The US Federal Reserve can pump as much money into the US financial system as it wants but it won’t really change things — only slow the momentum of the slide into recession and prevent the credit freeze becoming a credit lock-up.
The Australian market is having a great day out today and the increasingly desperate US markets enjoyed their strongest gains in five years after the Fed’s latest plans were revealed overnight. Banks led the rebound which boosted the Dow by 417 points.
Stocks in Europe also rose on the news that the Fed’s liquidity measures had gone international with the European, Swiss and UK central banks agreeing to pump more liquidity into their markets. The Bank of Canada and the central banks of Japan and Sweden also followed suit in a co-ordinated action.
The S&P 500 rebounded 3.7% from its lowest level since August 2006. US Treasuries fell, pushing two- and five-year note yields up the most since 2004, as investors dumped holdings of government debt and bought stocks. The dollar rose the most in six months against the yen and rebounded from a record low versus the euro.
But it’s a sucker rally: there’s no way the Fed’s cash injections will do anything but steady a floundering ship. The Fed is injecting loan funds, not capital. US banks don’t have enough capital to finance an upturn in lending and the subprime mortgage mess and slide in house prices still have a way to go.
The Fed is trying to make sure the credit creation process in the US markets isn’t frozen by fear and uncertainty to the point that a big financial group could fail. A freeze on the US financial markets with no lending or credit creation being generated by Wall Street would be terrible: even China would be badly hurt.
It’s a sign of how desperate the Fed is to stabilise the situation that it is now flinging the best part of $US75 billion to $US100 billion a week at the economy to try to hold the line. The Fed meets next week and will cut its federal funds rate by either 0.75% or 1% to maintain the momentum.
But this is short term money and banks are not going to recycle it to the needy parts of the economy: particularly the property market. Much of money injected into the markets will be re-lent back to the US Government to finance its huge and growing budget deficit.
The money won’t help underwrite the huge and growing budget deficits of State and local governments across the US which are suffering revenue shortfalls from the housing slump and subprime mess, nor will it lower the debt burden on US consumers or stop the slide in the value of US houses.
But it should buy some time and help convince nervous banks and other financial institutions that the Fed won’t standby and watch the whole mess slide into depression.
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