Sunday, December 2, 2007

More Financial Upheaval

Don't Look Now: But the U.S. Economy Is Bleeding Cash

These days, it seems like the U.S. economy has a gigantic hole in it, that slowly leaks all the cash out of the economy. Every time you turn around, the Fed has to inject another round of cash into the banking system.
When will it end? You know the economy is still shaky when the Fed has to allow the banks to borrow money just to ensure they stay working properly.
By this point, Bernanke and the rest of his Fed buddies must be afraid there won't be enough cash left in the banking system to handle the year-end buying this holiday season. Around this time, each year, consumers take more money out of their banks and get more loans to finance larger Christmas presents.
Some Fed Band-Aids Won't Heal a Hemorrhaging Economy
So what is the Fed doing about it? They've still got one trick left up their sleeves: Repos. Repos are a repurchase agreement. Basically, the Fed agrees to temporarily buy back U.S. Treasuries, mortgage backed debt and agency debt for a period of time. So as they "pay" the banks for these, it injects cash into the U.S. banking system.
However, these are just short-term arrangements. The banks eventually have to pay back the Fed in about a month or so. For instance, the Fed purchased a series of these "repos" starting on November 28th and they'll continue doing this on into January.
So the banks will have to buy back the repos the Fed bought on November 28th on January 10th. So these are fairly short-term arrangements (or "band-aids" as I like to call them).
Repos are not permanent solutions to the problems plaguing Main Street or Wall Street. They help out when the economy experiences these tremors. However, by using them, the Fed is showing that they understand the economy is still shaky. In fact, in the last Fed minutes, they stated that the economy is "still fragile."
So what does this mean for the U.S. economy? It means we're not out of the woods yet. We're still on shaky ground. The big "Wall Streeters" know it too. That's why they're selling every stock rally that comes its way. So no one is convinced yet that we'll avoid a recession in America.
We also know that banks have been reluctant to lend lately. That's why the overnight lending rate between banks has exceeded the Fed's target the last seven of the past eight days.
The New York Fed stated that it would "provide sufficient reserves to resist upward pressures" on money market accounts through the year's end.
Cut, Cut, Cut
So evidently, the cash injections that the Fed started on August 10th haven't stopped yet. Also, the Fed will meet to discuss interest rates in two weeks. The Fed Funds futures predict a 90% chance of another rate cut from the Fed at that meeting. I bet they're right.
The Fed still needs to give the economy that "shot in the arm" that it needs. Cutting rates is one of the best ways to do it. However, even shots in the arm take time to take effect. Fed actions on interest rates take six to nine months to affect the economy. So don't look for them to be able to save the economy tomorrow. This stuff takes time.
So in the long run, look for more U.S. dollar weakness. The biggest beneficiaries of the dollar fall may be the euro and the Australian dollar.
Both of these economies have held up much better than the U.S., so the scared money may very well run to these shores as a temporary "safe haven." If so, look for EUR/USD and AUD/USD to head higher in the upcoming weeks to months.

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