[ForexNews]

Yesterday morning got off on the wrong foot with a weaker than expected unemployment claims print. However, Ben Bernanke’s defense of Fed actions in his testimony to the House Oversight Committee helped buoy markets. In addition, the Fed announced that it will extend several of its liquidity facilities -- the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), and the Term Securities Lending Facility (TSLF) -- through February 1, 2010. Given that these programs require the presence of “unusual and exigent circumstances”, it is rather improbable that the Fed would contemplate raising rates at least until February 1, 2010. More broadly, this action reinforces forecast that the Fed will not hike rates at least until the end of next year.

Partly on this back of this constructive message from the Fed, 10 year note rallied 15 bps to 3.53%, falling to the lowest level in three weeks. Strong demand for government debt at yesterday’s Treasury auction provided further fuel to the rally in rates. With yields falling, equities were able to stage an impressive rally; the S&P finishing the day up 2.1%, its best one-day showing in three weeks. Commodities also rallied, with oil moving back above $70.


The rise in the saving rate underscores a welcome development: the patient is slowly recovering. Indeed, a medical analogy is quite instructive here. One can think of the financial crisis as a “heart attack” that was caused by an underlying disease, namely several years of financial excess in which many households and financial firms became overly leveraged on an unhealthy diet of cheap credit. Fortunately, due to prompt care from Dr. Bernanke and others, the patient has stabilized. But the paralysis caused by the financial crisis – manifested by the biggest recession in postwar history – will take time to wear off.

Broadly speaking, flag the following indicators to gauge whether the recovery is on track:

Is the health of financial institutions continuing to improve? One of the things that helped put in a bottom in the S&P this March was the better than expected performance of banks in the first quarter. US banks earned a rate of return on assets of about 2% -- more or less in line with the historic average. If this rate on assets can be sustained, then US banks should be able to generate enough profits on a pre-provision basis over the next two years to cover further expected charge-offs. This, combined with extensive capital raises to date, should support lending and help avoid another freezing of credit markets.

Will advanced economies move towards positive growth in the second half of this year? Now that the market has broadly priced in economic stabilization, we need to see evidence that things are getting better, not just less bad. If growth in the US averages 1% in the back half of the year, this should translate into a move in the ISM above 50. At this stage, the labor market is the biggest source of
concern. Historically, initial jobless claims have peaked about 2 to 3 months before the end of a recession. While the current 4 week moving average of jobless claims is down from its peak at the end of March, it remains at a very elevated level, and would probably need to fall by another 100K or so towards 500K over the next few months to support growth views.

Are the BRICs and other EMs continuing to support global growth? While the Russian economy has stumbled of late, growth in the rest of the BRICs, especially in China, has helped cushion the global economy. Outside the BRICs, the main challenge going forward is to avoid another financial flare-up. The turmoil in Latvia is a timely example that we are not out of the woods yet.