The Obama 'Honeymoon'/The King Speaks

When the stock market was tumbling towards the end of November last year, there was concern that the Dow Jones Industrials would break its long term support line stretching back to 1990. After a respite lasting barely two months, we are now in danger of re-testing that support line, as financials continue their long slide. It is tempting to view this simply through the prism of relentless losses being announced by banks. But the underlying cause is a failure of the FOMC to get ahead of the curve, and their continuing prevarication over quantitative easing (QE). As we warned last Wednesday, Mr Bernanke missed a major opportunity when he spoke in London last week. Only the announcement of aggressive and immediate buying of Treasuries can give us any hope of averting a significant unravelling of the 1990’s bull market.

Prevarication is the correct label for the Bank of England too. Mervyn King’s elaboration of QE last night contained a number of critical misapprehensions, and there was no sense of urgency either. With stock markets threatening to lurch down, it is not good enough to suggest that “at some point, the MPC might wish to adopt these unconventional measures as an instrument of policy”. Unemployment is accelerating upwards and corporate borrowing costs remain close to record highs. The BoE should be buying gilts now, and not just focusing on high quality corporate bonds.

Time For The Fed To Deliver

It is no exaggeration to say that this week’s FOMC meeting is the most important since April1932. The scale of the recent economic decline has been worrying, but unsurprising.Notwithstanding Friday’s small rise in core retail sales, consumer spending has plummetedsince the summer. Last week’s claims data suggests that November’s drop in payrolls may beeclipsed by even bigger losses in the coming months. The decline in mortgage rates has givenloan demand a lift. But the increase is unlikely to be enough to stop delinquency rates and foreclosures from climbing again. So much more needs to be done, particularly with corporate borrowing costs continuing to ratchet higher. The spectre of a General Motors default is hardlyhelping. Higher corporate bond yields mean more layoffs, more foreclosures and bigger houseprice declines. Offering to buy GSEs has not broken the vicious cycle. Unequivocally, theFOMC must announce true quantitative easing, namely an explicit policy to buy longer datedTreasuries. If it does not and merely cuts theFed funds rate to 0.5%, the bear market rallyin equities will dissipate by early next year.And 2009 will be more difficult than even 2008. It is time for the Fed to deliver.

TARP U-Turn/Euroland's Recession

Stock markets are flirting with new lows, and this morning’s GDP data reinforces the view thatEuroland has been in recession since April. The German GDP report was ‘worse than expected’ and yet the full impact of the recent slump in new orders will not be felt until Q4. The Bankof England recognised the risks of a sharp contraction in GDP in its latest inflation bulletin,but along with the government, it expects a strong rebound. That is not going to be possiblewith such a muddled US monetary policy and a tardy response from the ECB. The decision notto use some of the US$700bn TARP to buy MBS may well make sense. The priority for the USshould be a monetary policy that slows the rise in foreclosures. However, the U-Turn is notgoing to bring about the desired policy shift. Instead, the money will be used for bank recapitalisations, and that will not succeed either. That stock markets look set to hit new lows is recognition of the flaw in this strategy. In theUK, the MPC may cut aggressively down tozero. But the international backdrop couldyet swamp the benefits of such an aggressiveand welcome response.

Change? Unlikely ....

Change We Need was the popular slogan of the Obama campaign, and while it would be churlish to ignore the wider political significance of yesterday’s election, there is a harsh reality.Unless the Democrats execute a major policy U-turn, there will be no change. A more expansionary fiscal policy, courtesy of a stronger grip on Congress, will not solve the crisis. It maymake it worse. Paul Volcker is tipped by some to be the new Treasury Secretary, but that tooprovides real cause for concern. It is more of the same, ensuring that the US will slide towardsa debt trap. Other candidates in the frame, including Lawrence Summers, offer little encouragement. Democrat policies to date have been contributing to the rise in mortgage rates, whichhas culminated in a plunge in mortgage demand. The point was underlined this morning bythe steep decline in the MBA’s purchase index to just 260.9, its lowest level since early January2001. There is no chance of stabilising thehousing market in 2009. Unemployment willsoar. Choosing Volcker or Summers as thenew Treasury Secretary will be a mistake. Inthe absence of a radical shift in monetary policy, Obama will not be the next Roosevelt.

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