Friday, December 19, 2008
There is a slew of bad economic news out there, but finally a glimmer of light emerges. The light is dull – a 40-watt rather than 200-watt light bulb- but is nevertheless there: Fed policy is working.
What is Fed policy? Fed policy is massive:
- Adding $1.4 trillion in liquidity to the domestic and global banking systems via loanable funds and currency swaps
- Making unprecedented loans to the private sector, American International Group and Bear Stearns
- Buying agency bonds directly
- Creating demand in the commercial paper market with $315 billion net transactions
- Using the Treasury to sterilize inflows
- On the horizon: buying U.S. Treasuries directly, mortgage-backed securities (MBS), and perhaps other instruments not yet mentioned (CDS, corporate debt, etc.)
Corporate spreads are stabilizing if not falling
The chart illustrates corporate bond indices for investment grade and high yield corporate bonds since the beginning of the year. A sign of relief is emerging as corporate bonds spreads - borrowing costs for investment grade and high yield companies - stabilize, even fall.
Corporate bond rates are important - the higher are the costs to borrow, the lower will the borrowing be for new capital investment. See this post to for corporate bond spread indices (against Treasuries) on a longer horizon.
The money supply – all measures of – is growing faster on a weekly basis
And surging on an annual basis
The chart illustrates various measures of the U.S. money supply (the data and definitions are listed here). The growth rate of non-M1 components of M2 (Table 4) started to fall slightly at the end of October, but has since then picked up speed. The 4-week average M2 – a better look at the trend – is growing at a record 8%. Finally, M3 (at least most of M3) is slowing on an annual, but it is reverting back to its longer-term trend rather than falling off a cliff. The Fed is keeping the money supply afloat; this will offset some of the negative price pressures going forward.
Mortgage rates are falling
Who said that traditional monetary policy – cutting the target federal funds rate – was dead, because clearly it is not. In the wake of the Fed’s December 16th announcement, mortgage rates fell with force to 5.27% (as of 7am on December 19th from Bankrate.com). And with the Fed gearing up for its $500 billion MBS program, I expect that mortgage rates will fall further, potentially driving up buyer demand in the housing market.
It looks like the U.S. economy is just skirting a financial meltdown. Phew, now we have a recession to contend with.