Interest Rates..Banks Counter Attack

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Markets are now caught between debt deflation and policy attempts to reflate. After Japan's market fell 9% yesterday and Australia's 5%, you had to expect some concerted central bank counter-attack. It finally came.

The Fed, the ECB, the Bank of England and the central banks of Canada, Sweden, and Switzerland all lowered their key rates by a half percentage point. The bankers fired a volley of rate cuts into a human wave of selling on the share markets. Some shots found their mark. Others did not.

The credit markets appeared to de-thaw just a tiny bit after the rate cuts. The spread between the interest rate on a ten-year government bond on an interest rate swap narrowed from around 61 basis points the night before to 54 basis points in the heat of the battle. When the spread is wide, investors shun the credit market. The narrowing is an improvement.

But negative events are overwhelming good intentions at a breakneck pace. The Fed, for example, is lending another US$37 billion to insurance giant AIG. Some of AIG's U.S.-based life insurance subsidiaries will post collateral with the Fed in exchange for investment grade bonds. What's the collateral? Hmm. Let's hope it's not credit default swaps.
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