Don Miller (Money Morning):
The U.S. Federal Reserve may take an unorthodox approach to raising interest rates by paying interest on bank reserves rather than relying on traditional open market remedies, as it exits from its long-term fiscal stimulus programs, Reuters reported today (Tuesday).

Paying interest on reserves is mostly untested and would represent an unexpected twist in the Fed’s response to the financial meltdown.

“In the old days … the Fed controlled the federal funds rate with open market operations,” Antulio Bomfim, a former Fed economist now with Macroeconomic Advisors LLC in Washington told Reuters. “Now, at least in this period when reserves are over-abundant, the way the Fed hopes to raise the federal funds rate will be primarily by raising the interest rate it pays on reserves.”

Usually, when the central bank wants to set a target for the federal funds rate it buys or sells Treasury securities on the open market, influencing interest rates by deploying or withdrawing capital.

By paying interest on reserves, the Fed makes it attractive for banks to keep their money at the central bank as long as interest rates in private markets are lower.

By doing that, the Fed can put a floor under the lending rate that banks charge each other for overnight loans, which is the central bank’s traditional choice for influencing the economy. Open market operations to raise interest rates would be relegated to a supporting role in the initial stages of tightening.

In order to spark an economy mired in deep recession . . . Click here to read the rest of Mr. Miller’s article.

• The U.S. Federal Reserve has opted to hold the federal funds rate at 0% to .25% and “continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the central bank said in a statement yesterday (Wednesday). Information the Fed received since its last meeting in April suggests “the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months.”

• As unemployment in the United States is expected to keep rising, the world’s largest economy may need another stimulus package, billionaire Warren Buffett said in a Bloomberg Televisioninterview. “It looks like we’re going to need more medicine, not less,” Buffett said. “We’re going to have more unemployment. The recovery really hasn’t got going.” Buffett, who like many economists sees the unemployment rate surpassing 10%, said the economy “hasn’t turned yet. There’s no telling how long it will take. It will happen.”

• The Methodist University Hospital Transplant Institute in Memphis, Tenn. confirmed a weekend Wall Street Journal reportthat said Apple Inc. (Nasdaq: AAPL) Chief Executive Officer Steve Jobs had a liver transplant. The confirmation came with the permission of Jobs, who has an “excellent prognosis.” The hospital did not say when the transplant took place, but The Journal puts the procedure at sometime in April, citing an unnamed source. Billionaire investor and Berkshire Hathaway Inc. (NYSE: BRK.A,BRK.B) Chairman and Chief Executive Officer Warren Buffett weighed in on the controversy on whether Jobs should have revealed his condition to investors in an interview with CNBC: “If I have any serious illness, or something coming up of an important nature, an operation or anything like that, I think the thing to do is just tell the American public, the Berkshire shareholders about it. I work for ‘em. Some people might think I’m important to the company. Certainly Steve Jobs is important to Apple. So it’s a material fact.”

• Although gas prices are significantly lower than they were at this time last year, fewer Americans will be traveling on July Fourth weekend, according to a survey by AAA. The auto club expects 37.1 million travelers, or 12% of the U.S. population to take a trip of 50 miles or more from home this year, a decrease of 1.9% from last year and a 12% decrease from 2007, months before the recession began. Factors such as the rising unemployment rate and sagging personal incomes are to blame for the drop in travel, AAA said.

• The world’s largest seed maker suffered a 14% drop in profit and disclosed plans to cut 900 jobs, blaming the deteriorating performance of its mainstay revenue source. Monsanto Co.(NYSE: MON) reported a net income of $694 million, or $1.25 per diluted share on revenue of $3.1 billion for the third quarter. That compares to a net income of $811 million, or $1.45 per share on revenue of $3.5 billion in the same quarter last year. Executives were not expecting a drop in performance of the herbicide Roundup, once a primary revenue source for the company. Several generic products hurt the prices for Roundup and profit on the product is expected to drop by half this year, Monsanto said. Shares for the company closed yesterday (Wednesday) at 76.16, down 3.9%.

• The Securities and Exchange Commission (SEC) voted unanimously to institute tough new rules for money market funds to help avoid a repeat of what happened when the collapse of the Reserve Primary Fund triggered a flurry of redemptions in the $3.6 trillion market. The proposal will prohibit money market funds from buying illiquid securities and requiring them to hold at least 5% in liquid securities such as cash. “These proposals are designed to increase the ability of money market funds to weather future economic storms,” said SEC Chairman Mary Schapiro. “The stability of money market funds in times of turmoil is enormously important both for investors and for the securities markets. The proposals also would improve the operations of money market funds and oversight of their investments during calmer times, which can further protect funds and increase public awareness of potential risks.”

• The worst recession in 60 years has taken its toll on everyone, including the millionaire’s club. According to a report from Merrill Lynch Global Wealth Management and consulting firm Capgemini, the number of people with assets of between $1 million and $30 million fell by 14.9%, BusinessWeek reported. The drop in millionaires represents the largest decline in the report’s 13-year history, said Ileana van der Linde, a principal with Capgemini. “We’ve never seen such a decline in all the years we’ve been doing the report,” she said. The recession has now reduced the cumulative wealth of the world’s millionaires by 19.5% to $32.8 trillion.

Source: Investment News Briefs Thursday, June 25, 2009

There is certainly more stimulus than in any previous recession. The benchmark Federal Funds rate is essentially at zero, which has never previously been attempted, while inflation is still positive. The money supply has been increased by almost 20% in the last three months, which one would normally expect to lead to higher inflation.

