ECB cuts the refi rate to 2,5 percent. US jobless benefit rolls reach four million, oil falls to $44.

December 4, 2008

Today the ECB has reduced its main refinancing rate (which is quivalent to the Fed funds rate)  by 75 percent points, the biggest amount in its short history. The Bank of England also cut its key rate by one percentage point to 2 percent and Sweden’s Riksbank lowered the same by the most since 1992. My attitude toward the ECB has been the same throughout this crisis. They’re more disciplined, because the financial state of the governments and citizens who they regulate is much better than that of their counterparts in the US. M. Trichet today showed some willingness to purchase some troubled paper directly, but whatever, and whenever this happens, its size and scope is likely to be far smaller than the Fed’s operations.

European Central Bank President Jean- Claude Trichet signaled he’s reluctant to cut interest rates so low that policy makers are “trapped” with few options to respond to a deepening recession.

“We have to beware of being trapped at nominal levels that would be much too low,” Trichet said at a press conference in Brussels today. The ECB earlier lowered its benchmark by three quarters of a percentage point to 2.5 percent, the biggest cut in its ten-year history.

Some of the ECB’s 21 policy makers have advocated a steady- hand approach to tackling the recession.

Council Split?

Luxembourg’s Yves Mersch told Luxembourg’s Tageblatt newspaper today that the bank is “entering calmer waters” with future rate changes more likely to be in the order of 25 basis points. Executive Board member Lorenzo Bini Smaghi said on Oct. 31 that “the present crisis is partially due to interest rates that remained at low levels for too long.”

“The council is split between those wanting to cut rates by only 50 basis points and those who wanted a more aggressive 100 basis-point cut,” said Juergen Michels, chief European economist at Citigroup Inc. in London. “So 75 basis points was a compromise and policy makers can keep their powder dry until February.”

Trichet said today’s decision was reached by “consensus,” and declined to divulge if there were calls for smaller or bigger cuts. ECB has reduced rates by 1.75 percentage points since October after the financial-market crisis intensified.

ECB forecasts published today show the euro-region economy will shrink about 0.5 percent next year, which would be its first full-year contraction since 1993. Inflation will average about 1.4 percent in 2009 and 1.8 percent in 2010, the new projections show, meeting the ECB’s price-stability goal of keeping the rate just below 2 percent.

“European policy makers, as we’ve seen in past global crises, continue to underestimate both the degree of the problem and their own part in its creation and solution,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in a Bloomberg Television interview. “I prayed that the ECB would do 100. At least they didn’t do 50.”

Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October.

Recovery

While “global and euro-area demand are likely to be dampened for a protracted period of time,” lower commodity prices may support a gradual recovery from the second half of next year, Trichet said.

As well as cutting rates, the bank has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the ECB to purchase assets and securities outright, while declining to say if it would.

With those who don’t receive unemployment payouts included, the total joblessnumber is close to 6 million now:

The number of people on unemployment benefit rolls rose to 4.09 million in the week ended Nov. 22, the most since December 1982. A separate report showed orders at U.S. factories tumbled in October by the most in eight years as demand collapsed at home and abroad.

AT&T Inc., DuPont Co. and Viacom Inc. today announced plans to eliminate more than 15,000 jobs as consumer spending falters and the recession deepens.

Figures from the Commerce Department showed factory orders dropped 5.1 percent, the biggest decline since July 2000. Excluding transportation gear, bookings decreased for a third consecutive month.

Fed Perspective

Dennis Lockhart, president of the Fed Bank of Atlanta, told a conference in New Orleans the economy was “in the midst of a long and very painful adjustment process.” Chicago Fed President Charles Evans, speaking in Dearborn, Michigan, said the U.S. faced a “very substantial downturn.”

Trending Up

The four-week moving average of initial claims, a less volatile measure, climbed to 524,500, the highest since 1982, from 518,250, today’s report showed.

The unemployment rate among people eligible for benefits, which tends to track the jobless rate, increased to 3.1 percent, the highest since 1992, from 3 percent. These data are reported with a one-week lag.

Forty-nine states and territories reported an increase in new claims, while 4 reported a decrease. The biggest increases were reported by California, Ohio and Michigan.

Longer Slump

What started as a housing slump has spread to manufacturing and services. The Institute for Supply Management’s factory index dropped last month to the lowest level since 1982, and its services gauge, which accounts for almost 90 percent of the economy, fell to the lowest level since records began in 1997.

Financial firms are among those making the biggest job cuts. JPMorgan Chase & Co., the largest U.S. bank by assets, said this week it will cut 9,200 jobs nationwide at Washington Mutual Inc. as it acquires the Seattle-based lender.

