Goldman strategist predicts three rate cuts by year-end

Markets Wary of Further Fed Cuts
as US Bond Yields Dive to '87 Levels

By Ambrose Evans-Pritchard and David Litterick
The Telegraph, London
Tuesday, August 22, 2007

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/08/21/cnmark...

A flight to safety on Wall Street caused yields on 3-month US treasury notes to plummet at the steepest pace since modern records began, eclipsing moves at the height of the 1987 stock market crash.

Investors fled the $2,500 billion (£1,260 billion) money market that usually serves as a safe haven in times of turbulence, responding to reports that funds may be exposed to sub-prime mortgage debt and asset-backed commercial paper. "This is a sign of significant fear in the financial system," said one banker.

However, the Dow, after sinking nearly 100 points in early trading, staged a late rally and ended up 42 points at 13,121, as the pile into treasury notes eased later in the day.

Traders were initially unsettled by news that Deutsche Bank had tapped the credit window of the US Federal Reserve after the emergency half-point cut in the discount rate last Friday. Banks are typically reluctant to use the facility, fearing that it could send off a distress signal.

German banks have unexpectedly proved to be among the hardest hit by sub-prime losses, with IKB bank and Sachsen LB requiring a state-orchestrated bailout of E25.4 billion between them. Deutsche Bank holds E15.45 billion of exposure to vulnerable forms of debt through so-called conduits.

The yield on the 3-month note dropped within a period of two hours from 3.76 percent to 2.55 percent, a bigger shift than on the days of the 9/11 terrorist attacks or the 1987 meltdown.

"This is a mind-boggling rally in 3-month notes. There is absolutely no liquidity in the market now," said one trader, Kim Rupert, a fixed-income strategist at Action Economics. He said the debt markets were still frozen. "We're not out of the woods yet in terms of more credit-market fallout, and investors are basically staying parked in shorter-dated treasuries," he said.

Demand for longer-dated 3-year treasuries tumbled as investors began to bet on a string of rate cuts by the Federal Reserve in coming months. US car sales fell to the lowest level in nine years in July, pointing to a downturn in consumer spending.

Michael Vaknin, a strategist at Goldman Sachs, expects the Fed to cut rates three times by end of the year. "The Fed's actions so far should reduce the probability of a full-blown crisis," he said. However, he warned that the combined effect of falling house prices and the latest equity slide would hit spending more than generally realised, doubting whether there would be a sustained rally on the stock market until it was clear who held the main losses from the sub-prime crisis.

Countrywide Financial, the largest lender in the US, began laying off sales workers as it tried to weather the crunch. Meanwhile Thornburg Mortgage, which has also seen its finances ravaged, said it had sold $20.5 billion of assets to boost its financial health, citing "unprecedented conditions in the mortgage financing market." The Countrywide layoffs occurred in its Full Spectrum Lending business, which handles many home loans in a category known as Alt-A, or mortgages between prime and sub-prime that often involve borrowers who don't document their income.

Capital One, a financial services group better known for its credit cards, said it was shutting down its struggling GreenPoint mortgage unit, becoming the latest casualty in the mortgage meltdown. Almost 2,000 staff will lose their jobs. Capital One bought GreenPoint in last year's $13.2 billion purchase of North Fork Bancorp.

* * *

Join GATA at these conferences:

The Silver Summit
Thursday-Friday, September 20-21, 2007
Coeur d'Alene, Idaho
http://thesilversummit.com

New Orleans Investment Conference
Sunday-Thursday, October 21-25, 2007
New Orleans, Louisiana
http://www.neworleansconference.com

* * *

Help Keep GATA Going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.gata.org/.

GATA is grateful for financial contributions, which are federally tax-deductible in the United States.