After a 500 point loss, where next?

It’s 8AM on the morning after a 500 point loss on the Dow. It could have been a lot worse, honestly. So I’m happy to have gotten away with that. Nevertheless, trading in Asia was not exactly confidence building with the Nikkei 225 down 5%. Europe is down another couple of percent too. So where do we go from here?

If I were a clairvoyant, I could tell you, but since I’m not, you’ll have to make due with my measured opinion. I think we are headed for more volatility, yes. And we are going to see some major bankruptcies outside of Lehman, yes. But, there are a lot of things that could support the markets going forward, chief among them a robust policy response.

Today, at 8:30 AM EDT, the inflation numbers for the United States come out. What do I expect to see? Some, but not a ton of inflation relief. (Even if the CPI Index is flat, inflation will rise to 5.8% on the year). However, with WTI Crude futures down below $93 and Brent below $90, that’s a shed load of inflation relief in the pipeline. If we don’t see good numbers today, we are going to see nice numbers in October. That’s hugely supportive to financial markets.

Then, later today, the Fed is meeting and deciding on interest rate policy. I expect them to be pretty dovish. If the inflation number is good, we will see a 25bp cut is my prediction. Even if the number is not good, they’ll potentially cut. The U.S. needs a steep yield curve to rebuild earnings in the banking sector and low short-term rates are the only way to get there with long-term rates so low. The Fed is not particularly hawkish so I think they want to cut and just need the excuse to do so. Whether they should cut is a debate for another time.

Also supporting the markets are low long-term and mortgage interest rates. With the recent flight to quality (i.e. government bonds) and the Fed’s bailout of Frannie, you have a lot of stimulus implicitly added through lower long term rates. This should be supportive of credit markets, particularly the U.S. housing market.

On the other side of all that, we have continued jitters in the financial services sector. Last night both Washington Mutual and AIG suffered debt ratings downgrades. WaMu bonds are now considered junk. And then there’s Lehman Brothers, now bankrupt, with a massive unwind staring us in the face. They could be unloading a lot of paper over the next few weeks and that will not be good for financial markets – equity, debt or derivative. My personal view is that assets in currencies like the Swiss Franc and Singapore Dollar are looking very good right now. So are gold and silver.

There you have it, we’re set up for an eventful day. Everything is certainly not doom and gloom. But, we are by no means out of the woods yet.

  1. pej says

    The market is not going down, it’s actually going up, waiting for the fed and paulson the saviors to do something. (Bernanke+Paulson PUT)

    What happening in the US is simply disgusting.

  2. Edward Harrison says

    If you thought things were a joke when you wrote tat, what do you think now? It seems like the Feds are pulling out all the stops to prevent the markets from correcting down.

    I understand their concern — Depression and deflation. But it seems so predictable.

  3. pej says

    Unfortunately, I wasn’t joking. Market corrections are normal and clean up the excesses. But after 18 years of Greenspan and several years of Bernanke, the excesses are totally unbearable. It took a few billions to lift up the markets in 2000, it took a several dozens of billions a few months ago, then everything is accelerating more and more and we are now at the stage where hundreds of billions or even trillions of USD are required. Notice that they just want to lift the markets and bail out their friends in Wall Street. They do not care about the people who are losing their jobs and their HOMES. They didn’t try to prevent the massive bubble and the over leveraging through dept from people who didn’t understand what they were doing.

    Through dept and inflation, they have enslaved the people. You have to work more and more to achieve the same standard of living, since your savings are continuously wiped through this stealth tax and that you need to repay the bank for the next 25 or 30 years.

    This self system is reaching its limit, which is a good thing, but unfortunately, the people who where profiting from it don’t want to let go…

    Hopefully, we are at the tipping point where the Fed and the Treasury are not relevant anymore. Trillions cannot be pumped into the system as easily as billions.

    Please read this post as well:

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