March 17, 2008
These are extraordinary times. The Federal Reserve Board is moving quickly and decisively to ensure that capital markets continue to function.
First, it lowered the Discount Rate by 25 basis points. Second, it is now providing lender of last resort support to all of the primary dealers and will accept a broader range of collateral. The futures markets are building in a 90% chance of a 100 basis point cut in the Fed Funds Rate tomorrow.
The US dollar continues to slide on this news reaching a 12 year low against the Yen and the sensitive TED Spread, which measures the difference between 3 month US Treasury Bills and 3 month Euro deposits, has moved sharply higher to the 160 level. This spread should be watched carefully as it reflects how the market is judging corporate credit risk. Before the events of August, it was trading at 20.
What now? More credit spread widening and a weaker US dollar are very likely.
The Fed and other Central Banks will continue to provide liquidity until counterparties regain confidence in lending to one another. No one knows when that will happen but happen it will.
In the meantime, interest rates and government bond yields are headed lower. In the money market, government T Bills are the only place to be. There are many investment grade securities such as Government Agency bonds and Provincial bonds whose yield spreads are very attractive for patient investors.
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