Thursday, 18 December 2008

Interest rates fall

There already appears to be some favourable impact from the Fed's latest actions.

Bloomberg reports that LIBOR was sharply down on Wednesday.

The cost of borrowing in dollars in London for three months tumbled after the Federal Reserve chopped its key interest-rate target to as low as zero and said it will flood the economy with cash.

The London interbank offered rate, or Libor, that banks say they charge each other for such loans fell 27 basis points to 1.58 percent today, the lowest level since July 2004, according to British Bankers’ Association data. It was the largest decline since Oct. 22. The one-month and overnight dollar rates also dropped and rates in Asia slid. The Libor-OIS spread narrowed.

And US long-term securities rallied.

The yield on the 10-year note lost nine basis points, or 0.09 percentage point, to 2.17 percent at 4:44 p.m. in New York, according to BGCantor Market Data. It touched 2.0711 percent, the lowest level since the Fed’s daily data on the securities began in 1962. The price of the 3.75 percent security due in November 2018 rose 27/32, or $8.44 per $1,000 face amount, to 114 1/32.

The 30-year yield dropped seven basis points to 2.65 percent after touching 2.5816 percent, the lowest since sales of the security began in 1977. Two-year yields gained seven basis points to 0.72 percent. They fell earlier to 0.6044 percent, the lowest level since the note’s sales began in 1975.

Equity investors, however, had second thoughts about the Fed's move, pushing stock prices lower.

U.S. stocks fell and the Standard & Poor’s 500 Index retreated from a five-week high on concern the Federal Reserve has few tools left to combat the recession after cutting its benchmark interest rate to a record low...

The S&P 500 lost 1 percent to 904.42. Technology and energy shares were the biggest drag on the index as Apple tumbled and oil slid below $40 a barrel for the first time in four years. The Dow Jones Industrial Average declined 99.8 points, or 1.1 percent, to 8,824.34. The Russell 2000 Index of small U.S. companies added 0.8 percent.

And oil traders are still playing the deflation trade, pushing oil prices below US$40 to the lowest in more than four years.

Furthermore, oil prices are falling despite a weakening US dollar.

The dollar traded near a 13-year low versus the yen and at the weakest level against the euro since September as the Federal Reserve’s near-zero interest rate policy reduces the appeal of holding U.S. assets.

The fall in the US dollar occurred despite the US current account narrowing by more than expected in the third quarter. But then, we already know from the yen's experience that current accounts matter less for a currency when interest rates fall to zero.

Still, if other central banks follow in the footsteps of the Fed, the latter's low interest rates might look less unattractive. And don't underestimate the speed with which other central banks are going to cut rates. Just look at Norway's latest rate cut, as reported by Bloomberg.

Norway’s central bank cut its benchmark interest rate by 1.75 percentage points and signaled it will cut borrowing costs further next year, forecasting that the economy will slip into recession in the fourth quarter.

The overnight deposit rate was reduced to 3 percent, the Oslo-based Norges Bank said on its Web site today. All 17 economists surveyed by Bloomberg had forecast a smaller cut, with five estimating the rate would fall to 3.25 percent.

Looks like "basis points" is becoming redundant in describing rate cuts.

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