Monitoring the Crisis

Investors and policy makers are looking at new ways to monitor the financial crisis. After Lehman failed last September, there were clear metrics. For example, the spread between LIBO and the Overnight Index Swaps (OIS) and the spread between T-bills and LIBOR (TED spread) were widely used. While these metrics, popular thermometers for gauging the patient’s fever, have cooled somewhat, they still remain elevated. The TED spread for example peaked on October 10th near 464 basis points and has been flirting with the 100 basis point level most of this month. Prior to the crisis, the TED spread would typically average between 20 and 40 basis points.

Moreover, part of the improvement has been a function of government or central bank fiat. Yet as was already widely appreciated, easing a patient’s fever is not the same as curing the illness. We need to compliment our current tools with new metrics and that is the purpose of this note.

Thoughts on the FOMC: Ten Points

I. The Federal Reserve Open Market Committee holds a two-day meeting this week, with the outcome anticipated near 2:15 pm on Wednesday, January 28. There is little doubt that the Fed funds target of 0-25 bp will be retained. The accompanying statement will receive the market’s full attention.

II. The data since the mid-Dec FOMC meeting has been dreadful and this will prevent a substantive change in the Fed’s assessment. Labor market conditions have continued to deteriorate. Consumer spending, business investment and industrial production figures are poor. The outlook for continued weakening of economic activity will be retained.

A Crisis with Chinese Characteristics

There is no doubt that the advanced industrialized countries are deep in an economic downturn. Given that consensus expectations continue to overshoot the actual data, it appears that many still do not fully appreciate the magnitude. The fact that policy makers continue to cut growth forecasts implies they too have not appreciated the depth of the downturn.

There is hope in many quarters that the Chinese economy, which after passing Germany last year is the world’s third largest, will remain relatively insulated. This optimism is based on structural factors, such as where China is in the industrialization process, the command features of its capitalist economy with Chinese characteristics, and the vast resources it can bring to bear. Late last year, China announced a CNY4 trillion fiscal package and on January 11th Premier Wen Jiabao promised it would be increased.

The Future of the Strong Dollar Policy

Shortly after Barrack Obama is sworn in next week as the 44th President of the United States, the strong dollar policy turns 14 years old. It may not be much of an exaggeration to suggest as goes Obama’s dollar policy so goes his Administration.

This is not to endorse overly simplistic notions that the dollar is like stock in America. There are a multitude of factors that influence the price of the dollar not all of which have to do with what happens in the United States, like the conduct of foreign monetary and fiscal policy. Rather, a number of issues are involved in dollar policy and the judgments used to resolve them will be reflective of characteristics that may define Obama’s Administration.

CNBC: Bullish on the Dollar

Feel the Elephant

There is a parable about the human condition that is particularly apropos for investors in the current investment climate characterized by high volatility and great uncertainty. Five blind men walking through the jungle stumble on an elephant. But of course they don’t know it is an elephant because they are blind. One feels the tail and say’s it is a snake. One feels the side and says “No, it’s a wall.” Another feels the tusk and thinks it’s a spear. Another thinks the ear is a large leaf.

Like the blind men, our information set is fundamentally and irrevocably incomplete. Yet we nevertheless have to make judgments and decisions. So with that caveat, let me tell you about the part of the elephant that I am feeling here at the start of 2009.

No Exit For Japan

Early word from the G8 meeting, like the EU fin min meeting, is that officials recognize that it is premature to enact exit strategies from the emergency facilities and actions to address the economic and financial crisis.

The BOJ is the next major central bank to meet. It will hold its meeting on July 14th-15th. Its current program, which includes purchasing commercial paper, corporate bonds unlimited loans to commercial banks, are set to expire at the end of the September. There is some speculation that the BOJ may want to be pro-active and indicate an extension of the programs rather than waiting for either next month or September. This would send, arguably, important signals to the market about the BOJ commitment and lift some degree of uncertainty. Now is not the time, so the argument goes, for strategic ambiguity.