- The central bank cavalry

- Year end risks: Liquidity and P/L

- The new year economic outlook

The coordinated central bank action to supply whatever liquidity the credit markets required probably gave more support to the dollar than any other event this week. To the degree that the credit situation and its sub prime mortgage basis are seen as a greater drag on the United States economy and the dollar, any palliation in the financial markets redounds to the dollar's benefit. Positive American statistics, particularly consumer spending, also helped push the dollar to levels not seen since late October.

In the immediate future both the euro and the pound are vulnerable. The uncertain liquidity available in the remaining trading sessions this year will exaggerate any movement. The greatest problem for the euro and the pound is that there is still substantial unrealized profit in both currencies. The euro began the post August run at 1.3400, the pound started the year at 1.9200. Both currencies have broken the upward momentum which had been their greatest support.

The economic facts have been changing for several months. The growth prospects of Britain and the EMU are dimming and neither central bank will be able to raise rates in the coming months no matter what their view or the reality of inflation. The aggressive Federal Reserve rate reductions, which began in mid September, will produce economic growth in the US in the second and certainly the third quarter of 2008. The ECB has provided no economic stimulus and growth will continue to slip; when traders return to their desks in January the future for the EMU, the US and the UK will look very different from the past.

Central Banks

United States Federal Reserve

The Federal Reserve Treasury Auction Facility (TAF) first auction of $20 billion elicited $61.8 billion in bids for a bid to cover ration of 3.08. A second $20 billion auction was held on Thursday with demand of $57.7 billion for the $20 billion on offer. The average bid size rose to $790 million from the first auction's $660 million. The consistent interest was taken as a sign that the funds are being sought by non money center banks. One of the main goals of this facility was to get funds out into the banking system beyond the normal money center banks that participate in the Fed's open market operations. The number of bidders fell to 73 from 93 in the first auction. Credit market conditions had eased somewhat by week end.

Bank of England

The minutes of the December 6th Monetary Policy Committee (MPC) meeting revealed a 9-0 vote behind the 25 basis point rate cut and discussion of a larger reduction that was eventually rejected because of inflation concerns. Prior market sentiment had not expected a unanimous vote which put the condition of the British economy in a far starker light. Sterling immediately fell 50 points on the news. Credit conditions were the main reason for the cut according to MPC member Kate Barker.

European Central Bank

The ECB provided €348 billion in two week funding to ease the money markets over the year end. The average rate was 4.21%. The ECB approach is fundamentally different than that of the US Federal Reserve in that the European central bank provides as much funding as the market will accept, rather than auctioning a set amount as does the Fed. The results suggests that the majority of banks are relatively well funded and using the facility to store funds for use later in 2008.

Peoples Bank of China

The Chinese central bank raised one year deposit rates by 27 basis point to 4.14% and lending rates to 7.47%, or 18 basis points. It was the 6th hike this year. The hike will help to prevent the economy from growing too quickly into overheating and structural inflation developing into overall inflation, stated the PBOC. However with inflation at 6.9% annually in November and up 4.6% for the year this increase still does not bring the deposit rates in positive territory. More rate increases can be expected in 2008 as the PBOC continues trying to cool rampant economic growth and inflation.