Although Jim Cramer yesterday declared that Santa Bernanke had come to town (by reducing the Fed's target interest rate), that the worst is now behind us, and that a housing bottom will occur in July, 2009, Barclays Capital's chief economists shared a drearier outlook this morning at their office in the MetLife building. They essentially said it's hard to know what will happen until more policy decisions come out of Washington. "If credible policies are taken, everything will rally," said Larry Kantor, head of research. He expects the recession to end in mid-2009, but he believes the recovery will be "less robust than usual."
One thing Kantor said he would like to see is 4% mortgage rates. "That would be easy to do and it wouldn't cost taxpayers a cent," he says. Lower mortgage rates would stimulate mortgage refinancings and home buying and raise the value of banks' distressed mortgage-related assets.
Kantor recommended that investors invest in investment-grade assets such as short-term European government bonds, which he said are a good hedge against deflation.
The Barclays group expects the hedge fund industry to shrink 70-80%. "We believe only those funds with models that operate on near-zero leverage will be those left standing," they stated in the report they released today, "Positioning for an uncertain recovery." They expect to see little to no demand for CDOS and CLOs.
These economists do expect to see a rally in the valuations of mortgage-backed securities in the first quarter of 2009. "Balance sheets will start to recover," said fixed income economist Ajay Rajadhyaksha. The subprime lending phenomenon has ended, he pointed out, but there's an overhang of houses. He expects mortgage rates to stay low throughout 2009; in 2010 he predicts mortgage rates will rise rapidly.
On the corporate credit front, the economists says that although fundamentals will get worse, liquidity coming from monetary policy may help ease the credit crunch in 2009. "High-quality corporate credit has benefitted from programs like TARP, TLGP and CPFF that provide liquidity," said economist Ashish Shah.
Asked if a government intervention in Lehman's collapse would have helped prevent this economic downturn, Kantor said, "Absolutely. The integrity of the financial system has been severely damaged," noting that the Fed now holds more than 20% of all commercial paper.