On the fiscal side, the $1.19 trillion deficit forecast by the CBO is 8.3% of gross domestic product (GDP), considerably higher than the previous record of 6% of GDP in the recession-ridden year of 1983. And that deficit calculation doesn’t include President-elect Obama’s stimulus plan, which at $800 billion over two years could add $400 billion to the deficit and push it to more than 10% of GDP.

With both monetary and fiscal stimulus stronger than ever before in peacetime, the government is running the economy absolutely flat-out. Only if you thought the government had no effect at all on economic activity could you believe that recession and deflation would continue.

The initial rationale for all of this stimulus was the unprecedented nature of the housing finance disaster, with drops in market prices and loan-loss levels not seen since the Great Depression. Had the U.S. banking system imploded – as it seemed destined to back in September – the resulting recession could indeed have rivaled the Great Depression.

However the $350 billion from the first tranche of the Troubled Assets Relief Program (TARP), mostly invested directly into bank capital (although a number of banks admittedly used the taxpayer-provided infusion to play “let’s make a deal“), appears to have stabilized matters.

JP Morgan Chase & Co. (JPM), for example, is expected to make losses of around $2 billion in the fourth quarter of 2008 – a nasty result to be sure but by no means unexpected in a quarter when stock markets dropped 20% and illiquidity was at its height. With $25 billion of new capital from Uncle Sam, JP Morgan now has plenty of wiggle-room to survive – even in an extended downturn.

In 2009, further trouble may lurk for the weaker U.S. banks, but strong banks like JPM should gain market share and do quite well.

With liquidity now largely restored by both the TARP and by federal asset purchases, there would seem no reason why the banks’ corporate lending should be any more restricted than in previous moderate recessions. In those circumstances, the unprecedented fiscal and monetary stimulus should, in the short-term, produce a stock market bounce, an economic recovery, a dramatic run-up in the price of gold, and soaring inflation, in that order.

The conventional wisdom is that the U.S. economy will have a very difficult first half, but that recovery may appear in the second half of 2009.

These things are very difficult to predict, but my money would be on precisely the reverse scenario: The stock market will be strong in the short-term, and economic numbers will turn around quite rapidly, perhaps even producing modest first-quarter GDP growth, and quite robust economic growth in the second quarter.

By late summer, however, the resurgence in inflation and financing difficulties in the U.S. Treasury bond market will cause an increase in long-term interest rates, accompanied by a reassessment of the U.S. Federal Reserve’s 0% short-term interest rate policy.

That will cause the stock market to reverse direction and head downward.

Serious consumer price inflation will take longer to appear. But by the end of the year and in the first half of 2010, prices will be rapidly rising. Accordingly, both the Fed and the Obama administration will have to begin reversing their stimulative policies, raising interest rates and cutting public spending – or even raising taxes. The policy reversal will cause a second economic downturn, but one that’s of a very different nature from the first.

The current downturn has been caused by a collapse in asset prices, and has been reversed by exceptionally strong monetary and fiscal stimulus policies. However, the second downturn will be sparked by a crisis in the long-term bond markets, will be more concentrated on the real economy than on just the financial sector, and is likely to be much more prolonged since fiscal and monetary policies will be forced to be restrictive.

Monetary policy will have to be tightened to fight surging inflation, while fiscal policy will foster a lengthy battle in the administration and in Congress between the economic necessity of austerity and its hugely unattractive political effects.

Reversing such extreme fiscal and monetary policies will be exceptionally painful, and the second leg of the recession will thus be exceptionally damaging to U.S. corporate profits and to U.S. stock prices. The stock market is likely to take out its November lows by a considerable margin, although at its nadir it will offer patient investors an exceptional long-term bargain – just as it did in 1932, 1949 and 1982, with high real long-term returns for those bold enough to invest.

Currently, the balance of probabilities favors a rising market in the short term – perhaps even rising quite sharply because of the exceptional strength of the current monetary and fiscal stimulus. Gold and gold-mining shares should do particularly well.

Let’s enjoy this projected short-term bull run while it lasts!

Source: Obama’s Stimulus Plan: When is There “Too Much” Stimulus?

As we suspected, the Fed went for broke yesterday. We predict it will work: we will go broke!

“Fed effectively cuts its key rate to zero,” is how today’s International Herald Tribune brings the news.

This year has been a 1929 rerun. The feds don’t want to see the ’30s too.

Investors were buoyed up by the news. The Dow rose 360 points. Gold rose $6 too – to $842. If it can hold above $838, it will end the year in positive territory. Get your gold while the going is good…and the price is still reasonable.

“Going further than analysts anticipated, the central bank cut its target for federal funds rate to a range of zero to 0.25%, a record low, bringing the United States to the zero-rate policies that Japan used for six years in its own fight against deflation.”

As predicted, the US follows the Japanese model…and its own model from the ’30s…the ’70s…’80s…’90s…and ’00s. Borrow it, lend it, spend it and print it. Money, that is.

It doesn’t seem to bother anyone that these policies don’t work. Last time we looked, Japan was still in the on-again, off-again deflation/recession it’s been in for the last 18 years. And more recently, Japan’s share market is at a 22-year low. A whole generation of Japanese investors have gotten nothing for their trouble. Stocks for the long run? It’s a good thing the Japanese have long life expectancies!

But we are all Japanese now. Sushi it is! ZIRP – the “zero interest rate policy” – was tested in Japan for many years. There is no evidence that it did any good. Zip! Nada! Now, it will be used here…again, for many years.

There are really only two ways out of this mess – up or down. People owe too much money…and they’ve invested in too many things that aren’t worth what they paid for them. There’s no easy way out. Mistakes are mistakes; somebody’s got to pay for them. Either the people who made the mistakes…or people who didn’t.