“We have seen a fairly significant dropoff in demand, starting in October,” Delta Airlines Inc. President Ed Bastian said on a Webcast of a Credit Suisse Group AG airline conference in New York this week. “The revenue environment is as cloudy as it’s ever been. We’ve never seen the level of demand destruction that some are forecasting for our business.”

Delta, the world’s largest carrier, said it will cut seating capacity by as much as 8 percent in 2009 and eliminate an unspecified number of jobs.

The SIV story is not entirely over yet, and Bloomberg today reports that the creditors of the failed SIV “Sigma” may not paid “in full or in part”. In other words, they may get zero cent(s) on the dollar…

Sigma, which held securities with a face value of $2 billion, according to Moody’s Investors Service, raised a total $306 million from a Dec. 2 auction as part of its liquidation, the SIV’s receivers Ernst & Young LLP said in a statement today. Sigma has $6.2 billion of secured debt outstanding, the receivers said.

“Short-term liabilities which fell due for payment after Oct. 23, 2008 will not be met either in full or in part out of these assets,” the statement said. The liquidation follows a judgment by the U.K. Court of Appeal and the receivers said their estimate may change should the case go before the House of Lords.

Sigma, created by London-based Gordian Knot Ltd., survived longer than other SIVs that defaulted after money markets shut down by borrowing from banks through collateralized loans known as repurchase agreements. Sigma stopped paying creditors at the end of September after failing margin calls, according to court documents.

Sigma pledged $25 billion of its assets to banks to cover $17.4 billion of borrowings, according to Moody’s, leaving just $2 billion of unencumbered assets to repay about $6 billion of outstanding bonds.

Senior creditors in Cheyne Finance Plc, the first SIV to collapse, recovered about 61 percent after the company was reorganized, according to an Aug. 12 statement.

Not only hedge funds suffer redemptios. Mutual funds are also facing something of a run by worried investors nowadays. One positive development is the return of investors to money market funds, which is for now preventing some investment grade companies from falling apart:

Investors fled from stock and bond mutual funds for the third straight month in November, removing $86.4 billion as signs of a worsening economy drove them out from all but the safest investments.

Shareholders removed $52 billion from stock funds and $34.4 billion from bond funds last month, said Conrad Gann, chief operating officer of TrimTabs Investment Research, citing preliminary data compiled by the Sausalito, California-based firm. While outflows were less than a record $111 billion in October, investors are still scared, he said.

“There’s still plenty of fear out there,” Gann said. “It’s more of a continuing drumbeat.”

Stock and bond mutual funds have lost $270 billion to investor withdrawals since September. Every bond-fund category has lost ground in 2008 except those that invest in U.S. Treasuries.

Cash has poured into money-market funds, considered the safest investments outside of bank deposits and government-backed bonds. Taxable money-market mutual fund assets surged to a record of $3.657 trillion in the week ended Dec. 2, according to IMoneyNet of Westborough, Massachusetts.

Drop Since May

Mutual funds had $9.6 trillion in assets as of Oct. 31, a 22 percent drop since May, according to data compiled by Washington, D.C.-based Investment Company Institute.

Merril Lynch says that oil may fall to $25 per barrel if China falls into a recession:

Crude oil fell below $44 a barrel to the lowest since January 2005 and gasoline dropped below $1 a gallon as the deepening recession in the U.S., Europe and Japan cuts fuel consumption.

Prices may dip below $25 a barrel next year if the recession spreads to China, Merrill Lynch & Co. said in a report today. “We’ve got the U.S, U.K., Europe and Japan all in recession for the first time since World War II, and the oil market is reacting,” said Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $5 billion energy-company bond portfolio.

Oil prices have tumbled 70 percent since reaching a record $147.27 on July 11.

 “There is no sign where it will stop,” said Tom Bentz, senior energy analyst at BNP Paribas in New York. “We are now looking at $41.15, which was the pre-Gulf-War high and after that at the $40 and $37 level.”

Oil reached a then-record $41.15 in October 10, 1990, when Iraqi troops were occupying Kuwait. The milestone held until May 2004. Prices were last below $40 a barrel in July 2004.

“A temporary drop below $25 a barrel is possible if the global recession extends to China and significant non-OPEC cuts are required,” Merrill commodity strategist Francisco Blanch said in today’s report. “In the short run, global oil-demand growth will likely take a further beating as banks continue to cut credit to consumers and corporations.”

OPEC oil ministers agreed on Oct. 24 in Vienna that the 11 members with quotas would cut supply by 1.5 million barrels a day starting in November.

“Prices won’t rebound until either the financial crisis is fixed or oil-market fundamentals tighten,” said Michael Lynch, president of Strategic Energy & Economic Research, in Winchester, Massachusetts. “We will have to see substantial inventory reductions and OPEC cuts.”

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