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The Stimulus Trap?

Discussion in 'Market Predictions and Reports' started by dojit, Feb 8, 2009.

  1. dojit

    dojit Private

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    The Stimulus Trap?
    Sunday, February 08, 2009
    By dodjit
    In an effort to save the U.S economy from its worst recession since the 1930s, Democrats and Republicans came to an agreement on Friday, regarding President Obama’s stimulus plan. While most people are not exactly sure how the government is going to fund this enormous plan, the two parties managed to come to terms with the fact that the more they prolong the aid, the worse the global situation will get. Even though they didn’t agree on the whole deal, they managed to settle on a “tiny” amount of $780 billion, excluding further aid for parts of the housing sector and auto-industry.

    Last week’s trading days were packed with economic data and announcements, as three central banks gave their rate decisions, while the U.S continued to show a horrifying employment picture. The RBA and the BOE both slashed their rates, while the ECB paused this time round, stating that previous monetary easing is yet to leak through and have an effect on the system. Even though Trichet acknowledged that more rate cuts in March can’t be ruled out, he also hinted that he would try to avoid a zero rate policy like the U.S. Friday’s awaited employment data sent shivers down investor’s spines during premarket hours, as NFP result showed a horrifying figure of 598,000, the most in 30 years, while unemployment jumped to 7.6%. By taking a glance at the chart below one can see that despite all the efforts done by officials, unemployment levels haven’t yet formed a ceiling.

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    In addition, the Fed announced at the beginning of the week that they are going to extended their swap program with other banks, allowing more Dollars to flow around the global financial system. One has to remember that the U.S Dollars still dominates the currency market and global transactions are often done in Dollars. Due to the financial crisis and credit crunch, the sector has frozen up, as commercial banks are now unwilling to give out money or credit.
    Joint efforts between banks are trying to sooth the situation, but many are now wondering what will happen if the current stimulus plan doesn’t have a lasting effect and will also wear off, similar to previous ones?

    Liquidity Trap- According to the books, a liquidity trap is a situation where a government continues to engage in monetary easing, eventually reaching a level of 0%, but their efforts fail to have an effect on aggregate demand (AD).

    Or in other words…… they fail to stimulate the economy, restoring confidence and consumption.

    Over the last couple of months, more and more businesses have been going bust while consumers have pulling back, preferring to hold their money close to hand, than to spend it on consumption. In addition those who do want to spend money are being rejected by banks, as they are unwilling to give out credit. Even though LIBOR rates have declined rapidly over the last couple of weeks, the end consumer is not feeling that relief. According to the Conference board Consumer Confidence Index the CCI is now standing at 37.7 down from 38.6 in December. To date, consumer’s assessment of the overall current conditions remains pessimistic; signaling to a further increase of savings.


    Source
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    Will money remain trapped or will the economy start spending again returning to a normal state?

    To help us analyze the state of the economy, one can turn to major stock indices. A bullish market increases sentiment across the board, eventually sparking demand on Main Street.
    Despite the negative economic result on Friday, the major U.S indices ended the session with gains of approximately 2%. In addition carry trades on the forex market received a bounce, closing the week on a higher note. While it still too early to determine a change in trend, the stimulus plan is increasing investor’s sentiment regarding future market activity; which could stimulate the economy and turn sentiment around.
    Just remember before you start loading yourself with stocks, hold your horses and invest carefully! Even though the indices are now trading at a critical turning point after increasing on Friday, the senate still has to approve the enormous plan.

    S&P500 Daily Chart
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    USD/JPY- Daily Chart
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