Tuesday, November 27, 2007

Stocks Slide Despite Fed Move on Funding Fears

US stock prices and bond yields plunged on Monday as credit fears grew in spite of aggressive efforts by the Federal Reserve to head off a year-end funding squeeze.

Traders said investors were shifting out of equities for the security of government debt in a flight to quality that gained momentum in the final hours of trading. US bond yields touched their lowest levels in more than three years, while the S&P 500 index finished 2.3 per cent lower, 10 per cent off its record high in October - a technical "correction" in stock-market parlance.

"This had all the fingerprints of a massive allocation shift out of equities and into long-dated bonds," said William O'Donnell, UBS interest-rate strategist.

The US trading day began with the Fed promising to ensure there was enough money in the system to keep the overnight borrowing rate at or near its target level, now 4.5 per cent, around December 31. It announced a series of long-term liquidity operations to span the new year, starting with an $8bn repo deal that matures on January 10. These operations will allow banks to lock in funds to carry over the year end.

A New York Fed official said "we hope to reassure market participants of our commitment to providing sufficient balances at that time by starting to provide these balances now." The US central bank also said it was relaxing the terms on which market participants could borrow Treasury securities from its own portfolio, in a bid to help meet intense demand for these safe asssets.

The Fed move came as HSBC, Europe's largest bank, unveiled plans to take on to its balance sheet $45bn (£22bn) of debt - much of it mortgage-linked - that is owned by structured investment vehicles (SIV) it manages. HSBC said its decision to bail out its SIVs would provide certainty for investors in the funds, for HSBC shareholders and for the bank and could help support the broader market by removing the threat of a firesale of the assets its vehicles held.

However, its decision to go it alone deals a blow to US banks attempting to push through a US Treasury-backed plan to create a so-called super SIV. HSBC will not provide any of the liquidity for the super SIV as the US banks had hoped. Shares in banks began selling off in late London trading after Goldman Sachs said HSBC might need to make an additional $12bn of provisions for its US subprime mortgage and home equity loan exposure. The FTSE 100 fell 1.3 per cent.

Losses were heavier in New York as the S&P ended up in negative territory for the year and investors piled into government bonds. Yields on two-year Treasury note fell 19 basis points to 2.885 per cent, its lowest level since November 2004. The 10-year Treasury fell 16 basis points to 3.835 per cent, its lowest level since March 2004. Shares in Citigroup, which has the largest exposure of any bank to SIVs, fell 6 per cent, its lowest level in more than five years.

The latest Fed moves, which coincide with new expected money market operations by the European Central Bank today, come amid increasing fears that financial turmoil could spill over into the real economy.

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