If Australian stocks follow the American lead, they will fall, taking no solace from the Fed rate cut in short-term lending rates. A big fall would lead to more margin calls for investors who have borrowed to participate in the boom. But first, a recap of the Fed's latest move and what happened over night.
At around 2:15pm in New York, the Fed told investors what they expected to hear, and investors still didn't like it. Stocks were in the red before the Fed rate cut. Then they rallied to nearly 12,700. But by the end of the day, the patient could not be revived and the market closed down nearly 40 points despite Fed's cut of 50 basis points.
The Fed rate cut hasn't done much for stocks. But perhaps that was not the target. The Fed cited ongoing tightness in financial and credit markets and said "downside risks to growth" remain. You can say that again.
Why has the United States Federal Reserve been so bold as to cut rates again and by so much? We can think of at least three reasons.
First, is the 75% rise in foreclosures in the U.S. last year. Second, Standard and Poor's downgraded US$534 billion subprime-related mortgage securities and warned investors of the effect, saying, "It is difficult to predict the magnitude of any such effect, but we believe it will have implications for trading revenues, general business activity, and liquidity for the banks."
Third for the Fed is another land-mine for thinly-capitalized banks, the bond insurers. If the bond insurers who insure some US$2.4 trillion in securities lose their AAA credit rating, it will force billions more in losses at American banks, and throw the credit markets back in to a state of lock up.
In fact, once you ad it all up, plus the fact that America's economy grew at just half a percent in last year's fourth quarter, it's not hard to foresee short-term U.S. interest rates at two-percent by the end of this year. Craig Ferguson, a hedge-fund manager at Antipodean Asset Management, says U.S. rates could go as low as 1.25% this year while Aussie rates may reach 7%, creating the widest yield spread between the two currencies since 1991.
"The Aussie could go on a run unlike anything we've seen in the last two years," he told Bloomberg Television. "In the second half of the year you have huge potential for the Aussie to move higher.'"
It may not even take that long, although the currency markets are dominated by technical trading. Still, if you've wanted to see the Grand Canyon, Times Square, Niagara Falls, or go star-gazing in Hollywood, this could be the year to do it on the cheap as the Aussie approaches parity with the greenback.
With the Fed clearly willing to sell out the dollar and bond holders (the yield on the two-year Treasury 2.17%, nearly two full points below the annual inflation rate of 4.1%), who in the world is the target of the Fed rate cuts? Well, beyond the obvious inter-bank lending market, it's the mortgage holders.
And in point of fact, the Fed's rate cut policy seems to have influenced mortgage application activity. According to the Mortgage Banker's Association in the States, mortgage applications jumped 7.7% in the most recent reporting period. Applications to refinance made up 75% of all applications and were up 22% from the week before. Applications for new mortgages, however, fell by 17%.
And forgive us if you will for lingering on the American mortgage market. The reason for doing so is to point out that what the Fed intends and what it actually accomplishes are two different things. It may be trying to bail out distressed borrowers by giving them a chance to refinance at lower rates. And it may be trying to reflate the housing and stock markets. But it's not having much luck with either.
As you can see from the two charts below, prior to the Fed's aggressive inter-meeting 75 point cut and today's 50 point cut, 30-year and 15-year mortgage rates were actually going down in the States. The market was clearing a bit. As soon as the Fed interfered with the market process, the market reacted by pushing rates right back up-exactly the opposite of what the Fed intended we reckon.
Source: http://www.bankrate.com
Lesson? You can make credit cheaper. But you can't control where it goes. And you can't force lenders to lend. Remember, the MBA data represents applications, not approvals. Want lenders, in this environment, are willing to refinance American home owners?
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
