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The eye in the storm, of a perfect storm.

Posted by Adrian on April 30, 2008

The question, in which the so called optimists commentators are making, is the worst over in the financial markets?

I remember four years back when the optimists were saying that there isn’t going to be a slow down, that the US housing market will be ok and consumer sentiment will remain high (ad infinitum). That growth will be steady and constant or the global economy will slow to a nice gradual pace. It was a handful of commentators that saw some worrying signals, they are: Nouriel Roubini, Marc Faber, Paul Grugman, Paul Kasriel, Robert Schiller and others that offered an realistic viewpoint to an unrealistic expansion in global economies; in which a housing market in the US that was so inflated a crash was inevitable, then a contraction would occur in the credit markets, with widespread deleveraging to follow. Hence the credit crisis we have today. Now as I mentioned the optimist have reemerged (in fact they should concede to defeat and except reality of the markets) claiming the credit crisis is finishing or finished. The optimists, on the back of a very unstable Federal Reserve policy of massive amounts of liquidity being pumped into the financial system, hope that a steady return to credit valuations and security trading will return to normal market conditions (‘normal’ being a paradoxical assessment of free markets).

When I first started trading in the markets, I learnt about volatility. Although at the time in early 2000, the markets will far calmer to what they are now. Credit expansion had begun in earnest, when the Fed fund rate was chopped down to 1.0% by Greenspan on June 25th 2003. The bull run in global markets ensured, stocks and bonds rallied. Even betting on the EUR against the JPY (with a high leverage) would give a good return. But with the collapse of the credit markets, onset by the collapse of the subprime mortgage market. Volatility hit hard, the Federal Reserve under Ben Bernanke slashed rates (from 4.75% in 2007 to the current 2.25%) and went bonkers with liquidity injections – most likely bailing out a few US banks (apart from the Bear Stearns) that were on the brink of insolvency. The worlds central banks either tightened in small increments or got the timing somewhat wrong and have tightened in dangerous financial environments (retail banks tightening their lending and increasing interest rates on loans). So central banks that did have a tightening bias started to cut interest rates, note Bank of Canada from July 10th 2007 key interest rate at 4.50% now (22nd April 2008 ) 3.00%.

Soon the Australian and most likely New Zealand reserve banks will cut rates, rather than increase them. Recently economist Stephen Roach recommended that China should increase it’s interest rate by 1.00%. In respect to fighting inflation in China and protecting the yuan, rather than be concerned about economic slow downs. Rate cutting to help prop up slowing economies has been at the expense of inflation, in which has increased the chances that he global economy will enter into a simultaneous stagflation recession.

Every country is facing high inflation, oil, food (rice, flour), rental and utilities; with property and stock market prices collapsing.

The Federal Reserve with it’s chairman Ben Bernanke will cut rates another 0.25% this week. If the Fed decided to hold their rate cutting policy (after the 25 point cut – which will bring the Fed rate to 2.00%) we will not see a dramatic drop in commodity prices.

If there is a perfect storm of collapsing asset markets, with inflation that is out of control. It is a synchronized storm that has hit on a global scale and there could be small eye of the storm we are now residing in.

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