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Daily Archives: March 18, 2009

Fed’s action sharply drove down dollar

Fed’s new purchasing plan of over $1 trillion mortgage-back securities and long-term treasuries makes investors fret about the prospect of dollar. US dollar was driven down sharply today, the 3rd largest decline in recent history.


(graph courtesy of Bespoke Investments)

And gold was up sharply, for almost $50:

WSJ reacts to the Fed’s decision:

The problem with desperate measures: They can end up stoking fear, not confidence.

That’s the main risk with Federal Reserve’s shock and awe tactic of buying $300 billion in longer-term Treasurys and up to $1.25 trillion of mortgage-backed securities issued Fannie Mae and Freddie Mac.

The 10-year Treasury jumped, causing the yield to fall almost half a percentage point to 2.53%. But two key fear indicators immediately flashed red: Gold soared 6%, and the dollar weakened.

It’s highly unusual for a central bank to print money to buy large amounts of financial assets. Such unorthodoxy succeeds only if its purchases are temporary — and sufficient to kick start credit markets and the economy.

Any sign their impact is fleeting would raise expectations of further buying. If the Fed responds and balloons its balance sheet further, inflation fears intensify, hurting the dollar and pushing gold even higher.

The Fed’s $300 billion would account for around 28% of government issuance in the next six months according to Barclays Capital. To keep yields low beyond that might mean even heavier spending. The Fed’s decision Wednesday to ratchet up the purchase of mortgage-backed securities underscores its willingness to keep spending.

Investors should track the relationship between the dollar and Treasury yields. Ultra-loose monetary policy can debase the currency. That means foreigners, with around half of all outstanding Treasurys, could demand higher returns.

Yields are now artificially low because of Fed’s proposed intervention. That might push investors into riskier assets — something the Fed wants. It could also scare foreign investors, who are needed to fund the ballooning fiscal deficit.

Reaction to Fed decision

China Holding…

Now you understand why China’s premier Wen is “worried”.

(click to enlarge; graph courtesy of Brad Setser)

AIG’s counterparties

Source: NYT

Bill Gross of PIMCO is a winner

The Fed is buying $750 billion mortgage-backed securities, and $300 billion long-term treasuries. And Bill Gross’s bond fund, which is a big buyer of agency-backed securities, is surely a winner.

Fed Statement

Release Date: March 18, 2009

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve’s balance sheet in light of evolving financial and economic developments.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

World Bank cuts China’s growth to 6.5% for 2009

Source: WSJ

BEIJING — The World Bank cut its forecast for China's growth this year to 6.5%, below Beijing's target of around 8%, and cautioned that China should be prudent about expanding its stimulus this year as it may need to save its ammunition for 2010.

The bank now projects China's consumer price index, the country's key inflation gauge, will rise a mere 0.5% this year, compared with its previous forecast for a 2% increase.

The bank said February's CPI drop didn't necessarily signal "problematic" deflation, with core prices and wages, as well as output, declining in tandem, but cautioned that given the global economic weakness and potential overcapacity in China, "problematic deflation is a risk."

The bank lowered its forecast for China's GDP growth from its previous estimate of 7.5%, mostly due to the worsening global economy.

Government investment and consumption will help growth this year, it said. But policy makers can do more to spur private consumption and improve social programs to ensure that short-term growth targets don't undermine the work needed to rebalance the world's third-largest economy, the World Bank said.

Louis Kuijs, senior economist of the World Bank, said China's year-to-year economic growth will likely be weakest in the early part of 2009. Mr. Kuijs said declines in Chinese exports may have bottomed in February, but full-year exports will likely shrink significantly from last year. "Overall they remain very grim," he said.

Chinese exports in February fell 25.7% from a year earlier, down for the fourth month running and a sharper decline than in January.

Mr. Kuijs said it is not in China's interests to significantly depreciate the yuan as the country will not gain a lot in terms of exports by doing this. He said he doesn't expect China to move in this direction.

The bank said government-influenced direct expenditure will account for 4.9 percentage points of total GDP growth, the bank said.

The bank said China's fiscal deficit will rise to 3.2% of its GDP this year, a forecast slightly higher than the Chinese government's own estimate of nearly 3% due to the bank's lower GDP growth forecast.

Much of China's deficit is a result of the government's four trillion yuan (around $585 billion) infrastructure-focused stimulus plan, which was announced in November and will run through 2010.

The bank said that Beijing should be prudent about further expansion of its fiscal stimulus this year as it may need to widen its deficit in 2010 if the global slowdown isn't reversed.

Mr. Kuijs urged China to focus more on consumption-oriented fiscal spending and improve the domestic social safety net.

"Looking ahead, we think that there are limits to how much the government can beef up investment and infrastructure-oriented stimulus packages in the official manner," he said. "Given that China will continue to grow even in the very weak climate, it may make just as much sense to not go for the second or third general fiscal stimulus."

The bank's new overall growth rate estimate is below Beijing's target of around 8%, and down from last year's actual growth of 9%, which snapped five straight years of double-digit growth in China.

But the World Bank said that while the growth rate projected for this year is "significantly lower" than China's potential growth rate, this isn't likely to jeopardize China's economy or social stability.

"I don't want to be too gloomy. We do see the world economy recovering in the second half of 2009 and also a lot of strength in China's economy," said David Dollar, the World Bank's country director for China. "So, we see China as a relative bright spot in a rather gloomy global economic picture."

The World Bank estimated China's foreign-exchange reserves, the world's largest, will rise to $2.376 trillion by the end of this year, an increase of $425 billion. In 2008, the country's forex reserves rose by $420 billion.

It said China shouldn't worry about the slowing pace in the accumulation of foreign-exchange reserves and estimated China's current account surplus to rise to $425 billion this year, from an estimated $416 billion last year.

Swensen: Sleep soundly with your investment

Interview of David Swensen, Chief Investment Officer of Yale Endowment.

I quote some here:

Y: Explain this idea of asset allocation, please.

S: Asset allocation is the tool that you use to determine the risk and return characteristics of your portfolio. It’s overwhelmingly important in terms of the results you achieve. In fact, studies show that asset allocation is responsible for more than 100 percent of the positive returns generated by investors.

Y: How can that be?

S: It’s because the other two factors, security selection and market timing, are a net negative. That’s not surprising. They’re what economists would call zero-sum games. If somebody wins by buying Microsoft, then there has to be a loser on the other side who sold Microsoft. If it were free to trade Microsoft, the amount by which the winner wins would equal the amount by which the loser loses. But it’s not free. It costs money. It costs money in the form of market impact and commissions if you’re trading for your own account, and it costs money in terms of paying fancy fees if you are relying upon an investment advisor or mutual fund to make these security-specific decisions. For the community as a whole, all those fees are a drag on returns.

That’s why the most sensible approach is to come up with specific asset allocation targets that you can implement with low-cost, passively managed index funds and rebalance regularly. You’ll end up beating the overwhelming majority of participants in the financial markets.