Trader’s Narrative

There is an tsunami about to make landfall on the US economy. But will it be inflation or deflation? On the one hand we have deflation propelled by the crushing of commodity markets: oil, gas, gold, etc… as well as the massive real estate implosion across the globe.

On the other hand, consider all the inflationary agents:

• loose US monetary policy the discount rate (as expected) being lowered to 1%
• a loose fiscal policy (in an assumed Obama Biden administration)
• a $1 trillion financial bailout
• IMF bailouts of countries such as Iceland, Pakistan, etc.
• loose monetary policy for all major central banks of the world

To muddy the waters even more, the US dollar has shot up to 2004 levels. Most would argue that a stronger dollar is deflationary. So amid all these cross currents, what can we expect as the net result? I’m not smart enough to wade through all the econometric data so I’ll let the market do that for me.

To get an idea of what the market thinks inflation will be we can look at the difference between the 10 year nominal treasury bonds and TIPS (Treasury Inflation-Protected Securities) which pay a real rate of interest. The difference between them is the forward implied inflation:
Continue reading ‘A Tsunami Is Coming, But Is It Deflation Or Inflation?’

So after the Fed cut rates as expected, and the market was miffed that it wouldn’t be enough to remedy the credit crisis wreaking havoc in the financial sector.

And then a day later the Fed came out with all guns blazing, with their international “friends” in Switzerland, Canada, Europe and England by their side.

But, to paraphrase Austin Powers, “Whoop Dee Doo, But what does Global Coordinated Liquidity Injection really mean, Bernanke?”

Since I’ve already explained the sub-prime market in simple terms, lets see if we can also explain this new Fed maneuver.

Federal Reserve Discount Window
Before we get to the explanation of what the global central banks will be implementing, we need to understand what the discount window is. Normally banks borrow from each other, or the fixed income market when they need capital. The discount window at the Fed is an option of last resort for banks what can not find financing using normal channels or anywhere else for that matter.

Although the discount window has been open, the rate reasonable and the need beyond extreme, no significant amount has been drawn through it by any major bank.

Global Coordinated Liquidity Injection
So why would banks act so stubbornly? Why sit there and bleed slowly? Or seek capital elsewhere at much higher rates than the Fed’s discount window?

It turns out that banks, unlike the current batch of Hollywood starlets, are prone to public embarrassment. The stigma of having to rely on the generosity of the Federal Reserve is too much They fear that were they to seek out this available solution, they would expose themselves to evaporating public confidence.

Shhhh, It’s A Secret
The coordinated liquidity injection allows banks to access the discount window with anonymity. So they can borrow at below interbank rates, using the same collateral that they would put up in a discount window transaction, but the transaction is secret. No one will find out who and how much… and so, no stigma.

There will be four auctions of $20 each. The first will be next Monday, the second December 20th for $20 Billion each. The third and fourth will be contingent on the evolving international credit situation.

Private Banking
Reminds me of the time I had to withdraw a rather large sum from a European bank a few years ago. Since this was the first time for me, I was a bit nervous. I didn’t want to stand at the counter while the money was given to me in open view of everyone. I didn’t know they have special rooms in the back for these sort of transactions.

Walking to the back was an interesting experience. No music sounds sweeter than the whirring of counting machines. Walk in with a briefcase, walk out with a briefcase. No public scrutiny. No one the wiser that the briefcase was a little bit heavier than before.

I have a feeling that many US banks are now running towards their favourite central bank with very very large briefcases.