The equity markets trended lower as market participants took some profits off the table. Prices of long-dated treasuries rose today after the Fed purchased $3.51 billion of treasury bonds with maturities ranging 2026 to 2038 in an attempt to keep mortgage rates low. The Fed's attempt to reinvigorate the economy through interest rates is today's topic of discussion.
Many strategists are calling so a so-called "V-shaped recovery". Such a cycle is marked by a rapid economic decline (as we have just experienced) followed by a rapid recovery. However, no such recovery is possible as long as economic stability, never mind growth, is due to Fed policy. Many pundits point to the three-month LIBOR rate being below 1.00%. LIBOR rates have fallen due to the Fed's short-term borrowing programs and plan to buy commercial paper. Because banks can fund their short-term needs through the Fed, interbank lending has increased. The Fed is responsible for bank confidence. Mortgage rates have fallen, but not because banks are more comfortable lending for any fundamental reasons. The Fed's large purchases of treasuries, agencies and agency MBS has pushed rated lower. The Fed's extraordinary stimuli is barely keeping us flat.
Some pundits point to the fact that, other than food, energy and home prices, there isn't much deflation. That is because that, outside of food, energy and home prices, there wasn't much inflation in the years immediately preceding the recession. Prices will may not fall if they had not risen sharply during the economic boom years. If artificially low rates can only help us find a bottom, whet gets the economy back to on trend growth?
The question should be: What will on trend growth once the Fed stimulus programs are removed (after all, they cannot go on forever)? The answer is probably a long slow climb out of the economic hole we are currently in. Stifel Nicolaus strategist Joe Battipaglia believes that an elongated and modest recovery is probably in the cards. I agree with him.
Bond prices of bank bonds have improved since the release of the stress test results last Friday. It does not seem to matter that the test was not very stringent and the Fed cut some banks considerable breaks. However, the so-called Bank Vigilantes (my name for market participants who would push bank bond and stock prices lower as long as damage from toxic assets to bank balance sheets remained undisclosed) have been appeased by the stress tests. They have been appeased to the point that banks such as BAC, MS, BBT, Wachovia and just about every large bank other than Citi has been able to raise equity capital via IPOs to satisfy stress test requirements and banks have been able to issue non-FDIC guaranteed bonds to repay TARP. Banks want to separate from the government as soon as possible. Investors have been eager to invest in banks which seem poised to cut the cord. So much for the idea of investing along side of the government. Banks and their investors want to be as far from the government as is possible.
The bulls have used some ridiculous examples to prove that the economy is returning to "normal". Not only have they pointed to the lack of deflation within core economic sectors (where inflation has been tame for almost a decade), but they are pointing to percentage gains of stock prices among troubled banks. I'm sorry, a bank's stock rising from $2 to $4 could be viewed as positive, bit if that follows a decline from $30.
Again, I am not saying that the U.S. is sinking into an economic abyss just that the recovery will be long and drawn out. Bonds will rule. Corporate bonds continue to offer the best bang for the buck, but credit spreads continue to narrow as investors take cash off the sidelines. Beware anti-growth policies from the administration and Congress.
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