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Will the commodity bull run return?

September 19th, 2008 · 1 Comment

This is becoming more likely. Why? Because in the unprecedented actions that central banks everywhere, and more especially America’s Fed (or ‘sovereign wealth Fed’, as it’s jokingly called now) will lead to much more money creation. If it succeeds in stabilizing the US and world economy, the bets are on for another commodity bull-run. All that money has to go somewhere..

All that money creation might also not be terribly good for the US dollar, and we have seen what the relation is between dollar strength and commodity prices.

Can Uncle Sam Afford All This?

  • Friday, September 19, 2008 9:24 AM. These are momentous times in the financial markets. That’s why the Federal Reserve has been taking extraordinary steps to stabilize financial conditions — even to the point of stretching its own finances.
  • The central bank has been generously using taxpayer dollars to bail out ailing financial firms and keep liquidity flowing in the battered marketplace.
  • The latest handout came this week with the $85 billion loan promised to American International Group to prevent the corporate giant from collapsing under the weight of its insurance commitments on risky debt. Sure, the government is getting a hefty interest rate for its cash — one that tops 11.5 percent — but there is still no guarantee that such funds will be returned.
  • Long considered the lender of last resort, Ben Bernanke’s Fed is up against one of the biggest financial crises in decades. That’s why it has actively been trying to keep the financial system functioning through turmoil caused by massive losses on mortgage debt and other risky assets.
  • Not only has the Fed been using monetary policy to ease credit conditions and stimulate the economy — it has lowered overnight bank lending rates from 5.25 percent to 2 percent — it has also extended massive loans to financial companies, extended borrowing to banks and investment banks and changed some of its own rules to allow for more liquidity.
  • On Thursday, the Fed joined with other major central banks to inject as much as $180 billion into money markets in an attempt stave off the growing global financial crisis. In a separate action, it pumped another $55 billion into U.S. markets.
  • “We are in an emergency crisis. You suspend barriers. You lift rules,” said David Kotok, chairman and chief investment officer at Cumberland Advisors. “That happens when you are staring in the face of contagion and a meltdown.”
  • But this “sovereign wealth Fed,” as some have jokingly referred to the central bank — after the foreign funds that have been scooping up U.S. assets — is feeling the financial impact of its role in this crisis.
  • As the year began, the Fed had close to $800 billion of Treasuries on its books. By last week, that dropped to $479 billion. Of that new amount, some $200 billion was pledged to the Fed’s term securities lending facility, which auctions loans of Treasuries, according to Tony Crescenzi, chief bond market analyst at Miller Tabak & Co.
  • Subtract the $85 billion the Fed has said it would lend to AIG, and the Fed’s Treasury holdings would dip below $200 billion. When levels get that low, “the Fed has to embark on a course to expand its balance sheet,” Crescenzi said.
  • That drove the central bank on Wednesday to take the unprecedented step of asking the Treasury Department to sell debt on its behalf. The first of those auctions raised $40 billion, and two more to raise an additional $60 billion are scheduled.
  • While that provides a cushion for the Fed’s coffers, it doesn’t wipe out the risks to its books.
  • The Fed can “print” money if it runs low, which economists said it effectively did through its actions on Thursday to pump more money into the market. That, of course, has its risks, too — adding money supply to the financial system is often deemed inflationary.
  • Then there are its loan commitments, like the one made to AIG to prevent it from collapsing. It was a deal the central bank had to do since AIG had insured much soured debt in financial markets, meaning its demise could have had systemic consequences.
  • U.S. taxpayers could end up owning the insurance giant, and getting their money back hinges on whether AIG can sell off its parts and pay back the loan within two years. It could be a tall order in this tough economy, but analysts believe there will be interest in some of its parts, like its profitable aircraft leasing business.
  • There are some potentially bigger concerns for the Fed’s finances. For instance, the Fed has started to accept more toxic collateral in its Primary Dealer Credit Facility, which lends cash directly to securities firms. That means companies now can pledge equities and junk debt to back up their borrowing, two of the most volatile parts of financial markets in the last year.
  • The Fed also has waived its restrictions on how much bank holding companies can lend to their investment banking affiliates. The depositor-insured funds had previously been walled off from being used by the companies’ riskier broker-dealer units in order to protect the capital of a bank and its depositors.
  • “This is reckless as abuse of this new form of subsidization of near insolvent broker dealers with commercial banking deposits may eventually impair the viability and solvency of their commercial banking regulation,” said Nouriel Roubini, chairman of the consulting firm RGE Monitor.
  • At least some investors are worried about what the Fed’s actions lately say about U.S. financial health. The price of U.S. Treasury credit default swaps — which are a form of insurance on creditworthiness — has surged in recent days to new highs.
  • The Fed is taking bold steps in this crisis, but let’s not overlook how that could affect its own finances.

Tags: The Markets

1 response so far ↓

  • 1 Jim Tate // Sep 22, 2008 at 2:59 pm

    The dollar drops, inflation rises so commodities go higher