The feds can just butt out…and let the market take care of itself. That will mean HIGHER real returns on capital. Real money will be scarce. People will pay for their own mistakes – dearly. Savers will be rewarded with higher yields. They will save more. Prices will fall. The economy will go through a tough, but relatively quick, reorganization. Debts will be written off or paid off…or worked off. Investors will lose money…business and consumers too. It will be long and hard, but gradually balance sheets will be strengthened…and the economy will be re-capitalized with savings. Still, many people will go broke. And riots will break out …as the lumpen malcontents take to the streets demanding that their government ‘do something.’

Of course, there is nothing the government can do…but cause more mischief. That’s the low road – the road the feds have taken…by cutting interest rates to zero and spending trillions of dollars they don’t have. It’s the low road they’ve been on for many years…it’s where they feel most comfortable…and where they can do most damage. Instead of recapitalizing the economy by favoring savers, the feds are continuing the process of de-capitalizing it. Yields go down, not up. Savers get discouraged…and ripped off. Money becomes cheaper and cheaper…eventually reducing the debt load via inflation. Reckless spenders’ debts are erased. Mortgages are wiped away. Speculators make money on wild bets. Debtors come out way ahead – including the biggest debtor of all – the US federal government,

Meanwhile innocent savers, ordinary householders, taxpayers, foreign creditors, unborn children – all pay the price.

We’re not arguing with it. Nobody asked our advice anyway. (Nevertheless, we give some advice…below.)

The feds are on the low road, no doubt about it. But so far, they’ve haven’t gotten very far. Instead of inflation, they’re getting deflation. Yesterday’s news reports tell us that consumer prices are headed down. Sales are down too – with luxury goods off 33% since Thanksgiving.

And, of course, housing starts are down…states are cutting back spending for the first time in 25 years (they don’t have printing presses…poor things)…and even the mighty Goldman Sachs has had to report its first quarterly loss since it has been a public company.

If the Japanese example were the only thing we had to look at, we’d think the feds couldn’t win this fight. Mr. Market is bound and determined to lower prices. So far, he’s clearly winning.

But there are other examples that boost our confidence in the feds. They’ll get the hang of it eventually.

The rate cut “means the Federal Reserve will have to reach for new and untested tools in fighting both the recession and downward pressure on consumer prices,” says the IHT report. Untested? We bet Gideon Gono can show them how to use these new tools.

*** If our sage counsel had been courted, we would have told the feds to take the high road. Don’t cut rates, raise them. Get it over with. Reward savers, not spenders. Give people a bonus for doing the right thing, not for doing the wrong thing.

We’re not above a little showmanship either. If Obama wants to keep the masses at home watching TV rather than marching on the White House, he should offer a real stimulus:

Give people back their tax money. Declare a Tax Jubilee. No taxes in ‘09. No income taxes. No capital gains taxes. No federal taxes of any sort…not even any inheritance taxes. If we had our druthers, you could die in ‘09 and rest in peace…with no tax consequences…leaving your money to whomever you wanted.

But we know what you’re thinking…how could the federal government operate without tax revenue? Ah…that’s the other part of the plan. We would shut it down. Take a holiday from government. Send everyone home for a year. Tell them to make do with what they’ve got.

*** One thing is sure; we’d get along fine without the SEC on the job. It does more harm than good. It merely helps perpetrate a fraud – misleading investors into believing that their money is safe on Wall Street. As we’ve seen, donuts were safer on a fat farm.

Christopher Cox, chairman of the SEC, assured investors nine months ago that their investments in Bear Stearns were perfectly safe. The firm collapsed three days later.

“You are dealing with a commission whose effectiveness in fraud deterrence is open to serious question,” said Professor Joel Seligman, an expert on the subject. Open to question? We would say the question is settled. The SEC does not fight fraud; it aids and abets it. In the largest heist in Wall Street history, Bernard Madoff was able to tell investors that their funds were safe: the SEC had examined the company carefully twice in the last 3 years…and given it a clean bill of health.

*** “Don’t you know there’s a worldwide financial meltdown?” we asked Elizabeth last night. “This is no time to be buying new furniture.”

“Well, I needed a new desk. But I’m not buying anything else.”

“Aren’t you picking up a new horse trailer tomorrow?”

“Yes, but I ordered that before the crisis hit. When I thought you had some money…before you started worrying about going broke.”

The phone rang.

“Who was that?” we asked a few minutes later.

“That was the curtain man. I need to get new drapes for the living room.”

“What’s wrong with the old drapes?”

“They’re just not right.”

“They’ve been okay for the last 13 years…what’s suddenly not right about them?”

“They’ve never been right…and I’ve finally realized what it is…so I’m going to change them.”

“Don’t you realize that there’s a global financial crisis? This is no time to be spending money.”

“Yes, but the crisis is likely to go on for 10 years…and I don’t want to live with drapes that aren’t right for a whole decade…and then buy them after we’re too old to enjoy them.”

“You’re not one of those ‘toxic wives,’ are you? You know, those women who leave their husbands after they lose their money.”

“Don’t be silly. You didn’t have any money when I married you. And I’ll stick with you even if you go broke. We may not have any money. But at least we’ll have nice curtains to look at. That’s why I’m getting them now…while you’ve still got some money left.”

Source: We Are All Japanese Now

So the question no longer seems to be whether the Fed will ease, but whether the move will make any difference.

The Fed has been hamstrung by a credit-market double-whammy: borrowers who are in limbo due to fears of soaring unemployment, and banks that have turned off the lending spigot. Even so, a U.S. economy facing its worst financial crisis since the Great Depression demands the central bank take decisive action.

That has led to a strong undercurrent of opinion among analysts that the Fed will pursue other measures to spark a moribund U.S. economy.

