[B]Weekly Bank Research Center 8-20-07[/B]
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[B] After the Shock: Risks for the Global Economy and Markets
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[/B] [/B] [I][I] Stephen Roach, Head Economist, Morgan Stanley [/I] [/I]
The Fed?s aggressive action to restore market liquidity will avert a financial crisis, but investors still must focus on threats to global growth and their implications for risky assets. The Fed?s massive provision of liquidity, a 50bps cut in the discount rate and allowance of term financing at the discount window have alleviated intense strain in money and credit markets. Additional steps ? possibly unconventional ones ? may be needed to achieve the first objective, but there is no mistaking the Fed?s and the community of central bankers? resolve to respond in size (see “Unconventional Policy Options: Footnotes in the Fed?s Playbook”, Global Economic Forum, August 17, 2007 for a menu of unconventional options).
Full Story
[B] [B][B][B] [B] Restoring Liquidity Means Bolstering Confidence
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[/B] [/B] [I][I]John E. Silvia, Ph.D. Chief Economist, Wachovia[/I] [/I]
Notable developments this past week include a plunge in yields on short-term Treasury Bills, which reflects investors? nervousness in holding other types of short-term investments, notably commercial paper tied to the mortgage industry or housing sector. There was also a spectacular turnaround in the Dow Jones Industrial Average on Thursday.The Federal Reserve continues to provide liquidity to the financial markets through liquidity injections and the cutting of the discount rate by 50 basis points (see page six Interest Rate Watch). Unfortunately, much of the liquidity is not reaching the parts of the market where it is needed most: the mortgage-backed securities market and the commercial paper market. The Federal Reserve Bank of New York, which handles open market operations for the Federal Reserve Board, issued a statement yesterday noting that “early estimates suggest that the Desk will need to provide reserves through RP operations on most days.” The statement was made to provide clarity about the Fed?s intentions at the start of the new two-week maintenance period.
Full Story
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[B] Will the ECB Keep a Firm Hand?
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[/B] [/B] [I] Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
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The recent financial turmoil raises the question whether the ECB will hike interest rates in September. The reason is partly that central banks sometimes assist the markets in periods of unrest by lowering interest rates and partly that there is a risk that the financial turmoil may rub off on the general macro-economy. The financial markets have responded to the unrest so far by merely pricing in a small probability of a rate hike in September and will then almost expect a rate cut over the following six months.
[Full Story](http://danskeresearch.danskebank.com/link/WeeklyFocus17082007/$file/WeeklyFocus.pdf)
[B] [B][B][B] [B] Will the US sub prime mortgage crisis derail global economic growth?
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[/B] [/B] [I] Trevor Williams, Chief Economist at Lloyds TSB Financial Markets [/I]
The evolution of the current state of affairs in credit markets happened thus: US mortgage loans were packaged and sold on by commercial banks into capital markets. As the US housing market boomed so too did the demand for, and the quantity of, these loans. They were in turn collateralised and loaned on by the capital markets to other niche players and packaged in the newly expanding CDO and CLO markets, which developed quickly due to very low rates of interest, in an environment of plentiful liquidity. And computing power had increased enough to make engineering these new financial instruments viable. The circle was squared by the credit agencies validating these loans by giving high credit ratings to these instruments but some were based on high risk loans in the lower credit quality end of the mortgage market, some of which have now turned bad. As sub prime defaults rose alongside the rise in US interest rates from 1% to 5.25% so concerns spread and risk repricing began in the global financial system, see charts a through to d.
[B] [B][B][B] [B] Financial turmoil reflects re-pricing of risk
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[/B] [/B] [I] Steve Chan, Economist, TD Bank Financial Group [/I]
At the most basic level, markets are in the process of re-pricing risk. In recent years, investors became complacent about what could go wrong and an unsustainably low global interest rate environment encouraged them to purchase ever more risky assets to pick up higher returns. Low borrowing costs and strong income growth also meant that there was tons of money (i.e. liquidity) sloshing around looking for investment opportunities. This created an environment of double digit annual returns in equities, declining interest rate spreads on corporate and emerging market bonds, imprudent lending and borrowing decisions, and valuations that were priced for perfection. When one thinks about the financial climate, there really was only one direction to go and that was down - all that was needed was a catalyst.
[B] [B][B][B] [B] Other Pre-screened Independent Contributors[/B]
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[/B] [/B] [I] J-Chart [/I]
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