The Week Ahead

Over the near term we have two fronts to monitor; that is, two economic arenas, both of which will impact our individual lives. First of course is the so-called world sub-prime crisis, the liquidity panic/now solvency crisis, birthed due to lack of proper regulation of Fannie & Freddie. A flood of less-than-prime mortgage paper, collateralized for the final investor, is all over the world. No one knows what any of it is worth. Readers recall from past postings the chronology of this event. Key - trust evaporated between major world banks. They lied to each other and to their regulators. Inter-bank lending ceased, and with it, the heart of the world’s financial system nearly stopped beating. We know that temporary dams have been erected, most major world credits, to stop the free fall. We applaud this accomplishment. Most of these mechanisms followed Darling’s lead. Banking institutions are receiving capital injections from the US taxpayer. The taxpayer is receiving preferred stock in return. In the UK and EU there are similar measures. Next, in countries without the resources to rescue their own the IMF is extracting tough terms for money lent.

Second, we have the US economy in isolation - just how weak is it; what can we do, what ammunition does the Fed have left? These then are the two prime considerations for the US consumer. Let us address this second concern first.

This week we will have two important eco releases, one on the health of manufacturing and one of the overall employment situation. Today we will see the Inst For Supply Mgmt manufacturing survey for Oct (new orders, order backlogs, prices received, employment & inventories). This is a key release; it was through the floor for Sep - far below expectations after being flat for most of the year. On Fri we will see the Employment release for Oct. Although a coincident indicator, this remains the key release for each month. It is expected to be very weak and will no doubt cooperate. By Friday the view for a full blown recession will be set in stone.

What can the Fed do? Not much. It has already injected floods of $ into the system but this is little more than pushing on a string at the moment. Impact now is mostly psychological. We must look to Washington. The assistance of a corporate tax cut to 25% and a cap gains cut to 10% will go out the door if McCain does not win; the period of recovery will then be extended.

Next, beginning Nov/15 we will gain some idea of what finance ministers have in mind for the new world financial landscape. The IMF seems to have inherited the lead role for now. Just this weekend Brown urged the Saudi’s to kick up their contribution as Iceland and others have already used up $30 bln of the IMF’s reserves, with Belarus, Turkey, Pakistan and Serbia, Hungary and Ukraine waiting in line.

Meanwhile, other policy tools are easing the liquidity panic at home. The Fed's new commercial paper facility, which began on Tuesday, helped to reignite that vital source of corporate funds. Treasury's capital injections into banks as noted above are also restoring confidence as they reach some of the struggling regional banks. And the key 90 day LIBOR rate continues to decline, last at 2.86% vs 3.50% just a week ago. This is very good news and means activity between US banks, and between US banks and other major foreign banks, continues to thaw. Look for the UK, the EU and Australia to join the global easing cycle this week (following moves in the US, Japan, HK, Norway, China, Tawain & India last week) which should push this rate even lower.

What shocks may be offered up this week? Look perhaps to emerging markets, where gathering economic woes are bound to lead to more bank losses, but primarily banks in Europe, no so much the US. An analyst at the Royal Bank of Scotland points out that European banks have more than seven times the claims on developing countries than their American rivals; in eastern Europe, the ratio is 25 to 1.

Robert Craven