“We look for the accompanying statement to highlight that the main nexus of policy in the coming months will be quantitative easing operations, and we expect these operations to be aimed at lowering borrowing costs for households and businesses,” Dean Maki, economist for Barclays Capital Management (ADR: BCS), told MarketWatch.com.

In other words, get ready for another attempt to kick-start bank lending by injecting more federal cash into the U.S. financial system.

One move the Fed could make is to buy massive amounts of U.S. Treasuries in an effort to keep yields from rising. Fed Chairman Ben S. Bernanke suggested in a Dec. 1 speech that the central bank might buy “longer-term Treasury or agency securities on the open market in substantial quantities.”

Bond market traders seemed to confirm that notion yesterday (Monday) by driving the price of 10-year Treasuries higher for a third straight day. The yield curve, the difference in yield between two-and 10-year notes, flattened as the difference between the two narrowed.

Driven lately by uncertainty over the Bush administration’s handling of the Big Three automakers’ bailout, investors have pushed yields on Treasuries to record lows. Treasury security yields last week reached the lowest levels since the U.S. started selling two, five, 10- and 30-year securities.

In a report issued last week, JPMorgan Chase & Co. (JPM) predicted the yield on Treasuries in 2009 will be driven as low as 1.65% (from about 2.65% currently) amid “high uncertainty.”
Unloading stocks, corporate bonds and debt from mortgage-finance companies Fannie Mae (FNM) and Freddie Mac (FRE), investors purchased $34.6 billion of Treasury securities in October, up from $20.7 billion in September, according to the U.S. Treasury Department.
“You still have a massive paranoia in the marketplace and you’ve got that safety-at-any-cost mentality,” Jay Mueller of Wells Fargo Capital Management (WFC) told Bloomberg News. “People are not buying Treasury bills because they think the yields are attractive. They are buying them because they are afraid to put money anywhere else.”

According to Merrill Lynch & Co. (MER), U.S. government bonds have returned 12.4% so far in 2008. That’s the best return since 2000, when they gained 13.4%. Meanwhile, the Standard & Poor’s 500 Index is down 40%, and the Dow Jones Industrial Average has lost 35%.

The Fed’s Arsenal

The Fed is pulling out every weapon in its arsenal to avoid deflation.  A sustained drop in asset prices is the central bank’s worst fear since it could lead to more foreclosures and heightened economic chaos.

One undesirable side effect of the numerous economic stimulus packages is the potential for inflation and a decline in the dollar.  Based on its actions, the Fed is apparently willing to take that risk.

In fact, speculation around the probable Fed interest rate cut knocked the greenback down to a two-month low against the euro, touching $1.3703 yesterday, the lowest it’s been since Oct. 14.  With reduced demand for the dollar as a safe haven, the greenback dropped to a 13-year low against the Japanese yen and also lost ground to the British pound.

“We will stay in a low-interest-rate environment for some time,” Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank Ltd. in New York, told Bloomberg. “That will take away interest-rate play, and the dollar will suffer.”

After a four-month rally of 24%, consensus estimates for the dollar issued last week by Citigroup Inc. (C), Goldman Sachs Group Inc. (GS), BNP Paribas SA and Bank of America Corp. (BAC), predicted further weakness against the euro.

After strengthening from July to November, the U.S. currency has retreated by 6.6% from a two-year high on Nov. 21, as measured by the trade-weighted Dollar Index. The dollar has fallen against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona since peaking three weeks ago.

Source: Fed Policymakers to Cut Rates Today … But Does Anyone Really Care?

That doesn’t leave members of the central bank’s policymaking Federal Open Market Committee (FOMC) much room to maneuver. Still, the policymakers may have more ammunition in their arsenal and the statement that accompanies the rate decision at the end of the two-day session could shed some insight on the “creative” actions the Fed could consider in addition to rate cuts (For instance, the central bank could extend the new investment firm discount window, offer additional loan guarantees, or utilize any number of other tools).

And the Fed may well have to use those other tools. As Japan’s “Lost Decade” demonstrated, “zero” interest rates won’t necessarily jump-start an economy – especially when interest rates weren’t really the problem. And as several Money Morning investigative pieces have demonstrated, the low interest rates aren’t necessarily inducing banks to lend. Indeed, many banks are using the federal bailout money to finance buyout deals.

The ministers of the Organization of the Petroleum Exporting Countries (OPEC) will meet in Algeria on Wednesday and President Chakib Khelil implied that a surprisingly sizable production cut is in the cards.  While OPEC controls about 40% of the world’s oil supplies, energy analysts hold more stock in actions rather than words. Said one of those analysts: “You can announce all the cuts you want. Compliance is the key.”

Market Matters

In a major story last week, Bank of America Corp. (BAC) may be eliminating 35,000 jobs as it adds Merrill Lynch & Co. Inc. (MER) to its ever-growing list of subsidiary companies.

But in an even bigger story, Wall Street powerbroker, Bernard Madoff stole the headlines (and about $50 billion from investors in the process).  This former chairman of the Nasdaq Stock Market Inc. (NDAQ) ASDAQ was arrested for committing perhaps the largest investor fraud in history (Enron may be off the hook) as Bernard L Madoff Investment Securities LLC appears to have been “basically a giant Ponzi scheme” (his own words).  Though the client list seemed relatively small, at first, the implications will be quite widespread, as some of the largest hedge funds of funds participated in Madoff’s investments; their clients include some of the world’s (formerly) wealthiest folks.  Additionally, regulators will have quite a few questions to answer as lax oversight failed to uncover this massive fraud that may have been perpetrated for years.  Stay tuned – this one isn’t going away any time soon.

