The stock market's head-snapping volatility continues, with the Dow Jones industrial average posting an 800-point swing during the Oct. 16 session, ultimately finishing 400 points higher. The market's extreme gyrations, along with some gloomy data on the U.S. manufacturing sector and central bankers' ongoing efforts to bolster the global financial system, were much on the minds of Wall Street strategists and economists. BusinessWeek and S&P MarketScope staff assembled some insights from the pros on Oct. 16.
Action Economics
The U.S. VIX equity volatility index set a record above 81.0 [on Oct. 16] as back-to-back steep declines on Wall Street and unease in the financial sector appeared to be spreading to Main Street. From Tuesday lows near 53.65, the "fear gauge" surged more than 27 points before pulling back to 67.61. Volatility continues to be the main winner of the credit crisis, with hedge funds now pressured by redemptions and closures to unwind commodity, equity, debt, and carry-trade bets.
Marc Chandler, Brown Brothers Harriman, New York
Officials have taken huge measures to ease the money market strain. And yet interbank rates remain elevated at levels that continue to threaten the broader economy. What else can officials do? There are a few other steps that policymakers can take. First, rather than still try to target overnight rates (Fed funds in the U.S.) or the refi rate (euro zone), for example, officials can engage in a quantitative ease—target, for example, money supply—like [former Federal Reserve Chairman Paul] Volcker did, though for opposite reasons. Second, policymakers can force—yes, [it will be] unpleasant—contracts to be reset from the London interbank offered rate (LIBOR) to the Fed funds target. Third, if financial intermediaries are unable or unwilling to do their jobs—lending money—the government or central bank may have to consider stepping into the breach.
This of course is not intended to be a comprehensive list. Rather the purpose of the exercise is to suggest some new measures officials may contemplate. Owing to the opaqueness of the instruments and system, it is not clear how much more deleveraging is still left to be done. The elevated interbank rates are like a fever—the symptom of a deeper problem. The patient can remain sick even after the fever breaks. Rates will remain high until the deleveraging eases—until the demand for money—in particular, dollars—is satiated.
Tony Crescenzi, Miller Tabak, New York
LIBOR is probably set to begin falling, perhaps sharply in response to not only the massive support measures announced by the G-7, but also because of the announcement Monday by the Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank regarding actions commenced yesterday by the BOE, ECB, and SNB wherein each offered an unlimited supply of dollars at fixed interest rates, which in yesterday's auction, or tender, was substantially below LIBOR. The auctions will be for 7, 28, and 84 days (the first 28-day will be on Monday and the first 84-day will be Nov. 3), and the unlimited scope marks a sharp contrast to recent times that have seen, for example, paltry sums such as $25 billion made available—far lower than demand, as gauged by recent tender results.
Eventually, the lower rates paid on loans granted by the central banks will reduce LIBOR, both because of the rate effect, and because banks are now more likely to meet their dollar needs, and the market will hence become sated with dollars.
David Wyss, Standard & Poor's
Industrial production plunged 2.8% in September, reflecting hurricanes, the Boeing (BA) strike, and weaker capital spending. The drop was much worse than the 0.8% expected by the market. Manufacturing production fell 2.6%, with aerospace off 16.6% because of the Boeing strike. Machinery output was down 3.3%. Sharp declines in petroleum (down 9.2%) and chemicals (down 3.0%) were caused by hurricane-related shutdowns in the Gulf. Similarly, the 7.8% drop in mining output was caused by the hurricanes' impact on production. Utility output was up 2.2%, rebounding from a 3.1% August drop because of more normal temperatures. Industrial production is down 4.5% from a year ago, and manufacturing output is down 4.8%. Capacity utilization plunged to 76.4% from 78.7%. In manufacturing, utilization fell to 74.5% from 76.6%.
The October Philadelphia Federal Reserve survey of third-district manufacturers showed a plunge in business conditions to negative 37.5 from positive 3.8 in September. The market consensus was for a drop to minus 10. Even the expectations index fell into negative territory for the first time since 2001, to negative 4.2 from plus 30.8.
The data confirm the sudden weakening of the manufacturing sector, and suggest the recession will be deeper than we had thought.