Even though the Federal Open Market Committee lowered interest rates by 75 to 100 basis points to a range of zero percent to 25 basis points at their December 16th meeting, it may not be enough to quickly revive the U.S. economy. It now appears that more stimulus other than just zero short term interest rates is needed. As early as last December some analysts were thinking that the Federal Reserve would soon start buying Treasury issues directly from the Treasury Department in order to keep long term interest rates low. This feeling remained when the Federal Open Market Committee mentioned the possibility of this in their statement following their meeting on January 28th. Within their statement they said “The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.”
There was some disappointment when the Federal Reserve recently indicated that they are not going to start a program of purchasing Treasuries in the very near future. However, on March 5th the Bank of England’s Monetary Policy Committee announced they are initiating a program of quantitative easing by purchasing 75 billion pounds of mostly public sector debt over the next three months. Since coordinated policy actions among the Group of Seven (G-7) nation’s central banks are in vogue now, it is more likely that the Federal Reserve will establish a similar quantitative easing (QE) program in the U.S. in the near future.
Our analysis suggests that there will be additional banking industry related problems in the U.S. and overseas to be revealed later this year. The uncertainties within the financial services industry are not just a domestic problem. Several weeks ago the Royal Bank of Scotland announced the largest losses in U.K. corporate history. More recently Moody’s Investors Service said it could downgrade some of the banks that have large holdings in eastern Europe. Currently, monetary authorities in Germany are working on plans that would allow the government to nationalize the troubled lenders.
While the additional accommodation from the Federal Reserve and other major central banks is well intended, it appears to be too little and too late. It is amazing that it was only a few short months ago that financial markets analysts were almost unanimously predicting tighter credit policies from the world’s central banks because of the relatively high prices for commodities. Currently there is a fear that inflation will soon run rampant due to prospects of massive government spending. Our research suggests that just the opposite will occur, at least in the short run. As the global economy continues to remain in question commodity prices will drop, which makes the need for an extremely accommodative Federal Reserve more apparent. The myriad of stimulus packages, bailout plans and “bad bank” proposals, at least in the short run, will not be sufficient to offset the destruction of wealth that has taken place as a result of the subprime mortgage related crisis.
The main bearish factor for this market is the issue of too much supply. Last week’s Treasury auctions, though fairly well received, were a record amount. Currently there are worries that upcoming Treasury offerings will also total record amounts, as well. I have received many questions lately pertaining to upside price objectives for the interest rate futures. My analysis tends to focus on timing objectives rather than on price objectives when a major market move is taking place. Expect this bull market to continue over the next three months or so with a potential top late in the second quarter of this year. Once our timing objective has been met, whatever the level of Treasury futures is at that particular time, will be the upside price objective. Continue to trade from the long side, especially at the short end of the curve, as the pressure on the Federal Reserve intensifies to maintain an ultra low interest rate environment.
If you would like more information or have a question about this article, please contact Alan at 1.800.243.2649 or email at alan.bush@archerfinancials.com.
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