One phrase you probably haven't been hearing in recent weeks: "do-nothing central banker". The U.S. Federal Reserve and its counterparts have been busy slashing rates, propping up financial institutions, and backstopping credit markets—among other things in an attempt to bring the global financial crisis under control. This week, the spotlight will be on the Fed at its two-day policy meeting beginning on Oct. 28.
What can we expect from Ben Bernanke & Co.? BusinessWeek and S&P MarketScope staff rounded up insights from Wall Street economists and strategists on this topic and other key economic and financial-market issues on Oct. 27:
Michael Englund, Action Economics
The Fed will post large downward growth and inflation forecast revisions at the Federal Open Market Committee (FOMC) meeting tomorrow and Wednesday as it factors in the deterioration in conditions since August. We assume no change in the 1.50% Fed funds target that implies an actual 1.15% rate, equal to the rate for excess reserves. To satisfy hopes for a cut while trimming the impact, the Fed could eliminate the spread to the excess reserve rate and cut the "target" to 1.0%, which would leave an actual easing of 15 basis points, to a rate nearly in line with the 0.96% implied by Fed fund futures. We still believe that the Fed would prefer to preserve rate cuts as bargaining chips for announced global moves separate from the FOMC schedule, though policymakers may prove unwilling to buck market pressure for action now.
Tony Crescenzi, Miller Tabak
The Fed will initiate its Commercial Paper Funding Facility (CPFF) [on Oct. 27], a special-purpose vehicle (SPV) funded at a spread to the three-month overnight indexed swap rate, now 0.89%. The Fed said roughly $1.3 trillion of the $1.5 trillion of commercial paper outstanding would be eligible for the program. This is an enormous backstop. Further backstopping the CP market is the Fed's Money Market Investor Funding Facility, announced [on Oct. 18]. The MMIFF will fund SPVs with up to $540 billion, with the specific intention of enabling the SPV to purchase eligible money market instruments from eligible investors, including money market mutual funds.
By blanketing the commercial paper market, which has contracted by about $365 billion over the past six weeks, to $1.449 trillion, the commercial paper market will function better. It will also stop the surge in the corporate sector's tapping of bank credit lines. In turn, more cash will be available for inter-bank lending and help the financial system work better. The credit crisis first saw massive impact by hitting the commercial paper market in the summer of 2007. Perhaps it will see its end begin in this critical market.
Tobias Levkovich, Citigroup
As some measures of credit tightness ease such as LIBOR, there is a noticeable return to considering earnings fundamentals as a signal for equity market direction. The most significant uncertainty rests on the extent of the deterioration given a broadening array of possible sources of disappointment. When reviewing past recessions, the average earnings slide has been around 13%, with a range of 22% plunges in 1990-91 and 2001-02 to an almost imperceptible 3% drop in 1949. Weakening economic trends abroad and plummeting commodity prices argue for more earnings-per-share problems…[C]ontinued dollar strength is also nipping at currency translation benefits.
Yet there is some optimism building for the 2009 second half and earnings estimates revision trends are at recession-like lows. As we have noted in the past, the S&P 500 appears to be discounting annual earnings of $50/share. Identifying new buyers remains a challenge, however, as redemptions at hedge funds and mutual funds restrain demand. Meanwhile, pension funds and sovereign wealth funds seem reluctant to buy until some bottom is recognized. Indeed, looking for a trough suggests that investor capitulation has not yet occurred given the need for apathy to develop. In an environment where near-irrational selling would have protected investors far more than a sensible or thoughtful process might have, citing the litany of valuation and past bottoming indicators almost seems moot.
David Wyss, Standard & Poor's
Although there are signs that the housing market is reaching a bottom, the housing crisis still has a choke-hold on America. RealtyTrac reported that foreclosure filings on U.S. properties in the third quarter were up 3% from the previous quarter and up 71% from a year ago. Foreclosure filings were down 12% in September from the record-high number of filings in August, although this was caused largely by decisions by several states—such as California and North Carolina—to relax at least temporarily the housing laws. Already indicated in the September home sales data, increased bank-owned homes for sale could push down prices even more, though it might also start to attract bargain hunters to help absorb some the large inventory of unsold homes.
As foreclosures continue to wreak havoc across the nation's housing market, the U.S. government has announced a number of efforts to absorb toxic debt and shore-up investor confidence. In this regard, Sheila Bair, chairwoman of the FDIC, told the Senate Banking Committee on Oct. 23 that her agency and the Treasury Dept. are working closely to find ways to prevent avoidable foreclosures. The plan would use the Treasury Secretary's new authority under the Emergency Economic Stabilization Act to provide guarantees to mortgage lenders. Bair said loan guarantees could be used as an incentive for servicers to modify loans, where the government could "establish standards for loan modifications and provide guarantees for loans meeting those standards." In this way, she said, "unaffordable loans could be converted into loans that are sustainable over the long term."