Fed Dollar-Funding Cut Shows Limits of Action
The Federal Reserve-led global effort to ease borrowing costs for financial firms shows both the central bank’s power to jolt markets -- and the limits of its ability to alleviate the European debt crisis.
Stocks rallied worldwide, commodities rose and yields on most European debt fell after the Fed and five other central banks yesterday cut the cost of emergency dollar loans to banks outside the U.S. At the same time, the action falls short of more-drastic moves that central banks are reluctant to take, including purchases or guarantees of countries’ bonds.
Fed Chairman Ben S. Bernanke and his counterparts are revisiting their playbook from the U.S. housing-induced financial crisis that started in 2007 to cushion markets and economies from Europe’s fiscal turmoil today. Yesterday’s move deals with the consequences of the crisis without addressing the causes, said John Ryding, chief economist at RDQ Economics LLC.
“You have to do something to stabilize the sovereign-debt situation,” Ryding, a former Fed and Bank of England economist who is based in New York, said in a Bloomberg Television interview. That requires European Central Bank bond purchases that are “far beyond what they’ve been willing to do so far,” he said.
The Dow Jones Industrial Average rose 4.2 percent to 12,045.68 in the biggest gain since March 2009, boosted in part by reports on U.S. private employment, business activity and home-purchase contract signings that all exceeded forecasts. The Standard & Poor’s GSCI index of 24 raw materials gained 0.7 percent.
The Stoxx Europe 600 Index, which surged 3.6 percent yesterday, was little changed today. Yields on 10-year French debt fell to 3.13 percent from 3.5 percent on Nov. 29, while Italy’s dropped 42 basis points to 6.76 percent.
The S&P 500 Index (SPX) of stocks is still 9 percent below its 2011 high in May. Italy’s bond yields need to fall below 6 percent, where they haven’t been for more than a month, to calm the debt turmoil, Ryding said.
The premium banks pay to borrow dollars overnight from central banks will fall by half a percentage point to 50 basis points, the Fed said yesterday in a statement in Washington. The so-called dollar swap lines will be extended by six months to Feb. 1, 2013. The Fed coordinated the move with the ECB and the central banks of Canada, Switzerland, Japan and the U.K.
‘Not a Solution’
“Central banks appear to be willing to respond to the situation with the tools that they have,” said Roberto Perli, a former economist in the Fed’s Division of Monetary Affairs. Investors probably understand that cheaper dollar funding is “not something that can fix the problem” in Europe, said Perli, now a managing director at International Strategy & Investment Group in Washington.
Bank of England Governor Mervyn King also said today that lowering the cost of dollar funding won’t solve imbalances in the global financial system.
“This is not a solution,” King said at a press conference in London to present the Financial Stability Report. “All this can be is to help with temporary relief for liquidity problems, but those problems are a result of solvency issues.”
The Fed has additional tools available, including cutting the U.S. discount lending rate or restarting crisis programs such as the Term Auction Facility, said Michelle Girard, senior U.S. economist at RBS Securities Inc. in Stamford, Connecticut.
Still, the central bank will want to avoid the appearance of bailing out foreign banks or shifting U.S. monetary policy, said Robert Eisenbeis, former research director at the Atlanta Fed and now chief monetary economist in Atlanta for Sarasota, Florida-based Cumberland Advisors Inc. He put “zero probability” on buying foreign debt.
In yesterday’s move, the Fed and the other five central banks also agreed to create temporary bilateral swap programs so funding can be provided in any of their currencies, “should market conditions so warrant.” Those swap lines were also authorized through Feb. 1, 2013.
Fed policy makers voted 9-1 for the action in a Nov. 28 videoconference, with Richmond Fed President Jeffrey Lacker dissenting. Lacker said in a statement that the swaps amount to “fiscal policy, which I believe is the responsibility of the U.S. Treasury.”
Markets also got a boost from China’s decision, two hours before the Fed’s announcement at 8 a.m. New York time, to cut the amount of cash the nation’s banks must set aside as reserves. The level for the biggest lenders will fall to 21 percent from a record 21.5 percent in the first reduction since 2008.
The moves from the Fed-led group and China both take effect Dec. 5. Brazil cut its benchmark interest rate late yesterday by 50 basis points to 11 percent.
The decisions by Brazil and China are the latest in a round of easing moves by central banks seeking to shield their economies from the consequences of the European crisis.
The U.S., the U.K. and nine other nations, along with the European Central Bank, have bolstered monetary stimulus in the past three months. Australia, Brazil, Denmark, Romania, Serbia, Israel, Indonesia, Georgia and Pakistan have all reduced interest rates.
“The Europeans in particular, but also all central bankers, appreciate the urgency of the moment,” said Christine Lagarde, managing director of the International Monetary Fund and a former French finance minister. Leaders inside and outside Europe “will also understand that timing is of the essence” and the need for an “urgent resolution of the current crisis,” Lagarde said at a press conference in Mexico City.
Under the liquidity-swap program, the Fed lends dollars to the ECB and other central banks in exchange for collateral in other currencies, including euros. The central banks lend the dollars to commercial banks in their jurisdictions through an auction process.
The swap arrangements were revived in May 2010 when the debt crisis in Europe worsened. The Fed three months earlier had closed all swap lines opened during the financial crisis triggered by the subprime-mortgage meltdown in 2007.
Fed lending in the second round of swaps has been a fraction of the first round. The swap lines had $2.4 billion outstanding as of Nov. 23, the most since the program was revived in 2010, compared with a peak of about $583 billion in December 2008.
“There has been a real constriction of credit within the European community and the banking system,” Stephen Schwarzman, chairman of Blackstone Group LP, the world’s largest private- equity firm, said in a Bloomberg Television interview. “That has to be addressed because if you grind lending to a halt, a variety of predictable, very bad things happen throughout not just the eurozone but also around the world.”
Yesterday’s decision will help European banks that need dollar funding, letting them borrow money instead of having to sell U.S.-denominated assets, including mortgages and corporate loans, said Neal Soss, chief economist at Credit Suisse in New York. Still, the involvement of central banks outside the Fed and ECB made the joint announcement appear more potent than it actually was, said Soss, who was an aide to former Fed Chairman Paul Volcker.
“It doesn’t mean it’s not important, but the atmospherics of this were in that sense quite brilliant,” Soss said.
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