In “lighter” news, the U.S. House of Representative passed a “preliminary” auto bailout package that would provide $14 billion to the Big Three – Ford Motor Co. (F) may not need any for now – and create a new car czar to oversee an industry restructuring.  While Wall Street initially hailed the move as a positive step to a necessary overhaul, the Senate demanded greater concessions from auto unions and the bill became basically “dead on arrival.”  Since the U.S. Treasury Department appears to be growing more comfortable with the bailout concept with each passing day, Bush administration officials implied that aid via the $700 billion Troubled Assets Relief Program (TARP) would be forthcoming even without Senate approval. By the way, an oversight committee gave the financial bailout a rather poor initial report card, claiming a lack of transparency in terms of how dollars are being spent and whether recipients are complying with government intentions (no wonder the automakers want to participate as well).

Elsewhere, Merrill’s John A. Thain reversed an earlier position by “choosing” to forgo his 2008 bonus and Morgan Stanley’s (MS) John J. Mack quickly followed suit.  The Dow Chemical Co. (DOW), Sony Corp. (ADR: SNE), and 3M Corp. (MMM) joined BofA and others in announcing sizable job cuts.  FedEx Corp. (FDX) and The Procter & Gamble Co. (PG) reduced prior outlooks and sales projections.

Oil prices fluctuated greatly as traders weighed contrasting supply/demand reports:

• The Energy Information Administration expects weak demand to result in declining consumption through 2009 even as significant production cuts could be announced at the upcoming OPEC meeting.
• With oil trading below $47 a barrel, Goldman Sachs Group Inc. (GS) (of “we’re going to $200/barrel fame”) contradicted past forecasts by claiming prices could fall to $30 (and lost some credibility in the process).

Stocks reacted favorably to rumors of President-elect Barack Obama’s $500+ billion stimulus package (see below) and the apparent progress with automaker negotiations.  As the week moved on, reports of new job losses and more financial woes halted the brief optimism and the Senate’s inability to pass an auto bill brought more excessive volatility.  A “flight-to-quality” sentiment contributed to yields on 3-month T-bills dipping to 0.0% (that’s ZERO percent … talk about risk averse).

Economically Speaking

“I am absolutely confident that if we take the right steps over the coming months, that not only can we get the economy back on track, but we can emerge leaner, meaner and ultimately more competitive and more prosperous.”

Somehow an economic stimulus plan which directs $500+ billion into new FDR-like public works programs to increase employment does not necessarily imply “leaner and meaner.”  Still, many analysts believe the Obama plan (still in its infancy) may be just the tonic needed to jumpstart the economy.

Meanwhile, the European Union announced its own $200 billion package as the 27 member countries struggle with global recession.  Not to be outdone, Japan revealed some sizable stimulus measures of its own late in the week.  With the recession already pushing a year in duration, Duke University released results of its Global Business Outlook Survey which showed that 60% of domestic CFOs believe the downturn will last until the 4th quarter of next year – and perhaps longer. Similarly, a
Wall Street Journal forecasting survey predicted four straight quarters of negative growth as measured by gross domestic product, or GDP, the longest period of economic contraction since the Great Depression.

A light week on the economic calendar ended with a couple of major reports that gave the Fed a bit more anecdotal material to (over-)analyze prior to the FOMC meeting today and tomorrow. With claims for unemployment benefits soaring to their highest level since November 1982, Federal Reserve Chairman Ben S. Bernanke and friends must make job creation among their top priorities.  November retail sales fell by 1.8% as automakers reported their worst level of monthly activity in 26 years.

Still, the decline was less than Wall Street expected, leading Morgan Stanley’s analysts to speculate about future downward revisions.  Wholesale inflation (as measured by the producer price index, or PPI) declined by 2.2% as gasoline prices plummeted by 25% in November.  Normally, consumers would welcome such news and gladly spend those savings from the pumps at the malls during the holidays.  Instead economists continue to spread more “gloom and doom” by suggesting consumers may hoard their savings and resist spending amid these uncertain times.

Weekly Economic Calendar

Source: Fed May Cut Rates Again as Policymakers Meet

The Fed extended the lives of recently initiated programs (lending facilities for investment firms, for instance) and is exploring additional moves (like Treasury purchases) aimed at reviving the credit markets.  Bernanke believes more needs to be done to slow the pace of foreclosures, especially since they jumped another 10% in September.

Meanwhile, the U.S. Treasury Department is working on a plan to rejuvenate the housing market by slashing mortgage rates to 4.5% on new purchases.  Experts say that at some point these stimuli must take hold, but that’s not necessarily true.

This week’s economic calendar is highlighted by two late-week releases that are sure to garner much analysis.  The producer price index (PPI) brings another look into the inflation picture, though the dramatic decline in energy prices may renew “premature” talks of deflation.  And November retail sales should offer few positive surprises for the holiday season.

Are there any 12-step programs for overcoming “gloom and doom?”

Market Matters

Black Friday has passed. And so has Cyber Monday (the Monday after Thanksgiving when online shopping begins in earnest).  So let the analysis begin.

While retailers continued to cry “gloom and doom,” the so-called experts did not appear to be quite as pessimistic.  According to National Retail Federation, holiday sales will climb by 2.2% from last year’s levels.  Research firm ShopperTrak claimed that sales on Black Friday rose by 3%, and ComScore Inc. (SCOR) said Monday’s online activity soared by 15% from 2007. Toys “R” Us Inc. execs “were definitely pleased with sales” during the initial holiday shopping weekend, and Internet data collector, Hitwise, revealed that web traffic increased by 21% at Amazon.com Inc. (AMZN).

While November sales remained bleak (see below), analysts point out Thanksgiving came late in the month (Nov. 27) and Cyber Monday actually fell in December.  The optimists (rare as they are) are hopeful holiday activity may be skewed with December faring far better than November.

