PrefBlog

The Fed cut by 50bp today, giving equities a big boost at the expense of long bonds and the greenback. As justification, their statement said:

Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

 For those keeping score, a handy guide to predictions of the Fed move by the brokerages houses was compiled by the WSJ Economics blog. Post-event reactions ranged from ‘Bold!’ to ‘Irresponsible!’. Tom Graff at Accrued Interest supplies an interesting prediction for the next two years.

James Hamilton of Econbrowser noted:

The Fed deliberately took a step back from its longer-run mission of containing inflation today. I don’t think Bernanke did so because he’d like to see 3-1/2 instead of 2-1/2 percent real growth next year. I’ve been saying all along that his intention is to squeeze inflation as much as possible without sending the economy into recession or financial crisis.

The verdict is still out on whether we’ve avoided one or both of those last two pitfalls. If we have, I’m not sure that the market’s confidence in another 50 basis points of cuts is warranted. If we haven’t, today’s exuberance in equity markets cannot be rational.

Well, US Core PPI looks OK anyway!

Over the past 12 months, producer prices rose 2.2 percent, down from a 4 percent increase in July. The year-over-year increase in costs excluding food and energy also eased to 2.2 percent compared with 2.3 percent in July.

In a highly interesting Canadian ABCP development, it looks like Dundee Bank flamed out:

Scotiabank will pay C$260 million in cash for Dundee Bank, a small bank that had been raking in deposits but was recently shaken by its exposure to a troubled corner of Canada’s asset-backed commercial paper sector, a short-term debt market that ground to a halt last month.
…
That was even after DundeeWealth said it will realize a net loss of about C$70 million on the sale of Dundee Bank “as a result of certain investments that are currently being valued below initial cost.”
…
DundeeWealth revealed on August 23 that the group was holding about C$400 million of commercial paper, instruments that are currently locked in a moratorium while the biggest players in that market try to hammer out a solution to prevent defaults.

I’d love to have more details on this. $70-million is an awful lot of mark-down on a $400-million position that, by all accounts, is reasonably well-secured with underlying assets anyway (albeit of a much longer term than originally intended). I wonder what else is going on with them? According to my interpretation of today’s DBRS rating confirmation, the problem was that they simply can’t place the money that has been deposited with them:

Aside from not yet achieving ongoing profitability, the Bank’s business model had become somewhat constrained given the recent credit market disruption. Without a lending operation, the Bank was relying on investments in collateralized loan obligations (CLOs) and asset-backed commercial paper (ABCP) to support its deposit liabilities, a strategy that is no longer practicable in the current market. The Bank grew to about $2 billion in assets since it began operations in September 2006.

Dundee Wealth has a ten-year retractible, DW.PR.A, in the preferred share market, rated Pfd-3 by DBRS. The issue soared on the news, presumably on market speculation that it is effectively an obligation of Scotiabank now and therefore of much higher quality.

Does everybody remember my speculation about the possibility of  a spectacular flame-out if a large bank suddenly discovered its risk controls weren’t exactly perfect? Looks like one shop, anyway, has come close:

Calyon, the investment banking arm of France’s Credit Agricole SA, said third-quarter profit will be “sharply down” after an unauthorized proprietary trade cost the bank 250 million euros ($347 million).

Calyon discovered an “unusually large market position” on diversified credit market indexes at its New York unit on Sept. 4, the Paris-based company said in a statement today. The trade, which breached authorized limits, has no relation to the subprime mortgage market, the bank added.

And, finally …

US Equities roared upwards after the Fed rate cut, as did the Canadian market.

Treasuries pivoted:

The difference in yield, or spread, between two- and 10-year notes widened to 0.5 percentage point, the most since Aug. 21. The gap was about 0.38 percentage point before the Fed statement.

Always remember: the short end trades on monetary policy while the long end trades on inflation expectations (the 10-years trade on futures & mortgage hedging!). One of the most educational graphs I’ve ever seen was of the Gilt market for a period of some years in the ’90’s … a beautiful, huge, smooth pivot, centered on the 10-year which barely moved.

Canadas pivoted.

The preferred share market continued its quiet ways. Volume continues to be light; entertainment was provided by the DW.PR.A mentioned above.

There were seven other $25-equivalent index-included issues trading over 10,000 shares today.

This entry was posted on Tuesday, September 18th, 2007 at 10:03 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.