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Strategies & Market Trends : Currencies and the Global Capital Markets

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To: Zeev Hed who wrote (2646)	12/23/2000 11:09:42 AM
From: Henry Volquardsen	Read Replies (1) of 3536

Hi Zeev, it's been awhile, hope you are well. Interesting point about the National debt. I was speaking to someone about two weeks ago who does a lot of research on national accounts etc. Always has some interesting insights. He made two forecasts. 1) the projections for the budget surplus over the next ten years will be revised upward an additional $500bln to $1trln. This was even considering the recent spending hikes. I am naturally skeptical but this guy knows the topic better than I do. 2) the Fed will be more aggressive in cutting rates than many expect. This last was before the recent market swoon so the market's expectations may have begun to catch up with his. Your analysis about corporate tax receipts is probably a good catch regarding short t-bill rates and that aspect will likely be short lived. But the real forecasting of rate cuts can be seen in the back end of the eurodollar market. The shorter euro rates have stayed firm and that is where the liquidity would show up. Regarding what the Fed will do I agree that it is probably not a clear cut argument. The biggest argument is the still strong employment numbers. The recent uptick in durable goods is not as strong an argument however. Volatile series, previous month had been a much bigger down, this month has large aircraft component yadda yadda yadda. I think what will have the Fed very concerned is the clear damage that has been done to public and business confidence. Personally I think this is temporary but I am an optimist by nature. However we are seeing real weakness in planned spending and certain industrial commodities. I think the Fed is very concerned that this could easily snowball into a very nasty contraction. Therefore it is quite possible and probably likely that we will get at least a quarter rate cut very early in order to stop a potential cascade decline in confidence. One other issue in favor of a potential cut is the international economy. 97 and 98 showed clearly that the Fed looks at more than domestic consideration. Rightly or wrongly. The international economy has been living of the US and is still frail. If the US slows Asia and South America will get into trouble before it shows up in US employment numbers. I suspect the Fed will be keeping a close eye on this. I think it would also be worth addressing a more fundamental question regarding Fed policy. Has it been to tight? If it has been to tight then cuts would be justified regardless of the employment numbers just to reach a neutral stance. I believe oil prices are a key element in answering this question. When oil prices first started to rise someone asked me whether I thought the increase was inflationary or recessionary. Interesting question. My answer was recessionary. Yes oil prices were rising because of much stronger global demand but we weren't seeing a rise in other commodity prices and the global monetary base had not shown inflationary increases. So, to my way of thinking, the oil price rise was not a result of inflationary forces but the result of supply shortages and therefore were acting as a tax increase. At the same time we were suffering tighter liquidity. The Fed was flooding the market with liquidity at this time last year because of Y2K fears. Starting late in the first quarter they withdrew the liquidity. So we had two tightening factors entering the market at the same time. The Fed was clearly correct in their original rate hikes. But as we moved into the spring and summer, I believe, they were to slow to appreciate the impact of these two forces. It is understandable that there was some debate regarding whether the oil price hike was inflationary or recessionary. But they should have had a clearer picture of the impact of the liquidity situation. My own opinion is that there was enough evidence by fall to go to a neutral bias. If that were followed by a quarter point cut in the late fall that would have probably been enough to neutralize the impact of higher oil prices. The delay has put us in a position where it may be trickier. Btw I think oil prices will be lower by summer. Therefore if the market gets close to what it is forecasting from the Fed then they will have wound up going to far.

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