Automakers returned to Capitol Hill. But for “Begging for a Bailout II,” the “Big Three” CEOs were smart enough leave their corporate jets at home and arrive in hybrid sedans.  Maybe next time they can carpool. But there’s a problem: Combined, the Big Three are this time are requesting $34 billion in loans, which is $9 billion more than they’d been lobbying for all along. Ford Motor Co. (F) implied its situation may be less dire and a mere $9 billion standby line of credit would suffice (assuming the others don’t fail).  The execs also expressed a willingness to operate under a federal oversight board, and even the unions offered concessions regarding health plans and the jobs bank.  While some politicos used scare tactics to predict even greater economic hardships should relief not be granted, others remained skeptical of the unlimited bailouts.  Mostly, they chose to grandstand and politicize the tragic times to win support at home (as if their constituents even watch C-SPAN).  Stay tuned…

In other corporate news, Goldman Sachs Group Inc. (GS) may be forging more into the banking world as it considers launching an Internet operation to increase its deposit base.  Meanwhile, analysts predict its fourth quarter loss could skyrocket to $2 billion.  Beezer Homes USA Inc. (BZH) and Blackberry-maker Research in Motion Inc. (RIMM) both lowered their quarterly outlooks and AT&T Inc. (T) became the latest domestic giant to announce layoffs.  While General Electric Co. (GE) believes its earnings will be weaker than initially expected, the company plans to maintain its dividend and solid commitment to shareholders.  Merrill Lynch & Co. Inc. (MER) shareholders approved its sale to Bank of America Corp. (BAC), though total valuation plunged to $20 billion (from $50 billion at announcement) as a result of the stock market decline.

Oil continued its never-ending decline below the $41 a barrel level, a point not seen in four years, while gas fell below $1.80 a gallon nationally. While winter weather generally means higher energy prices, the economic doldrums have more than offset the traditional trend.

Treasury yields plunged to historic lows on speculation that the Fed may purchase government securities to support the credit markets (as well as the ongoing “flight-to-quality” moves).  Stocks resumed their overall bearish ways on dramatic volatility, as investors grew more fearful about the economy before totally disregarding the awful unemployment data (see below) and staging a late-week “illogical” rally.  Then again, since when have markets been considered logical?

Economically Speaking

In what could one of the worst kept secrets of the year, the National Bureau of Economic Research (NBER) revealed the domestic economy has been in a recession since December 2007.  In the post-World War II era, the average length of recession has been 11 months, with the downturns of 1973-74 and 1980-81 lasting 16 months.

And the current recession will likely surpass the norm.  As the data gets weaker with each passing release, most economists expect this recession to last beyond the next four months and to set a new duration record in post-World War II times.

Then again, each new month means we are getting closer to the end; additionally, equity markets typically serve as leading indicators and begin to rebound months before a recovery starts – meaning we’ll see a bull market get under way while the economy is still in the depths of recession.

The weekly releases revealed that any pending rebound should remain on the back burner for some time.  In November, the unemployment rate jumped to 6.7% as the U.S. economy lost more than 500,000 jobs, the largest monthly decline in 34 years.  In the last three months alone, more than 1.2 million individuals have moved into the ranks of the unemployed.

November represented the 11th straight month of labor contraction.  Both the manufacturing and services sectors continued to struggle according to Institute for Supply Management and factory orders plummeted by the largest amount in eight years.  Retailers reported weak same-store sales numbers, with only Wal-Mart benefiting from the dire times.  Even Costco Wholesale Corp. (COST) experienced a steeper than expected decline.   And of course, dismal auto sales brought more ammunition to those Congressional hearings as General Motors Corp. (GM) (-41%) and Ford (-31%) were joined by Honda Motor Corp. (ADR: HMC) (-32%) and Toyota Motor Corp. (ADR: TM) (-34%) in the “if misery loves company” category.  Meanwhile, Bernanke and friends are hard at work dreaming up creative ways to shore up the economy, particularly after the Beige Book reported softer activity across the country.

Weekly Economic Calendar

Source: Fed Looking at Another Rate Cut, While Treasury Has New Plan for Housing

“The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures,” the Fed said in a statement. “Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports.

“Moreover,” the statement added, “the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.”

The Fed also lowered its discount rate – the rate at which it lends directly to banks and Wall Street firms – by a half-percentage point to 1.25%.

A wave of failures among banks and financial institutions have stymied lending and roiled global credit markets. The world economy faces a significant uphill battle as a result.

The U.S. economy expanded by 2.8% in the second quarter, but that expansion was largely the product of government stimulus checks and a weak dollar. The federal government returned roughly $168 billion back to American taxpayers in the form of rebate checks earlier this year. The tax rebates, which were mailed through May, kept U.S. consumers afloat, while a weak dollar accelerated a torrent of exports out of the country.

Since then, consumer spending has been undermined by rising unemployment and the dollar has strengthened substantially.  The advance estimate for third quarter gross domestic product (GDP) is to be released today (Thursday), and most analysts anticipate the U.S. economy shrunk during the three months ended Sept. 30.

“The growing reality is that this is not just a slowdown, but a true recession,” Joel Naroff, president and chief economist of Naroff Economic Advisors said in an interview with Money Morning.

“U.S. GDP contracted significantly in the third quarter,” said Naroff, who believes the economy may have contracted by 2.5% to 3.0% in the quarter. “Such a sharp slowdown is not expected.”

Citigroup Inc. (C) analysts Geoffrey Dennis and Jason Press said last week that they now expect an entire year of contraction before the economy gets back on track in the second half of 2009.

“We are now expecting one of the sharpest recessions in the post-war period,” Dennis and Press wrote in a report to clients on Oct. 21.

