Liquidity Factors

Recent data suggest the Fed has changed policy to a more full blooded
easing. It has been reducing the FFR% and now appears to be adding
some monetary liquidity to the system. The Fed has "sterilized" the vast
bulk of its term swap facilities to banks and primary dealers by having
the Open Market Desk sell Treasuries in amounts comparable to what
it has swapped out in exchange for the very much less liquid private
sector finance paper. Still, total Fed Bank Credit has been growing
more rapidly since last autumn. Specifically, total Fed Bank Credit has
grown at a 5.6% annual rate over the past six months. This compares to
a paltry 1.3% annualized rate of growth for the prior six months. This
development, coupled with falling short rates constitutes an important
positive for the economy down the road.

The much broader measure of credit driven liquidity has also begun to
accelerate in growth, rising at a 4.7% annual rate since mid-2006. The
improvement here has come far more slowly, mainly reflecting
continued weakness in the asset-backed commercial paper market.
The Fed has also been concerned about the large rate spreads that have
opened up for A2/P2 and lesser paper against prime paper. Moreover,
private sector paper continues to trade at yield levels well above short
Treasuries as investors continue to fly to quality. In short, there have
been improvements in liquidity, but the system remains far off kilter.

The liquidity improvements to date were far too tepid to stave off an
economic downturn and are still shy of what's needed to help put the
economy on a much stronger footing, but you need to be aware that the
system is repairing despite the gravity of so many comments in the
media. Ditto the banking system where loans are improving modestly
along with a decent recovery of primary capital.