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06-02-08
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Market Commentary: Monetary policy to the rescue - further interest rate cuts necessary
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Last autumn, when the US Federal Reserve and the Bank of England lowered their core interest rates in response to the unfolding US subprime mortgage crisis, they attracted a lot
of - sometimes vehement - criticism. The institutions were accused of providing excessive and unwarranted support for banks and bourses. Since then, these voices have
fallen silent one by one as the risks to global growth have become apparent. Given that the self-regulating forces of the market do not appear to be up to the task at present, a
stronger hand - despite possible side-effects in the form of inflation - is called for. Further interest rate cuts and fiscal measures such as tax cuts for US households
and companies are needed.
The fact of the matter is that even after two interest rate reductions totalling 1.25% in January 2008, US monetary policy is still, literally, behind the curve, as developments
in the money and bond markets demonstrate. The yield curve between overnight rates and yields on two-year Treasury notes is still inverted, which is an abnormal state for interest
rates, which means that a paper with shorter maturities now earns more than some long-term securities. If the Fed really wants to come to the aid of the economy, it will have to
lower its key rate to at least 2.5% - 2% would be better - as quickly as possible. We have the impression that the Fed is aware of how serious the situation is and, in
particular, is willing to administer the medicine. We can only hope that the thoroughly theoretical and unrealistic discussion about interest rate cuts failing to address the
actual problem, or the central bank mistakenly propping up the stock market, will not deter the Federal Reserve from fulfilling its responsibilities. Of course it is correct that
interest rate cuts cannot solve the problem of the excessive debt burdening the US government and US households. Nonetheless, every institution must do all within its power to try
to solve the problem. The situation is similar to that of an overweight patient who is taken to hospital with a suspected heart attack. For years the attending physician has been
urging his patient to adopt a healthier lifestyle by exercising more and eating less, but in vain. Should the physician now refuse to operate on the patient and give him the
necessary medications only because the patient had not listened to him? The same reasoning applies to the USD 150 billion fiscal stimulus package announced by the US
government.
What does all this mean for investors? As long as the levels of uncertainty and volatility in the financial markets remain as high as they are, it is of particular importance for
investors to maintain a balanced, structured portfolio with a broad range of asset classes. At present, favored assets include certain commodities such as crop and gold,
high-quality government bonds and the Swiss franc. On the other hand, the market's mood can turn very quickly and unexpectedly, which will help equities that are currently
cheap.
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Dr. Thomas Steinemann
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| Chief Strategist of the Vontobel Group |
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| +41 (0)58 283 78 44 |
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Contact
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