The Fed statement said the rate cut “should help over time to improve credit conditions and promote a return to moderate economic growth,” but noted “downside risks to growth remain.”

This is the ninth time that the central bank has lowered rates since September 2007. The Fed has also loaned hundreds of billions of dollars to banks through a new lending program and earlier this week began loaning money directly to major businesses by purchasing commercial paper.

The Fed yesterday lowered the interest rates it will charge to buy unsecured commercial paper to 1.84%, down from 1.89% on Tuesday. It lowered the interest rate on asset-backed commercial paper to 3.84% yesterday, down from 3.89% the day prior.

The central bank created its program to buy 90-day commercial paper directly from issuers on Oct. 7, meaning it’s now three weeks old.

The Fed’s new loan programs have expanded assets on its balance sheet by 104% during the past year to $1.804 trillion, or 12.6% of GDP, Bloomberg reported.
Rate Reductions Around the World

While the Federal Reserve struggles to keep the U.S. economy from sinking into a second Great Depression, central banks in Europe and Asia are also on the defensive and could soon join the Fed in slashing rates – if they haven’t already.

The British Office for National Statistics last week said that, after a flat second quarter, the U.K. economy contracted 0.5% in the three months ended Sept. 30. It’s likely that Germany, France and Italy have already entered into a recession, as their second-quarter GDP fell 0.5%, 0.3% and 0.3%, respectively.

The International Monetary Fund (IMF) said last week that the economy of the 15-country Eurozone would grind to a virtual standstill in 2009.

The European Central Bank (ECB), which raised rates as recently as July, backtracked and cut its benchmark rate by half a point on Oct. 8, dropping it down to 3.75%. ECB President Jean-Claude Trichet said Monday that the central bank’s Governing Council could take additional steps at its next meeting, currently scheduled for Nov. 6.

“I consider it possible that the Governing Council would decrease interest rates once again at its next meeting,” ECB President Jean-Claude Trichet said yesterday. “Taking into account the recent substantial decline in commodity prices together with a substantial weakening in demand which has emerged lately, upside risks to price stability have diminished.”

Nick Parsons, head of markets strategy at nabCapital (OTC: NABZY) in London, told The Guardian that the Bank of England (BOE) could also follow the Fed’s move with a one-point cut of its own. That would leave the BOE’s rate at 4.5%

China, on the other hand, wasted no time in following the lead of the U.S. Fed. The People’s Bank of China cut its interest rates yesterday, reducing its key one-year lending rate from 6.93% down to 6.66%.  The rate cut was the central bank’s third reduction in two months.

China’s economy registered a solid GDP expansion of 9% in the third quarter – a noticeable step down from the 11.9% pace set in 2007.  Beijing is clearly worried about the effects a global recession would have on its economy and wants to ensure growth does not slow any further.

Of course, lowering rates will also help keep the Chinese currency, the yuan, from appreciating against the dollar and the euro as central banks in the West pull out all the stops in dealing with the credit crisis.

“This cut was driven by the slowdown in the third quarter and the likelihood that the U.S. and other central banks will cut rates,” Xing Ziqiang, an economist at China International Capital Corp. in Beijing, told Bloomberg.

GDP growth in China has slowed for the past five quarters but so long as the nation keeps inflation in check it should be able to maintain a “reasonable” economic expansion of at least 8% next year, said Liu Erh-fei, managing director and chairman for China at Merrill Lynch & Co. Inc. (MER).

Whether Chinese banks were “wise, lucky, or better regulated,” they avoided exposure to the risky subprime mortgages and derivative products that caused the current financial firestorm,” said Liu. “There is no systemic risk in China’s banks that could spill over into a full blown financial crisis.”

China has more than enough economic weapons at its disposal to ensure strong growth going forward, including a world-leading $1.9 trillion in foreign currency reserves. China also has a budget surplus of 2% of GDP, according to Stephen Green, of Standard Chartered PLC. And public sector debt is just 16% of GDP.

Earlier this year, Beijing shifted the focus of its policy to growth rather than inflation – a choice analysts say is now paying dividends.

Inflation in China, and worldwide, is beginning to ease alongside commodities prices. Inflation in China receded to 4.9% in the year to August, from 8.7% in February. And Goldman Sachs Group Inc. (GS) forecasts that it will fall as low as 1.5% in 2009.

Source: Federal Reserve, Bank of China Cut Interest Rates as Financial Crisis Deepens

The next meeting of the Federal Open Market Committee is scheduled for tomorrow Wednesday Oct. 29. There is no doubt that growth will be the central issue of the committee’s discussion, as fears of a global recession are intensifying alongside deteriorating economic data.

The British Office for National Statistics’ said Friday that, after a flat second quarter, U.K. gross domestic product (GDP) contracted 0.5% in the three months ended Sept. 30. There’s little doubt that other European nations have already succumbed to recession, and the near bankruptcy of Iceland has highlighted the interdependency of the world’s financial system.

It’s likely that Germany, France and Italy have already entered into a recession, as their second-quarter GDP fell 0.5%, 0.3% and 0.3%, respectively. Japan – the world’s second largest economy – is also dangerously close to recession, with its economy having contracted 2.4% in the three months ended June 30.

The International Monetary Fund (IMF) said last week that the economy of the 15-country Eurozone would grind to a virtual standstill in 2009. And the prognostications for the United States are equally bad, if not worse.

The U.S. economy expanded by 2.8% in the second quarter, but that expansion was largely the product of government stimulus checks and a weak dollar. The federal government returned roughly $168 billion back to American taxpayers in the form of rebate checks earlier this year.  The tax rebates, which were mailed through May, kept U.S. consumers afloat, while a weak dollar accelerated a torrent of exports out of the country.

