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The Fed's $200 Billion Liquidity Package
March 12, 2008
Federal Reserve:
Yesterday morning, the Fed announced that it would lend $200 billion dollars to financial intuitions who do business with the Fed - basically the big boys on Wall Street. The loans to these institutions would be treasury securities and in return these institutions will be putting up mortgage backed securities as collateral, for which there is little to no market. So, by allowing financial institutions to put up mortgage-backed securities (getting the securities off balance sheets) -- for which there's little market appetite -- in return for safe securities that are in high demand, the Fed hopes to take pressure off financial companies and make them more inclined to lend to individuals and to businesses.
Right now fear is at peak levels, as the financial crisis can't be quantified. Two days ago Bear Stearns was going bankrupt...next week it will be rumors of Citigroup, etc. While this injection of liquidity will not reverse the fear factor, it helped yesterday and boosted the Dow by over 400 points. This will likely be short lived due to the fact that the Fed Funds Futures are pricing in a 66% chance of a 75 basis point rate cut, meaning investors still want more to ease these markets.
The large Wall Street banks benefited yesterday with the injection of liquidity, however, I would want to at least see earnings reports out of the money center banks before declaring victory against all of the doom and gloom.
How does this effect the price of gold:
Yesterday, upon hearing the news, the price of gold dropped about $20 before it bounce back to breakeven for the day. This morning, gold is up about $4 to $977.
Gold watched what the dollar did yesterday and this morning and is doing the exact opposite. Once the news was announced yesterday, the dollar rebounded a bit due to the fact that investors were thinking that the US economy may not slip into a recession with this injection of liquidity. After the initial movements within the market, yesterday afternoon and this morning saw the dollar fall a little, boosting the price of gold almost $20 from market bottom.
This increase in liquidity may also reduce the need for additional liquidity during margin calls. Gold has suffered when the stock markets fall dramatically, as institutions liquidate gold positions to raise cash.
The gold market will be watching to see what additional fall out will come from the move by the Fed. Clearly, it is not a bad thing for gold since the metal is up about $8 from yesterday's open and $20 from yesterday's market bottom.
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