Good Afternoon Esteemed Investors,
Needless to describe in detail, these are tumultuous economic times. We here at GEE and VEE pride ourselves on our 100% success rate with determining the Federal Funds Rate over the lifetime of this memo and wish not to fail you in these pressing times.
Among the more dire threats to the Federal Reserve’s dual mandate lies predominately the issue in credit markets. As prescribed as a cause for the struggling repo(repurchase agreement) market, January FOMC minutes stated: “market participants reportedly were reluctant to lend Treasury collateral out of concern that counterparties might fail to return borrowed securities.” A lack of Trust coupled with low supplies of loanable funds and weak demand is causing historic congestion in the credit markets. Commercial Bank credit has fallen for the second consecutive month in December echoing the lackluster demand and dwindling supplies and month to month recovery in select areas such as liquidity in corporate bond markets and short–term funding markets have occurred; though marginal at best. Please note there remains renewed deterioration in the banking sector’s financial condition as well as consumer spending, business investment, sales of new homes, foreign demand (of US treasuries), unemployment, GDP, and industrial production. The message of the January 28 FOMC meeting is bare; the committee stands united to combat the credit crisis before all other issues. It is the committee’s belief that this will subsequently loosen the flow of capital to all other deteriorating sectors. We must let you know that the FOMC has already stated after the January 28th meeting that “policy rates would likely remain low for some time and that the FOMC might engage in additional nontraditional policy actions such as the purchase of longer term Treasury Securities.” We here at GEE and VEE do not believe the purchase of longer term Treasury Securities will be resorted to. Adverse price movements which occurred after this initial announcement were “more than reversed after the turn of the year, despite the worsening economic outlook.” Further as month to month relief comes to short term funding markets and spreads in the LIBOR decline, there is no reason for government purchases of long term treasury securities to occur.
It is difficult to find opposing views from the January FOMC meeting in media and the Beige Book Summary for 3/4/09. The Summary confirms the prevailing failure of consumer spending in all sectors including real estate, manufacturing, retail, travel/tourism, and services. Price levels are not showing signs of increasing either due to low energy prices. The summary also confirms that “availability of credit generally remained tight” through February and the opening of March. As mentioned in the 1/28 FOMC report, the summary reaffirms: “Demand for commercial and industrial loans was reported lower in most Districts,” and that “Lenders continued to impose strict standards for all types of loans”. Credit markets have not loosened in the period after the last FOMC meeting. Though some might find problems with WSJ reports that show unemployment increases beyond the FOMC projection of 4.8-5.0%, careful readings of the Summary of Economic Projections (SEP) show that the FOMC acknowledged, “projections for unemployment rate were to be tilted to the upside”. Also, the FOMC was aware of the potential for large drops in GDP. The 1/28 SEP reads: “projections for real GDP growth were judged to being skewed to the downside.” There should be no surprises here folks. The WSJ reports after the 1/28 FOMC meeting show that FED officers have become much more comfortable with delivering the blunt truth to the ailing economy. As the March 4th WSJ article reminds us, the U.S. is aggressively attacking weak credit markets by injecting up to $1 trillion in new lending through TALF and associated relief to Mortgage backed Securities. Please note that the problems cited by the FED and FOMC are indeed being addressed through substantial measures.
Reports from the fifth and twelfth Federal Reserve district verify all claims in the Beige Book summary. Retail, Manufacturing, tourism, service, finance and real estate sectors all show declining and contracted states with very low consumer spending even in the holiday season. The economic picture is bleak both nationally and regionally.
We here at GEE and VEE see not the courage in the FOMC to make the bold decision to increase the Federal funds rate. Doing so would be akin to pulling away the crutches of an already lame and aged man. Reducing the rate further, would not make lending services anymore available then a 0-.25 rate have already done. The credit markets are severely disabled at historic proportions. Extraordinary measures in bailout funds are being pledged in this second round of funding. Ladies and gentlemen, we wish to warn that as the effects of the TALF become felt that long-term inflation will become the next threat to the FOMC as the Federal Reserve’s balance sheet continues to grow. For this reason, assuming no further shocks to the economy occur, as effects of TALF spread through the economy and credit markets loosen, the FED will refocus measures to scale back liquidity and begin to address the multitude of issues weak consumer spending and low industrial lending/borrowing have created. However, in these markets trying to anticipate future movements of the FOMC are best labeled unwise for the sake of safe investing. For the time being, please prepare investments for an unchanged rate for today, March 17th, 2009.
Yours in Finance
Nirav Lakhani
Research Associate, GEE and VEE
