
lower long-term interest rates.We mention this because apparently the
momentum traders in the U.S. markets failed to get the memo as
they ramped the banks and brokers higher and higher. The chart
argues, however, that the trend for BSC turned negative early in
2006 so all of the recent drama was little more than a stock and
sector coming back ‘on trend’.
It wasn’t the end of the world or
the beginning of never ending darkness so now that the dust has
cleared somewhat we can see that both MTU and BSC are back at
2005 price levels. MTU just did it in a much more orderly
fashion and without the accompanying UTube hysterics.Our sense is that the negative trend for
the banks has more to do with flat or inverted yield spreads
than it does with subprime mortgages although ultimately it is
likely a chicken and the egg problem.
The trend turned negative in early 2006
when Japanese short-term interest rates began to rise. The chart
below shows that 3-month euroyen futures declined over that time
to reflect an increase in short-term Japanese yields from
roughly .1% to .9%. That wouldn’t have been a problem, of
course, if long-term yields were actually rising but now with
10-year Japanese yields at 1.53% it is little wonder that things
are currently difficult- profit-wise- for Japan’s major banks.
So... this leads us to the chart below
right of BSC and heating oil futures. The simple explanation is
that rising energy prices applied upward pressure on short-term
interest rates which, in turn, helped flatten the yield curve
and ultimately bomb the banks and brokers. Another view might be
that the banks and brokers were soaring so far off trend into
the end of 2006 that something had to happen somewhere within
the markets to bust the bubble and bring prices back to earth.
Ultimately the markets are still going to have to figure out
some way to widen the yield spread.
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Kevin Klombies is a prolific writer and market
analyst. He graduated in 1980 from the
University of Saskatchewan with a Bachelor of
Commerce degree (Honours) in Finance/Economics.
Click here for
full bio >>
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