Monday, August 13, 2007

Is there a rate cut on the Horizen.

On Friday morning I was called into a meeting with the Global Heads of all the relevant business heads in my organization. The topic, Will the Fed do an emergency Ease?

It is a good topic and one not taken lightly. Clearly there is a problem. This sub prime mess although "small and contained" is taking a toll on the overall market. Think about it in terms of your family. You are on vacation, hiking in Yellowstone park and you have an ingrown toenail. Small problem, easily fixed, if you do something about it. If you do nothing it would ruin your vacation and make everyone around you miserable.

Fed officials, and many "talking heads" on TV have stated that this is a very small problem in regards to the overall economy. I think when you walk down the street they are absolutely correct. But in Treasury's around the world it is a much bigger problem, one with far reaching consequences.....FUNDING. Banks, and corporations are having trouble funding their balances sheets. Paying as high as 6.0% (up from the Fed official rate of 5.25%) for o/n dollars. The entire curve has pushed out and the market has traded considerable wider. This is a real problem when you pay an additional 75bp to fund your position this money is gone. You cannot make it back (unless another day you fund at 75bp below the effective). The Fed (and ECB) have responded by making available all necessary funds to ensure that their is no problem. The Fed on Friday funded the market (billions of dollars) on three separate occasions.

As one head of a funding desk told me, "their is no problem getting is at what cost you get them?". Isn't this what got us into the problem in the first place. People getting loans to purchase houses with less then stellar credit,finances higher rates then usual and when things go bad (lose a job,need to sell,etc) walk away and let the mortgage default. If you cannot fund your assets, be it an individual mortgage or a CMO owned by a bank you have no alternative but to walk away.

Flooding the o/n market with funds may work. I am not an expert economist, but I think from judging market movements, they are looking for a more permanent solution.

25bp cut in the official lending rate Plus adequate liquidity to get the market through this hump ?? Time will tell.

Good Luck and Good Forex trading.



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