More Government Intervention, This Time to Save the Money Markets

It seems that there’s a never-ending supply of cash floating around Washington these days, and this time it’s the money markets which are the beneficiary. The Fed has observed that "short-term debt markets have been under considerable strain in recent weeks" and that about $500 billion has flowed out of prime money-market funds since August, which with other money-market mutual funds control $3.45 trillion.

If you’re not already familiar with them, money market funds are mutual funds that invest in short term instruments that mature in less than 13 months. What’s more, the SEC mandates that average maturity of all securities in a given fund must be less than 90 days. That looming expiry date minimizes risk for instruments including US Treasury issues, short-term corporate paper, and CD’s.

But that hasn’t stopped recent liquidity problems at several of these funds, and the lack of FDIC insurance for any losses isn’t helping investor confidence either. During normal times, money market funds are not expected to sell their holdings any more than a more traditional corporation is expected to sell its accounts receivable. But in response to a one-way exodus that is forcing an apparently-unsustainable amount of redemptions, the Fed has launched the Money Market Investor Funding Facility to smooth over the disruption.

The New Financial Band-Aid is About to be Applied

This is not a troubled asset purchase program like Paulson proposed for the banks, however — it’s more of a backstop for money-market mutual funds to meet redemptions. Here’s how it works:

JPMorgan Chase & Co. will run five special units that will buy up to $600 billion of certificates of deposit, bank notes and commercial paper. The Fed will provide up to $540 billion of this cash, with the remaining $60 billion coming from commercial paper issued by the five units. The special-purpose vehicles will finance 10% of their purchases by selling asset-backed commercial paper. The New York Fed will lend the remaining 90% on an overnight basis at the discount rate, which stands at 1.75% at the moment.

This sounds great, right? But then again, it seems that the earlier two programs set up last month by the Fed and U.S. Treasury to help money-market funds haven’t stabilized the industry at all. Will this one do it? No one knows, but of course the "masters" of Wall Street and high finance are proclaiming that the world has once again been saved.

But don’t worry, if this latest and greatest sure thing doesn’t work, the Fed will start an unlimited program to purchase commercial paper directly from issuers next week … just in case companies which had to pay more to borrow or were cut off from that market need help.

Hmmm … it just gets deeper and murkier, doesn’t it?

Another Day, Another DOW-nturn

The dropping DJIA hasn’t set new annual lows, but it’s hardly bounced as some of the more optimistic observers would have liked. The index seems to be consolidating around the 9,000 level as you can see here:

But is this the bottom? The On Balance Volume indicator isn’t giving a bullish signal yet. It should be rising (indicating accumulation) rather than dropping (a strong hint that distribution is occurring instead). It would seem that most people are still trying to get out and that “smart” buyers aren’t yet bargain hunting in force.

Here’s another look at the Dow, this time with Fibonacci retracement levels overlaying the price:

Fibonacci retracement is a popular tool used to identify strategic support or resistance after a prolonged rise or fall. The key levels are 0.618 and (1 – 0.618) 0.382. Each term in the Fibonacci sequence (1, 1, 2, 3, 5, 8, 13, etc.) is the sum of the two preceding terms. As the sequence grows, the ratio converges to 0.618.

So why is this considered important?

That 0.618 ratio is a number found many times in nature in such forms as sex ratios in certain insects, the number of seeds or petals in flowers or cones, and branching in plants. Many body dimensions also adhere to this ratio, such as the ratio of the distance from your head to your feet when compared to the length from your navel to your feet. The "golden ratio" is everywhere, and many true believers feel the market (being guided by "natural" human psychology) is subject to the same irresistible forces.

The DJIA certainly found it hard to close over that 38.2% retracement level, didn’t it? In fact that massive one day rally ran smack into the magic 38.2% level and was unable to hold above it the next day. A decisive close over the 9,425 level would be needed before resistance becomes support and a genuine rally can be considered to have begin. 

Euro-wned by the Mighty U.S. Dollar

About the only thing moving in the right direction for U.S. investors right now is the dollar. Only the Yen has really outperformed the dollar over the last little while, with the Euro (pictured below), Canadian dollar, Australian dollar, British pound, and pretty much everything else getting absolutely hammered over the last few months.

Right now, the Fibonacci levels shown on this chart haven’t yet been tested as the Euro is still plunging. It’s fallen from 1.60 to 1.27 (an eye-watering 20%+) in only three months and hasn’t yet appeared to be forming a bottom.

We still believe quite firmly in our long-term bullish prognostications for gold and other commodities (especially since gold has historically been considered an alternative to paper currencies). However, it will be a longer wait than expected for US dollar alternatives to truly shine.

There are already rumors of a rate cut from the Fed, and if that occurs, it is unlikely the dollar will be able to stay on top for much longer. Don’t wait until it’s too late to diversify and ensure your long-term safety during what is sure to be a highly interesting next few years in the markets.

Good investing,

Nick Thomas
Analyst, Oxbury Research