Better Late Than Never!

Hong Kong's Hang Seng Index rose 2,332 points (10.7%) to close at 24,090. The HSI had declined more than 10,000 points from the peak in October 2007 and was in danger of breaching the 21,400 support level, closing 21,757 on 22 January 2008. Since October 2007, the HSI had given up almost all the gains in 2007 which began the year at just over 20,000.

The catalyst was the Fed cutting Fed Funds rate by 0.75% from 4.25% to 3.50%. The Fed Discount rate was cut by the same percentage from 4.75% to 4.00%. The last time the Fed made such a large cut was in August 1982.

The expectation is that the Fed will continue to cut rates aggressively at the meeting next week, perhaps by as much as 0.50%. The Fed is expected to cut rates down to 2.75% by April, and 2.0% by September. How low can it go? The lwest was 1.0% on 25 June 2003.

Will cutting interest rates help? Almost certainly. The problems with providing liquidity to banks through the discount facility is that the banks do not want to borrow. They have sufficient cash. The problem is that they need capital injection because of the book losses they have taken from revaluing the "sub prime loans". By cutting interest rates, the Fed makes it easier for borrowers to keep up their payments. Taken together with the US Government's efforts to negotiate a moratorium on interest vrates re-setting, this will reduce the expected default rate, and allow the banks to start valuing the sub prime based securities at closer to their real value rather than the current "fire sale" levels.

Why didn't the Fed cut by 0.50% in December 2007 instead of the miserly 0.25%? The reason given was that there were still inflation worries, and the Fed wanted to try injecting liquidity directly to banks through the discount facility. That did not really address the problem of pending defaults on sub prime mortgage loans. Only a moratorium on restting interest rates, and a reduction of the rates will achieve the aim of stabilising the market.

The HK market reacted positively to the rate cut. However, we still expect the market to be volatile over the next 6 weeks until the rate cuts take effect. In the short term, we are looking for 27,000 for the near term and up to 34,000 sometime during 2008.