Trader’s Narrative

Speaking of monetary policy, I thought it would be interesting to look at the global central banks. Here is a chart for six of them for the past 10 years: European Central Bank (ECB), Bank of Canada, US Fed, Reserve Bank of Australia, Riksbank (Sweden), and the Bank of England (EDIT: after a request I added Japan).

Not surprisingly, they more or less move in synch with each other. Sometimes even cutting rates in quick succession to catch up with the leader. The outlier in this group is Australia. Not only did they take their rate higher than others, they also haven’t lowered it to match the others. But in the previous easing cycle (2001) they only came down to 4.25% also.

The Fed was the first central bank to lower key interest rates. The next was the Bank of Canada. The slowest among the 6 in the chart is the European Central Bank and Australia. These laggards have tried to make up for their mistake by making some incredibly deep cuts recently. I’m especially surprised by the 0.75 cut from the ECB.

The Bank of Canada will most probably deliver a 50 basis point rate cut when they meet next week, on December 9th.

Considering the swiftness of rate cuts, their global coordination, as well as their level in comparison to previous easing cycles, we are probably close to the end of the easing cycle. But, and I hate to say this, if this time is different, then who knows if history is any kind of a guide.

At this point, it is tempting to throw out all historical templates because they have done a monumentally poor job so far. While keeping in mind the danger of thinking that “this time it is different”, we are seeing signs that the world is undergoing a dramatic downturn in economic activity.

Just today, data was released showing the largest one month increase in unemployment in the US since the 1970’s - taking the unemployment rate to 6.7%. Add to that a swan dive in consumer confidence, an implosion in Detroit, melting real estate, etc.

It is safe to say that the central banks will continue to prioritize economic growth over inflation for the moment. Especially since we may very well experience a bout of deflation.

Last Friday when I found myself agreeing with Jim Cramer, I felt very uncomfortable for obvious reasons. But it seems that the central banks around the world, including the Federal Reserve are now on the same page.

It is all over the news that today and yesterday that the European central bank injected billions of euros into the banking system. The same was done on this side of the Atlantic with both the Fed and the Canadian central bank. Here’s the statement:

OTTAWA – In light of current market conditions, the Bank of Canada would like to assure financial market participants and the public that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of financial markets.

These activities are part of the Bank’s normal operational duties relating to the stability and efficient function of Canada’s financial system. The Bank is closely monitoring developments, and will deal with issues as they arise.

The same went for Australia, Japan, Korea and other major markets. But the reason why international markets had to move was that the Fed was slow off the mark (just as Cramer schreeched).

Paging Helicopter Ben
Had the Fed acted last week, things would have been much more contained. Again, I’m not calling for an interest rate reduction. That would be a blunt instrument for this type of situation. And in fact it could trigger a panic if it is interpreted the wrong way (like Bear Stearns’ statement). But increasing liquidity, as the central banks around the world have done, is the right way to go.

It is lamentable that they didn’t take action earlier. This isn’t about rescuing fat investment banks or hedge funds, it is about ensuring the stability of the financial system. When banks are timid to borrow from each other, when trust starts to evaporate, that’s when things can fray at the edges.

By not acting fast enough, what happened was that the overnight lending rate actually shot higher than the benchmark rate. This kind of move is so extreme because you have to understand that the short term rates were significantly below the benchmark rates set by the Fed. So in essence we had a pseudo tightening of the Fed funds rate. Definitely the opposite of what the market has needed for a while and most definitely not what it needs in this stressful times.

Contrarian Comedic Insights
On the plus side, usually when things trickle down to the general media and the public, the move is almost unwound. Take for example these two videos from Comedy Central. In the first Cramer tries to explain his on camera meltdown:

In this one, the sub-prime market is explained in rather, shall we say, simple terms… to comedic effect:

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