Don’t be surprised if the US Federal Reserve stops cutting interest rates and joins our Reserve Bank in sitting on its hands for a while for similar reasons.
Both will want to see how the impact of recent monetary policy moves will play out in the wider economy.
Our central bank won’t do anything at its board meeting next month after pouring over the March quarter Consumer Price Index this week.
A one percentage point rise in official rates and up to 0.40% in extra increases from the banks in less than year is a very sharp tightening in policy and seems to have come at a time when the overheating economy was just starting to tip over into slowdown. That slowdown has accelerated.
But this week we will see just what level of price pressures remain in the economy.
For the Fed, it’s the reverse: it has cut rates by three percentage points since September (our rate first of four official rises happened in August, three days before the credit crunch erupted).
There’s a belief that if it does cut, it will be 0.25% to 2% where it will sit for some months: if it does that there will be a signal in the statement after the April 29/30 meeting ends.
But there’s a growing minority of analysts who reckon there’s a good chance the Fed will leave rates alone.
Looking at the way bond prices have risen dropped as yields across the curve has risen, that’s a solid tip.
US 10 year bond yields rose by more than a quarter of a per cent last week to finish at 3.71% after briefly reaching over 3.8% at one stage late last week.
In fact there was a sell off of US Treasuries as investors took their cash to put back into the market and into commodities and other riskier investments. (Within reason, no one is asking, ‘more subprime mortgages, please’.)
The Consumer and Producer Price Indexes for March were not too worrying, but in the year to the end of that month, they rose over 6% and 4% respectively, as oil, transportation and food prices soared.
Consumer demand is being battered by the rising cost of petrol, heating oil and food: and the Fed’s version of inflation strips out most of these costs (as does our core readings of inflation here). Retail sales are very soft.
The $US162 billion one-off rebate will be issued next month which may help the Fed justify sitting on its hands for a couple of months.
It has saved Bear Stearns and started funding the US banking and financial sector with billions of dollars of cash a day via special auctions to swap poor quality asset backed securities for high quality US Treasury securities which are second only to cash. That happened from March 14 to March 17 and that changed the atmosphere in markets, which have risen sharply since in the US and Asia (except China).
In remarks last week several senior Fed members voiced concerns about rising prices and inflation. That, plus the performance of markets and the ease with which big US banks have raised $US20 billion in a week in new capital, has set off a round of speculation about a rate sit and not a cut, at the end of the month.
Also, in a potential sign of renewed financial market pressures, the three-month London Interbank Offered Rate jumped from 2.73% on April 16 to 2.91% on Thursday as British banks tremble at a imploding mortgage market, rising bad debts and the unsettling experience of the failure and nationalisation of Northern Rock.
The huge RBS bank (Royal Bank of Scotland) is due to reveal the terms of a mooted rights issue that could be the biggest in history at around $US20 billion.
It will be done at a big discount to the share price last week and it could come with some sort of commitment from the CEO, Sir Fred Goodwin, for change at the top, including his role. RBS will reveal big losses tonight and other details as it prepares the market for the funding.
That will be as much as Citigroup, Washington Mutual and Wachovia raised last week and could be the first as British commentators wonder if the country’s banks can maintain their current business models without new capital injections.
The Bank of England will expand the types of securities it is willing to use in repos and other funding deals with the banks: it is funding the banks to the tune of billions of dollars a day like the Fed and now the big price is to be paid by the banks and existing shareholders.
Normally that would not worry the Fed, but the US and UK banking systems have become interdependent in the past five years of cheap money and the growth of London as the world’s biggest forex market and the major trading centre for Europe.
British, Swiss, French and German banks have tens of billions in subprime and other losses: UBS has been crippled.
The Fed’s rescue of Bear Stearns (through JP Morgan) has seemingly stabilised the US markets, but not Europe.
The sell-off in the US Treasury market on the belief that the worst was over and risk was now coming back into favour, sent mortgage rates soaring.
Which is going to be bad news for banks, building companies, retailers, borrowers, of course, and the US economy.
The yield on the 10-year Treasury bond hit a high of 3.85% on Friday from less than 3.50% a week earlier as investors sold bonds on expectations that the Federal Reserve could soon end its rate-cutting cycle.
The Fed sees the rise in yields as signalling increased market confidence in US economic prospects.
However, mortgage rates also moved higher, making it more expensive to buy homes and less likely that existing homeowners will be able to refinance mortgages.
Rates on 30-year fixed-rate mortgages rose to 5.87% from 5.63% a week ago and Jumbo mortgages, those of more than $US417,000, rose to 7.19% from 7.06%.
This means that those with so-called ARMs (adjustable rate mortgages) face an unpleasant experience if their loans reset from this week onwards.
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