While writing about Bernanke, I spoke of how he had to project a feeling of confidence, and by not lowering rates: he basically told investors that there is no need to panic. Markets are like that. While one bigwig do one thing, and then do something to destroy that very thing. In an unprecedented move yesterday, the European Central bank poured a record 94.8 billion euros (US$130 billion) into the markets, with the Federal Reserve also injecting capital as banks gasped for liquidity. Now, isn't that a bit silly. Bernanke looked like Churchill for a while and then like a Japanese prime minister the next. When you cave so soon after a non-action on the fed funds rate, you send out a strong signal that ALL IS NOT WELL.
The move came in the aftermath of France's largest listed bank BNP Paribas shutting the door on withdrawals of funds worth 1.6 billion euros, tied to subprime securities. BNP Paribas said it can not provide a fair value of the holdings of the funds, regardless of their quality or credit rating. Credit issues spilled deeper into the European markets, engulfing more of the continent's banks, and concerns grew that losses could multiply. BNP's woes and ECB's firefighting move sparked a sell-off in all major European markets
The Federal Reserve injected US$24 billion in temporary reserves to the US banking system as there was spillover demand for funds from the European market. Dutch investment bank NIBC Holding also said it had incurred a loss of at least 137 million euros on its subprime investments.
The ECB said it will provide unlimited cash to meet demand after the fastest rise in the overnight interbank rate seen since June 2004. The supply of funds by banks was sharply reduced as investors retreated from investments due to losses in subprime related assets. BNP said it would suspend three funds - Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia - which have all declined rapidly in value in the past few weeks to 1.593 billion euros on August 7, down from 2.075 billion on July 27. The suprime crisis hit commodities as US oil fell more than US$1 to US$71 a barrel and metals futures plunged 1.1 and 2.9 percent respectively. Emerging debt spreads blew out 12-14 basis points over US Treasuries while the volatile equity market saw investors scurry to bonds with a rally in eurozone government bond futures.
This looks like a pre-emptive strike to head off any possible liquidity problem. Its a bit funny, in the US the Fed did not think its a big thing but the ECB is telling everyone ITS A BIG THING - it seems the Europeans are saying if you don't act first, we will. We should also bear in mind that ECB's 95 billion euros move is significant and will calm waters, while Fed's US$24 billion is only a trickle to US markets. Before the injection of funds the overnight rates for the euro spiralled to 4.62% the highest level in 6 years. After the injection the rates went back to the targeted 4%.
Volatility will reign for a while as markets try to anticipate other problems coming out of the closet. I still do not think the subprime mess is a big problem, but when you have the media "hyper-focusing" on the issue 24/7, it gets magnified. Have to wait it out while they play "horror movie game". Look at it this way, I have already calculated the dividend yields for the few US big financials. The story is the same everywhere else, the rebound will be substantial once the scary clowns finish their act.