Since then, consumer spending has been undermined by rising unemployment and the dollar has strengthened substantially.

The unemployment rate hit a five-year high of 6.1% in September and jobless claims have continued to mount this month, with a seasonally adjusted 478,000 Americans filing for first-time unemployment benefits in the week ended Oct. 18. Initial jobless claims have soared 47% in the past year and continuing claims are up 44%.

Meanwhile the greenback has posted a strong rebound over the past month, making U.S. goods more expensive to foreign nations, and thereby weakening exports.

The dollar climbed 5.9% against the euro last week and yesterday (Monday) surged to a two year high of $1.2462 versus the European currency.

The economy has nothing left to lean on at this point, and that fact has most economists projecting a debilitating recession for the United States.

“We are now expecting one of the sharpest recessions in the post-war period,” Citigroup Inc. (C) analysts Geoffrey Dennis and Jason Press wrote in a report to clients on Oct. 21. Citi sees an entire year of contraction before the economy gets back on track in the second half of 2009. Dennis and Press predict U.S. unemployment could climb as high as 8.5% next year.

“The growing reality is that this is not just a slowdown, but a true recession,” Joel Naroff, president and chief economist of Naroff Economic Advisors said in an interview with Money Morning.

“U.S. GDP contracted significantly in the third quarter,” said Naroff, who believes GDP may have contracted as much as 2.5% – 3.0% in the quarter. “Such a sharp slowdown is not expected.”

So far, Federal Reserve Chairman Ben S. Bernanke has turned to his ever-expanding arsenal of liquidity measures in an attempt to thwart what now seems to be an unavoidable recession. However, he may eventually be forced to cut interest rates all the way to zero like the Bank of Japan did in 1999.

But first the Fed will reduce its benchmark Federal Funds target rate tomorrow by 25-50 basis points.

“The cut is already in the market,” John Ryding, economist at RDQ Economics told AFP.
“The question is whether it’s 25 or 50 basis points.”

The latter would mean reducing the key rate from where it currently stands at 1.5% to just 1%. Cutting below 1% could be seen as a sign of panic, according to some analysts.

Earlier this month, the Fed conducted a joint rate cut with a number of its global partners, and other central banks around the world could again join the United States in reducing rates.

The European Central Bank (ECB) could cut its rates as soon as next week at the next meeting of the central bank’s Governing Council scheduled for Nov. 6.

“I consider it possible that the Governing Council would decrease interest rates once again at its next meeting,” ECB President Jean-Claude Trichet said yesterday. “Taking into account the recent substantial decline in commodity prices together with a substantial weakening in demand which has emerged lately, upside risks to price stability have diminished.”

Nick Parsons, head of markets strategy at nabCapital (OTC: NABZY) in London, told The Guardian, that the Bank of England (BOE) could also follow the Fed’s move with a one-point cut of its own. That would leave the BOE’s rate at 4.5%

The ECB, which raised rates as recently as July, cut its benchmark by half a point on Oct. 8 to 3.75%.

The Fed’s Broadening Balance Sheet

Cutting rates would certainly fit into Chairman Bernanke’s tactic of flooding the market with liquidity – a tactic that began last August and has broadened over the past year to include more and more tools at the Fed’s disposal. As a result, the role of the U.S. Federal Reserve as an institution has completely changed.

After previous rate cuts and cash injections failed to unfreeze credit markets, Bernanke got the green light to start buying up troubled assets and taking equity stakes in financial institutions.

Up until a year ago, the vast majority of the Federal Reserve’s holdings were in Treasury securities. However, over the past several months, Bernanke has expanded the role of the Fed to include the programs ranging from the Fannie Mae (FNM) and Freddie Mac (FRE) bailout, to becoming a buyer of last resort for undesirable assets.

In fact, the Fed set the interest rates it will charge for its purchases of commercial paper from banks and companies. The Fed said it would charge 1.88% for unsecured commercial paper and 3.88% for asset-backed commercial paper, Reuters reported.

The Fed created its program to buy 90-day commercial paper directly from issuers three weeks ago, on Oct. 7.

“The net effect of these facilities has been a truly staggering pace of growth in the Fed’s balance sheet,” said Jan Hatzius, chief U.S. economist for Goldman Sachs Group Inc. (GS).

The Federal Reserves balance sheet has more than doubled as a result, and it’s showing no signs of abating. As of Oct. 15, the Fed’s balance sheet had ballooned to $1.754 trillion from around $850 billion last year, according to The Wall Street Journal.

“In coming months, further rapid growth in the Fed’s balance sheet is likely,” said Hatzius. Hatzius also pointed out that during the Japanese credit crisis of the 1990s, the Bank of Japan’s balance sheet hit 30% of GDP, compared to the United States where the Fed’s balance sheet is currently at about 12% of GDP.

“To be sure, part of this increase occurred in an environment of outright quantitative easing by the Bank of Japan, which is not our current forecast for the Federal Reserve,” he said. “Nevertheless, the Japanese experience illustrates that central balance sheets can grow to very large numbers when the monetary authority is called upon to take over short-term financing for a large part of the economy.”

Japan suffered a decade of stagnation in the 1990s after its property and stock market bubbles burst. Money Morning Executive Editor Bill Patalon has written extensively about the eerie similarities between that collapse and the potential lost decade that could be faced in the United States.

The H.4.1 report – the Federal Reserve’s weekly report on changes to its balance sheet, set for release Thursday – will reveal how much capital was withdrawn from the Fed’s new commercial paper facility in the first three days of this week.

Source: Fed to Cut Rates at Next FOMC Meeting as U.S. Recession Appears Likely