The Fed cut the discount rate from 6.25% to 5.75% today in what many economists describe as a “psychological” gesture to boost liquidity in the market. The more important Fed funds rate remained unchanged, but consensus is this will change at the Fed’s September 18th meeting.
A strong yen and residual effects of US subprime loans tanked Asian stocks Friday, as the major indices closed down across the board. Thursday’s meltdown in the US stock market had many jumping ship, fearing a falling US economy would impact manufacturers of electronics and autos in the region. Japan led the way, with the Nikkei closing down almost 5.5%, followed by South Korea and Hong Kong. The “unwinding” of the yen carry trade (where investors borrow yen at low rates, then turn around and lend in other currencies at a higher rate) contributed to the decline, as investors feared a rising yen would further dampen exports to the west.
In response to the continuing snowballing subprime credit fiasco, the markets retreated beyond the 10% threshold to officially enter into “correction” territory today. Investors jumped ship after Countrywide Financial’s credit rating was downgraded and Residential Capital LLC joined the esteemed ranks of companies with “junk” credit status. Housing also torpedoed the market as well, as July starts came in at their lowest in 10 years. Bottom anyone? For the housing market - I think probably so. But in trying times like this I always listen to our buddy Warren Buffett:
“Generally speaking, when there is a certain amount of chaos…the fallout sometimes offers real opportunities”
Hey, it’s not the rosiest of outlooks, but I’ll take it.
Stocks seem to be on the rebound today following an injection of cash by the central banks. Per the Wall Street Journal, the ECB injected the equivalent of $65 billion US into European money markets. The Fed did not act in the US, however, but stated it was prepared to conduct operations if required. This, combined with an announcement by Goldman Sachs that it would rescue one of its ailing quant funds, as well as the release of decent retail sales numbers has helped the markets recover.
The markets just can’t seem to shake the pervasiveness of subprime mortgages, as the credit market continues to tighten in response to further potential losses. According to their website, BNP Paribas is suspending 3 of its funds, citing the inability to calculate a reliable Net Asset Value. Per the company press release, a lack of liquidity is having a spillover effect which impacts even creditworthy securities:
“The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating. The situation is such that it is no longer possible to value fairly the underlying US ABS assets in the three above-mentioned funds. We are therefore unable to calculate a reliable net asset value (“NAV”) for the funds.”
However, total losses due to US subprime mortgages are estimated to be less than 200 billion. Given the current market capitalization of US stocks, this would only be an impact of around 1.5% (which is relatively small). Still, the resulting tightening of credit standards could do even more damage, which has investors concerned today. Futures are pointing to a lower open as Wall Street digests information, as well as relatively weak July retail sales data.
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