“Chart 2 highlights the impact of the Fed’s recent policy actions have had on liquidity. The Fed’s balance sheet has exploded in size, resulting in a massive build up in liquidity. One way to measure this is with the monetary base (currency plus commercial bank deposits at the Fed), which has increased by an unprecedented magnitude since the beginning of December. At some point, all of this money is going to work its way through the financial system into the economy.”
“Bottom line: Global policymakers have declared war on the credit crisis to limit its fallout for their economies. Collapsing commodity prices and the downside risks to most economies has eliminated inflation as a concern for at least the next 1-2 years, giving policymakers everywhere unlimited scope to take additional actions. This implies ultra low central bank policy rates everywhere for a considerable time to come. Today's action and comments from the Fed are completely consistent with this assessment. Alongside other policy actions directed at the financial system, this creates a strong case for short-term market yields to fall considerably. In Canada, this implies much lower yields on commercial paper and bankers' acceptances in coming months. In fact, we should see a 15-20 basis point drop next week as year-end pressures in Canadian money markets dissipate. For investors this means increasingly meagre returns on cash holdings. In coming months investors and banks will tire of the low returns associated with the safety of liquid cash holdings and will begin to ponder much more attractive returns in riskier assets like lending, corporate bonds, preferred shares and common equity.”
Comments made by John Johnston on October 29, 2008, Chief Strategist of The Harbour Group, part of RBC Dominion Securities Inc. in response to the US Federal Reserve’s 50 basis points cut, dropping the Fed funds rate to 1.00%.
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