Money, money everywhere, but no one wants to lend. Global markets continued to feel the effects of a liquidity squeeze, as yield spreads extended to record wide levels and interbank lending slowed to a crawl. The squeeze prompted the Federal Reserve, along with other central banks from Europe and Asia, to step in with a coordinated plan to bolster liquidity on Sept. 18. Also the same day, reports on weekly initial jobless claims and the Philadelphia Federal Reserve Bank's index of economic conditions for September gave some clues about the health of the U.S. economy.
What to make of all this? Here is a sampling of reaction from investment strategists and market economists on Sept. 18, as compiled by BusinessWeek and Standard & Poor's MarketScope staff:
Meyrick Chapman, UBS Investment Research
Today the Fed doubled the U.S. dollar swap lines with [Bank of Japan, European Central Bank, Bank of England, Bank of Canada, and Swiss National Bank] through its Term Auction Facility (TAF). The announcement was followed immediately by announcements of U.S. dollar liquidity auctions by the SNB, the ECB, and the BoE. Demand for the U.S. dollar remains extraordinarily high as seen in the wide levels of the euro/dollar basis swap, so the provision of extra dollar liquidity is unquestionably a good thing. The auctions added $64 billion of liquidity to the local systems for one day. There is no doubt the facility will be repeated tomorrow on expiration of the facility and, presumably, again thereafter until it is no longer needed. The auction results reversed some of the recent basis swap widening, and Libor rates fixed lower in short dates. But gains were relatively modest; repo remains elevated, and money market spreads are still wide.
Jacques Patrick, BNP Paribas
Tensions on liquidity have never been so high, apart from cataclysmic conditions (World War II, October 1987). Dollar liquidity has died…As the main problem is U.S. dollar liquidity, coordinated action involving major central banks (Fed, ECB, BoE, BoJ, BoC, SNB) has been decided, implying a potential $180 billion liquidity addition. However, current open market operations appear unable to fix the crisis. It may be time to change the way liquidity is provided, at least temporarily.
Andrew Rowan, UBS Investment Research
Swap spreads, money-market spreads, and country spreads remain at historically extreme levels. But as an intervention by government authorities looks more likely, the risk of a major tightening of swap spreads increases. Solving the current financial crisis requires, at a minimum, three elements to work together.
1. There must be a reversal of banking isolation—banks must deal with one another.
2. There must be sufficient liquidity available for the banking system to fund its collective balance sheet.
3. There must be a base price found for asset values. In an effort to remove bank isolationism, 10 major banks last weekend pledged to deal with one another. So far, this does not appear to have produced a major change in behavior, but at least the vows of cooperation have been taken.
Gerard Lyons, Standard Chartered Bank
Lehman (LEH) filing for bankruptcy, Bank of America (BAC) buying Merrill (MER), and the nationalization of AIG (AIG) all provide further evidence of how severe this financial crisis is. And this is only one week after the effective nationalization of Fannie Mae (FNM) and Freddie Mac (FRE).
That the Chinese also surprised with an interest-rate cut has already added to the general air of uncertainty. We believe proactive policy responses should prevent a financial meltdown, but deleveraging will take time and interest rates will head lower and sooner. Meanwhile, emerging markets will slow but should remain positive. Asia is slowing, and we should not be complacent about it. At the same time, we should not panic. After the boom seen in recent years, it would be a surprise if there were not a slowdown. The current slowdown is the result both of the downturn evident in world trade and the previous policy tightening across the region to curb inflation pressures. The region is not decoupled, but it is better insulated.
Zach Pandl, Lehman Brothers
New claims for unemployment insurance benefits continued to climb in the week ended Sept. 13, rising by 10,000, to 455,000. Initial jobless claims have now held at over 400,000 for nine consecutive weeks—a highly worrying development for the labor market outlook. On a four-week moving average basis, claims climbed to 445,000 from 440,000. Continuing jobless claims improved slightly, to 3.478 million from a revised 3.533 million, in the week ended Sept. 6. The insured unemployment rate held at 2.6%. On today's worse-than-expected report, we revised…our forecast for September nonfarm payroll employment growth to [a loss of] 125,000 [jobs] from 100,000.
Mike Englund, Action Economics
The big September Philadelphia Fed bounce [to 3.8 from -12.7 in August] suggests that the factory sector is indeed ending the third quarter with sufficient resilience to support our 2.3% third-quarter [gross domestic product] forecast, though we continue to assume a sharp moderation in GDP growth, to a lean 0.6% rate in both the 2008 fourth quarter and 2009 first quarter. Although the high claims figure was attributed to Gustav, the lack of a more meaningful underlying downtrend following the big claims surge through August has boosted downside risk to payrolls in September, which will also receive a hit from both the hurricanes and the Boeing (BA) strike.