Trader’s Narrative

Today’s Bank of Canada rate decision is being watched very carefully. Not because of any lingering doubts about what they will do; because according to the rate futures there is a 100% expectancy of a 50 basis point cut (and a 73% chance of a 75 basis point cut).

The question on everyone’s mind is what will the six big Canadian banks do?

The last rate cut decision by the Bank of Canada resulted in a huge public relations mess for the Canadian banks because they refused to pass on the full rate cut to their customers. While the central bank lowered Canadian rates on December 9th, 2008 by 75 basis points, the banks grudgingly lowered their prime rates by only half a percentage point.

They have also refused to lower mortgage rates, citing “extraordinary credit market conditions”. This in spite of the fact that all stress measures of the credit market as well as money “costs” have fallen tremendously.

For example, the Banker’s Acceptance rate is now hovering around 1%. The 5 year bond rates are around 1.58% and the 30 year at 3.6%. Compare that to 5 year mortgage rates of approximately 6.75%-6.50% and you notice that that is a huge gap. In fact, according to historical data, Canadians have never seen such a discrepancy in their financial markets.

If the banks refuse to lower their prime rate again, the Canadian banks will not only widen the gap between the central bank rate and the “real rate” available to people but they will also negate any influence which the central bank is trying to have on the Canadian economy. In the end, by their belligerence, they could be pushing Canada into a deeper and longer recession than it would otherwise have to endure.

In that case, it would be a good idea for the usually soft-spoken governor of the Bank of Canada, Mark Carney, to call a meeting with the head of all Canadian banks and throw some chairs around.

Here’s a chart showing historical central bank rates for 7 major countries (Canada, US, ECB, Japan, England, Australia and Sweden).

UPDATE:
The Bank of Canada lowered its overnight benchmark rate by half a percentage point as expected. All Canadian banks followed by lowering their prime rate by the same amount to 3%, which means they are still 25 basis points behind the central bank’s lowering agenda.

The bad news is… well, look around. The good news is… it is almost over. The year that is.

The bear market? For that we’ll only know in hindsight. Until then, its the weekend, so kick back and grab your favourite beverage to catch up on some interesting reading you may have missed over at news.tradersnarrative.com:

• The Fed’s fierce battle plan
• The Madoff economy
• Rates help refinancing, not home sales
• The hedge fund collapse
• Wall St. where bonuses are real, profits? not so much
• Markopolos, Certified Fraud Examiner, told SEC about Madoff in 1999, 2005 but was ignored
• Madoff’s auditor… doesn’t audit
• OPEC’s cuts ignored as oil falls below $35

Don’t forget to check regularly since there are interesting links posted regularly.

Have We Seen the Worst of This Bear Market?

Today we’ll be keying off only one market tell: the scheduled Federal Reserve rate cut decision.

I’ve been following a simple model of the Fed’s actions: approximation of the 90 day US government T-Bond yield. At yesterday’s close, the 3 month US Treasury Bond’s yield was 2.280% and in overnight trading they were a bit lower at 2.20% (last time I checked).

Here’s a recent graph comparing it with the Fed rate (in blue):

If only they’d listened to me when I suggested they cut, way back in the summer of 2007!

The Fed is now way behind the curve and in a desperate (some say futile), last ditch effort to forestall a recession in the US economy. I know this sounds crazy but they would have to cut 125 basis points to bring the Fed target rate in line with the bond market - see above graph.

The odds are that we will get a generous rate cut. But probably not that generous. According to Federal Fund futures, we have more than a 70% chance of a 50 basis point cut and about a 30% chance of a quarter point cut. But really, no one knows what the Fed will decide.

All I know is at 2:14 pm today, the futures will go nuts. Since the market is clearly expecting (and needs atleast) a 50 basis point cut, anything less will be a major disappointment. If we get anything more, we could be riding a rocket. The market is clearly in a very oversold condition and a catalyst like an unexpectedly larger rate cut would be all it needs to recover. If we do get exactly 50 basis points, we could flail around and end the day unchanged for the most part.

In any case, the first directional jab is usually a head fake, or has been in the past. So unless you really really have to don’t trade around the decision time.

If you do, just know the risks. Including the risk of losing internet connectivity, losing power, etc. Believe me, you don’t want to be stuck in a position that can move against you mercilessly unless you have planned for every contingency.

While everyone waited for the open of today’s market with bated breath, the word crash was thrown around like confetti. Retail investors crapped their pants (again). Here are a few frontpage stories from digg:

That’s notable because digg occupies itself usually with technology and science news. The stock market and the economy rarely make it to the front page. When they do, it is sensationalist headlines like those above… which makes for great a contrarian indicator.

With so much anticipation, the only prediction that came true was the Fed “surprise” rate cut that had been telegraphed weeks ago. The market certainly did not crash. It quickly recovered after the gap down from overnight trading.

Volatility
The volatility indices finally spiked higher: VIX reached a high of 37.57 and the VXN 40.77 - an almost 5 year high.

I was surprising to find that the number of Nasdaq stocks above their long term (200 day) moving average reached a low not seen since 2002:

This indicator is saying that the market’s internal breadth is as bad as it was in the final days of the bear market. I don’t know what to make of this since we only reached such horrendous levels after a brutal 3 year bear market.

Now, we are nowhere near that kind of market condition. Even so, here we are - as oversold as then.

The market is drifting higher this morning, as it tends to do ahead of Fed meetings. This is the defining moment for Bernanke. The first chance he will get to create his legend and legacy.

Maestro vs. Helicopter Ben
With the upcoming release of his memoirs, Greenspan has been all over the news with attention grabbing sound bites. He pontificates on a lot of topics that he was silent about during his tenure as the “Maestro”: tax cuts, the Iraq war, the mortgage and housing market, etc.

Interesting that he only speaks out now when he is enjoying the freedom of retirement. When had the power to actually do something about these things he was conspicuous in his silence and acquiescence. In any case, today, Helicopter Ben finally gets the limelight.

25 bp or 50 bp?
At 2:15 Eastern time we’ll find out. A 25 basis point cut is a foregone conclusion since it has been priced in 100% since mid August by the Fed Funds futures market. Meanwhile the same market tells us there is a 75% chance of a 50 basis point cut. Personally I think they should go with the latter.

Not because I’m talking my book, but rather because that’s what the bond market is saying. Right now the 90 T-Bill rate is around 4.05%. While the Fed Funds rate has been 5.25% since June 29, 2006, since this spring, the bond market has been signaling repeatedly that it should be lowered.

What do you think will happen? No cut? 25 bp? 50 bp?

Leader or Follower?
A prolonged gap of around 100 basis points is simply too much. The Fed doesn’t have a choice. They have to lower the rate. If they don’t it will be a market shaking decision and as far as I know, the first time they have decoupled from the fixed income market.

I find that highly improbable because the short term T-Bill rate leads the Fed by the nose. Of course the Fed would hate for this to get out but it is the truth. Each and every major trend change in rates has been preceded by the free market and later followed by the Fed.

That isn’t hard to fathom once you realize the incredible power of free markets for price discovery. To see what I mean, click below to see a long term chart of the Fed Funds rate along with the 3 month T-Bill rate.

Click To Enlarge Graph: