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Friday, December 12, 2008

Some rumblings on next FOMC Meeting Tuesday, 16 Dec 2008

Sometimes, it takes a while before "the obvious" becomes "obvious" and stares at you right in the face.

I don't know why I didn't see this earlier. Perhaps when one's mind is distracted, it is too easy to miss this reasoning.

I came across this article by Kathy Lien a couple of days ago - http://www.kathylien.com/site/federal-reserve/what-zero-yield-in-treasury-bills-signals-for-currencies. The interesting chart is this below:

Note that Fed fund futures are now pricing in a 98 percent chance that the Federal Reserve will cut interest rates by 75bp to 0.25 percent on December 16th:

98% chance! Fed rates cut to just 0.25%! And it seemed today, the same Fed Fund Futures are now pricing in 100% probability of a 75bp cut!

And then, there is the negative/zero yield on the 4 week US treasuries bills, and the 3 month US treasury bills which looks set to head to zero also soon ... Again, it should not be a surprise since markets are now "certain" that the Fed funds rate will be dropped by 75 bp. Fed funds rate drops, yields on US Treasury Bills and other instruments drop. Whilst it is tempting to short longer term US government bonds today since it's near historical high, the possibility of rates continue to drop next week could mean that what looks expensive today (the price of longer term bonds are inversely related to yields), can become even more expensive tomorrow.

And with interest rates at all durations look set to drop, it is no surprise that we could finally be seeing downward pressure on USD currency, quite possibly soon ... the USD has been on a fantastic bull run in the last 4 to 5 qmonths quite possibly "without wings" and recently, I've seen USD currency charts looking set to test 50 day Moving Averages and this is generally considered to be a critical signal. The immediate question is could next Tuesday's announcement be that catalyst that will confirm the start of the USD downfall? (obviously, it's never this obvious)

The impact on US stock markets is now "obvious" in hindsight. Lower rates, lower cost of doing business, generally regarded as a good thing for US stock markets. In fact, we've just seen S&P 500 rising well above 20% since the last bottom on 21 November 2008, technically, qualifying US markets to be in a bull run (due to the more than 20% gain in the index, just like a more than 20% fall in markets being declared to be a Bear market). Again, the general impression is that the real US and global economy is still in a rut, i.e. this bull market - like the USD - appears to be flying without wings too ... Again, the immediate question is - will next Tuesday's Fed announcement be the catalyst that would trigger profit taking, or even well before that? In other words, is what we are seeing an anticipation of 100% probability of a 75 bp rate cut, and when this becomes fact, will markets then correct itself like what it did with the most recent rate cut?

Global banks have been coordinating their rate cuts recently, and it seems a few countries have been actively cutting interest rates:

http://business.theglobeandmail.com/servlet/story/RTGAM.20081209.wrates1209/BNStory/Business - Bank of Canada Bank slashed its benchmark rate by three quarters of a percentage point to 1.5 per cent, a level not seen in Canada since 1958.

http://business.theglobeandmail.com/servlet/story/RTGAM.20081211.wswissrates1211/BNStory/Business/home - The Swiss National Bank slashed interest rates by half a percentage point on Thursday, the SNB cut its target band for the 3-month Swiss franc LIBOR for a fourth time within two months to 0.00-1.00 per cent.

http://business.theglobeandmail.com/servlet/story/RTGAM.20081211.wtaiwanrates1211/BNStory/Business - Taiwan cuts rates by most in 26 years

http://business.theglobeandmail.com/servlet/story/RTGAM.20081211.wkorearates1211/BNStory/Business - South Korea's central bank carried out its biggest interest rate cut ever Thursday, slashing borrowing costs by a full percentage point to a record low in a bid to stave off recession. The benchmark seven-day repurchase rate is now 3 per cent from 4 per cent.

And a nice picture showing various Central Bank key rates for this decade - all pointing south and in many instances, doesn't appear to have more room to go south further ...

So, bottom line - what does all this means to US stock markets and our own backyard KLCI? To me, definitely critical to monitor the US markets to see how it reacts to Fed's announcement this Tuesday. The past 2 Fed announcements was widely anticipated, and the beneficial effect on markets was getting shorter and shorter to the extent that the last announcement actually caused markets to fall on / just before the announcement day ... If markets continue to run after this Tuesday's announcement, other things equal, consider the possibility that we may be seeing another critical divergent signal that perhaps the bear market could be over ... However, if it doesn't, and if it tanks, then, we definitely need to see more divergent signals than what we are already seen so far from monitoring various stock markets around the world, VIX, bond spreads, commodity markets, shipping rates, copper prices, etc., before we can conclusively say the bull is truly around the corner ...

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