The floodgates are opened

Last few days, Morgan Stanley revisited the arguments contained in its article entitled The Great Monetary Easing of 2008 (dated January 3, 2008), where it opined that that many central banks, led by an aggressive Fed, would shift towards an easier monetary policy stance in 2008, thus starting a new global liquidity cycle. While anticipating global inflation pressures to remain high, Morgan Stanley expected many central banks to eventually put concerns about economic growth and financial stability above inflation worries.

The Fed’s current easing cycle, which involves taking the real rate of interest to zero, would be carried out in 3 phases:

• In Phase 1, which lasted from the summer to December of last year, policymakers returned the fed funds rate from a restrictive 5.25% to a broadly neutral level of 4.25%.
• In Phase 2, rates were reduced by a total of 125bp to the current level of 3% in two steps in January, which turned monetary policy expansionary.
• Phase 3, which we are entering now, is about pushing the real policy rate to and below zero.

In response to the rising strains in the financial system, further dollar weakness and the large Fed rate cut, other central banks are now more likely to ease (or tighten by less) too:

• The ECB is expected to cut rates by 25bp later this year & once again at the beginning of next year.
• The BoJ may go for a 25bp rate cut in the April-June quarter, once the BoJ leadership issue is resolved.
• In the UK and Canada, Morgan Stanley expects central banks to cut rates at the next meeting in April.
• In Australia, RBA's rate hike is expected to be less likely.
• In China, further interest rate increases are less likely in an environment where the Fed is slashing rates.
  

Taken together, Morgan Stanley feels that the Fed’s and other central banks’ recent and prospective action is likely to bring an end of the bear market in credit and eventually a recovery of asset markets and the global economy in 2009. You can read Morgan Stanley's recent updates on the Great Monetary Easing (here & here).

It is debatable whether an end to the credit crunch is near. Some, like Jeremy Grantham, feel that the credit crisis still has a long way to run. With poor employment data & increased home foreclosures, the US economy is considered by many to be in a recession ( go here & here). Thus, the outlook for US equity is grim (see this article).

Nevertheless, I believe that the moment is at hand for those who have been waiting for the fat pitch. In a recent article entitled Wait for the fat pitch, Jeffrey Saut wrote:

Warren Buffett has often quoted legendary baseball player Ted Williams, who stated, “Waiting for the right pitch is the most important thing for a batter.” Of course, Mr. Buffett modifies Williams’ quote for the investing world by noting, “There are no called strikes so you can watch stocks come by and wait and wait until the right pitch and no one is going to call a strike (on you).” Buffett goes on to say, “Wait for the fat pitch and then swing for the fences!”

With the floodgates opened wide, I believe the US equity market is likely to experience a fairly strong rally for the next 2-3 weeks. Whether this rally is enough to change the medium- to long-term outlook of the equity market is yet unknown. It is likely to push the Dow up 1000 points from the recent lows. In the process, most equity markets will enjoy a similar rally. Despite our political uncertainties, I believe our Malaysian stock market will also firm up during this period.