Personal Finance Advice

CNBC reported earlier today that a bailout plan to rescue trouble bond insurer Ambac would be announced sometime early next week.  The news sparked a late rally on Wall Street even as investors cope with increasing signs of an economic slowdown.

Yesterday’s news that manufacturing activity was slowing as well as a bleak forecast on future economic growth had stocks trading down sharply until the CNBC report surfaced late in the afternoon.

There is a lot at stake for the financial sector in keeping Ambac and it’s rivals at their AAA rating level.  With the industry insuring over $2.4 Trillion in bonds that are in danger of being devalued, the ramifications of a ratings downgrade are incalculable. 

Already new bond issuance has slowed to a trickle and bonds that are being sold are doing so at sharply increased costs.  Municipalities are having an especially rough time of it, with many of them delaying their scheduled public works projects.

The biggest fear for investors is that a bond devaluation would lead to a new wave of write downs for an already beleaguered banking system.  Some analysts are estimating that bank write downs could go as high as $100 Billion.  It would pretty much signal a deathblow to any chance of our economy staying out of a recession.

Even with this bit of good news most analysts are remaining cautious.  The bond insurance industry still has a lot of exposure to sub prime debt that isn’t going to go away overnight.

The stock market made big gains last week on the strength of the recent rate cuts, only to give them back at the start of this week as more bad news on the economic front was released.  A major contraction  in the massive U.S. service sector led to a large sell off on Wall Street.

While The Fed had been much more aggressive in it’s monetary policy recently, inflation is still a major concern.  Philadelphia Fed President Charles Plosser earlier today stressed the hazards of rate cutting.

“Ignoring inflation during times of economic weakness risks undermining our ability to achieve economic growth over the long run.”

“It [monetary policy] cannot solve the bad debt problems in the mortgage market. It cannot reprice the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies, because some of their assets are now worth much less than previously thought.”

While the economy has been slowing recently, inflation numbers have been higher than expected and economists will be keeping on close watch on the January data.  On a positive note, while the price of oil broke the $100 barrier for the first time last month, it has been trading at under $90 recently.

Nonetheless despite the renewed inflationary concerns, many analysts believe the Fed will cut rates once more in the upcoming weeks.  They point to the fact that there has been little or no signs of wage inflation since the rate cutting campaign began last fall.

The Fed’s surprise rate cut of 75 basis points stunned investors on Tuesday.  Coming on the heels of an overseas sell off when Wall Street was closed for trading on Monday, it still couldn’t stop the market from falling sharply as investors worried that this move only confirms their worst fears, that a recession is on the horizon.

After taking a couple of days to digest the move the market rebounded with financial stocks leading the way.  On early trading yesterday the Dow Jones was down over 300 points before making a 600 point rally to finish the day up 300.  The rebound may have taken longer to materialize due to the troubling news on the tech front as both Apple and Motorola are expecting lower earnings this year. 

There is still concern though because European Central Banks are not following suit with their own rate cut.  You can expect exchange rates to fall even further in the near future because of the imbalalance in interest rates.

Is this a panic move by the Fed?

I don’t believe so, one would think they would have made the move anyway after their regularly scheduled meeting later this week.  However, due to turbulence in the global markets they must have felt that initiating the rate cut early would help mute its effects.

I believe it was a smart move on the Fed’s part.  If they had waited until after the meetings, who knows how much the market would be down by then.  At that point many would have considered the 75 basis point cut as a panic move.