A friend of mine asked me how low markets will go from here. If I knew that I would be playing GOD. But I can provide a rational basis for predictably irrational markets. To able to see end of tunnel we need some lights to at least start glowing in terms of stabilizing housing prices, resumption in credit markets functioning, improvements in consumer and business confidence and most importantly the new stimulus package should put some sort of damper around growing unemployment rate. If these events happen then we can say signs of life coming to economy.
Treasury is working jointly with Federal Reserve and created various plans under the umbrella of financial stabilization plan to bring life into economy. It is tackling various problems in the economy through its bailout programs. Housing sector is being supported by treasury’s purchase of agency debt and mortgage backed securities. These two activities were part of Fannie and Freddie’s activities. Treasury is ensuring that mortgage rates remain lower and bring more buyers into the market. Also it is plugging the pressure on housing markets coming from foreclosures. Will these actions bear some fruits? Only time will decide but at least we can say it will not deteriorate drastically. Treasury is doing everything possible to bailout financial sectors. Treasury is pumping money into the recapitalization programs, working plans for removal of toxic securities on banks balance sheets. These actions will start showing slow improvements in the economy. Treasury’s new TALF program will start aiding credit starved nation and jump start securitization industry. Recent stimulus package is aimed at providing state and local governments to start new projects and reduce the rise of unemployment. These factors jointly shall improve consumer and business confidence and leads to increased consumption expenditure and industrial activity.
Risks to above scenario is coming from further weakness in banking sector, ineffective stimulus and further deterioration in real estate sector coming in the form of commercial real estate sector. Also some macro themes that can work against broad based recovery are rise of global protectionism measures.
From here what can be said about individual financial markets
FX markets
USD has become safe haven currency. It will strengthen during this despite domestic weakness
Interest rates markets
Short term libor rates are totally anchored to lower levels.
Long term treasury rates will be rising due to supply of treasury. But international investors purchases will keep a cap on this from going too high.
Equity markets:
Stock markets will weaken further but rally on small good news events.
Commodity sector:
Oil will live for rest of the year under 50. Reason being global unwinding and lack of industrial activity. Even If dollar weakens, gold will benefit but not oil.
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