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Nearly ten years ago
the Federal Open Market Committee convened a special meeting to address the
problems in U.S. financial markets regarding the failure at Long Term Capital
Management. It is not without irony that one decade later the Fed and the
U.S. Treasury are addressing an infinitely more complex problem with respect
to Fannie Mae and Freddie Mac, while at the same time contemplating the
potential failure of major investment and commercial banks.
Unlike the special
meeting that occurred over a decade ago, there is little doubt that the Fed
will remain on hold ahead of the September 16 FOMC meeting. Due to the issues
with inflation that still are at the forefront of Fed considerations, there
will be no rate cut to assuage a market still reeling due to the ongoing
problems in the financial system.
We expect that the
statement will forthrightly acknowledge the actions taken by the U.S.
Treasury and employ language regarding positive market reaction in light of
the unprecedented move by the Federal Government. The FOMC will probably seek
to place light on the narrowing in swap spreads and the decline in long-term
mortgage rates that have occurred in the aftermath of Mr. Paulson's statement
on Sunday September 7.
 
Without a doubt the
actions taken by the U.S. Treasury will provide a major subject for
discussion either in the formal meeting or any prospective special meeting
that the statement may announce. The systemic risk posed by the issues at
Fannie and Freddie are such that we went back and examined the transcript
from the October 15, 1998 meeting surrounding the problems at Long Term
Capital Management to ascertain the possible shape of the upcoming statement
and the ensuing minutes to the meeting that will be released on October 7.
In that meeting
committee members had a three primary concerns that provide an eerie parallel
to the current crisis. First the committee was primarily concerned about a
potential spillover of instability into the non-financial community. Like
today, fear and uncertainty in the markets prevailed.
Second, the
committee was concerned with major problems at other banks that were not
acknowledged. William McDonough, who was the head of the NY Fed at that time
openly, wondered if there were "skeletons still rattling around in the
closets that have not been revealed."
Third, the committee
was concerned with the issue of moral hazard caused by the bailout.
We think that this provides
a good frame or reference in which to evaluate the upcoming FOMC statement. One
year into the domestic financial crisis, the market has only observed partial
spillover into the greater non-financial community that has largely been
responsible for keeping the economy afloat during the crisis. And it is quite
clear that many of the financial players singed by the heat from the meltdown
in the housing industry have yet to come clean and mark to market their
losses.
Given that the
financial industry continues to access "temporary credit
facilities" at the Fed we would not be surprised to see in a few years
when the transcripts for this meeting are released if the committee is found
to be considering opening access to such facilities to the non-financial community.
Our Senior Economic
Advisor William Poole has made a very persuasive case that the Fed has
inadequately defined the post Fannie and Freddie financial world. Concerns
over moral hazard still prevail. After saving Bear Stearns we wonder if the
Fed might be tempted to say yes, should a large auto company, a large
insurance company or a major metropolitan area suddenly need emergency
financing. We believe that these are but a few of the ideas behind the
interesting discussion taking place in markets regarding the credit quality
of the United States.
Thus, we anticipate
that the committee will utilize language reinforce its intent to provide
adequate liquidity should conditions in the market change in the aftermath of
the action taken by the U.S. Treasury.
The committee should
note the deceleration in economic activity in the context of weak labor
markets and the ongoing stress in financial markets. The statement should
retain language regarding the efficacy of past monetary policy with respect
to fostering market liquidity and moderate economic growth.
We expect that the
committee will note the recent decline in the prices of energy and some
commodities, while reaffirming their expectation that inflation will moderate
later this year, although that outlook will remain highly uncertain.
The assessment of
risks should remain balanced between risk and growth. Even with the basic
Taylor Rule implying that monetary policy remains accommodative by at least
150 basis points, the Fed will continue to hold rates steady as it modestly
attempts to reduce the money supply after a long period of accommodation.
Joseph Brusuelas
Chief Economist
VP Global Strategy
Merk Investments LLC
Merk Investments LLC is the manager of
Merk Mutual Funds, including the Merk Asian Currency Fund and the Merk Hard
Currency Fund. The Merk Asian Currency Fund invests in a basket of Asian
currencies. Asian currencies the Fund may invest in include, but are not
limited to, the currencies of China, Hong Kong, Japan, India, Indonesia,
Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.
The Merk Hard Currency Fund invests
in a basket of hard currencies. Hard currencies are currencies backed by
sound monetary policy; sound monetary policy focuses on price stability.
The Funds may be appropriate for you
if you are pursuing a long-term goal with a hard or Asian currency component
to your portfolio; are willing to tolerate the risks associated with
investments in foreign currencies; or are looking for a way to potentially
mitigate downside risk in or profit from a secular bear market. For more
information on the Funds and to download a prospectus, please visit www.merkfund.com.
Investors should consider the
investment objectives, risks and charges and expenses of the Merk Funds
carefully before investing. This and other information is in the prospectus,
a copy of which may be obtained by visiting the Funds' website at www.merkfund.com or calling 866-MERK
FUND. Please read the prospectus carefully before you invest.
The Funds primarily invest in
foreign currencies and as such, changes in currency exchange rates will
affect the value of what the Funds own and the price of the Funds' shares.
Investing in foreign instruments bears a greater risk than investing in
domestic instruments for reasons such as volatility of currency exchange
rates and, in some cases, limited geographic focus, political and economic instability,
and relatively illiquid markets. The Funds are subject to interest rate risk
which is the risk that debt securities in the Funds' portfolio will decline
in value because of increases in market interest rates. The Funds may also
invest in derivative securities which can be volatile and involve various
types and degrees of risk. As a non-diversified fund, the Merk Hard Currency
Fund will be subject to more investment risk and potential for volatility
than a diversified fund because its portfolio may, at times, focus on a
limited number of issuers. For a more complete discussion of these and other
Fund risks please refer to the Funds' prospectuses.
This report was prepared by Merk
Investments LLC, and reflects the current opinion of the authors. It is based
upon sources and data believed to be accurate and reliable. Opinions and
forward-looking statements expressed are subject to change without notice.
This information does not constitute investment advise nor a solicitation or
an offer to buy or sell any products or services. Foreside Fund Services,
LLC, distributor.
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