text: Fed's Rate Cut Has the Desired Effect of Calming Nervous Markets, But for How Long? | Barron's
  https://www.wsj.com/articles/SB909184460774217000
  Fed's Rate Cut Has the Desired Effect of Calming Nervous Markets, But for How Long?
  A lan Greenspan knows a thing or two about gloomy and pessimistic pronouncements. Phrases like "irrational exuberance" and "50 mile-per-hour headwinds" will forever be part of his legacy. But recently, the famously dour Federal Reserve chairman came across something in the newspaper that even he found too dreary.
  It was the morning of October 7 and The Wall Street Journal had run a package of articles warning of an emerging credit crunch. Biding time before a speech that morning, Greenspan read the stories. Irked by the coverage, he stepped to the microphone and, in a rare burst of spontaneity, poked fun at press reports that he felt gave the impression the economy and capital markets were close to collapse.
  Nearly three weeks and a surprise Fed rate cut later, this incident is especially instructive. Greenspan believed speculation about a credit squeeze was overblown and that the reduction in bond-market liquidity was manageable. But he also knew a crunch was a risk if the Fed didn't take clear steps to offset a loss of liquidity in the financial system. After all, "credit shortages" on Wall Street can be self-propagating; the very fear that a crunch is emerging can cause one on Main Street. So, eight days later, the U.S. central bank shocked the world with a rate cut.
  It's worked, so far. After weeks of panic, illiquidity and huge investment losses, an eerie calm has come over the capital markets. Disaster, it seems, has been averted for the time being.
  The big question is whether this truly marks a return to stability or merely is a period of calm in the financial storm that began in Thailand nearly 16 months ago. With Murphy's Law ruling the global economy these days, much could go wrong. But some encouraging developments are unfolding to allow the bond market to breathe easier.
  "Things are improving in terms of direction, but we still have a long way to go," says Martin Mauro, manager of financial economics at Merrill Lynch.
  The central bank's market-friendly move had the intended effect of calming shaken financial systems in the U.S. and abroad. The wave of hedge-fund deleveraging that slammed U.S. bond prices and the dollar appears to have receded for now. Markets in Thailand, Indonesia and the Philippines are showing tentative signs of stabilization. Japan is rolling up its sleeves to boost its economy and repair its banks. Brazil is on the verge of billions of dollars in aid from the International Monetary Fund. And spreads on Brady bonds and sovereign debt of emerging markets have narrowed markedly after ballooning last August with Russia's ruble devaluation and debt default.
  Domestically, things also are looking up. While Treasury yields jumped higher, there was a new sense of optimism that the narrowing of emerging-market spreads could be a harbinger for the domestic debt market. The corporate market in particular could certainly use a dose of investor confidence, not to mention some demand from bond buyers who plunged money into more liquid government bonds. Clearly, the Fed's recent rate cuts pumped some life into the market and the likelihood that more easings are on tap played a role in encouraging some issues to come to market last week.
  In recent weeks, moreover, commercial and industrial bank loans have picked up. Banks have matched the Fed's two quarter-point cuts with similar reductions in their prime lending rates. That's more important on Main Street because most small businesses and households depend on bank credit, rather than the capital markets. So if banks don't close their doors to borrowers, as they did in the early 'Nineties, a credit crunch of recessionary proportions may be avoided.
  But if stability really is returning to the fixed-income markets, it won't happen overnight. Indeed, it's hard to believe that by cutting the cost of overnight money a half-point, the Fed has reliquefied the global financial system. And while animal spirits have returned to the stock market, where even small-caps have revived, they're still relatively scarce in the bond market.
  Corporate and mortgage spreads narrowed somewhat after their recent explosion, notes Margaret Patel of Third Avenue Funds, who thinks that the move lacks conviction and, potentially, staying power. Last week's sharp downgrade of Seagram by Moody's -- to Baa3, one notch above junk, from single-A2 -- was an ominous reminder that a long process of confidence restoration lies ahead. The news caused many spreads to widen. Meanwhile, bank paper widened after having narrowed significantly after the Fed's recent rate cuts.
  Spreads between benchmark "on-the-run" and less actively traded "off-the-run" Treasuries haven't budged much either, observes Greg Jones of briefing.com (http://www.briefing.com/ ) , an online advisory. There has been scattered talk of renewed interest in off-the-run Treasuries last week, but it didn't translate into much actual buying. "The more stable markets this week have not convinced people it's safe to get back into riskier waters," Jones reckons.
  One thing that could go wrong for both stocks and "spread products" -- debt securities like corporates and mortgages whose returns depend to a great extent on their yield relative to those in the Treasury market -- is a recession. While the global economy seems to have calmed down a bit, the nature of the international crisis -- which has less to do with economic fundamentals than fear -- means Wall Street and Main Street shouldn't get their hopes up. The surge in the U.S. trade gap to $16.77 billion in August from $14.55 billion in July was just the latest reminder that demand for U.S. exports is falling amid weak growth overseas.
  Fed officials were out in force last week reminding Wall Street that they're awake at the wheel and that more rate cuts are on the way. Indeed, an easing of monetary policy when policy makers meet on November 17 is a pretty safe bet. And many Fed watchers think another rate cut could be in store in December. Job No. 1 for the Fed now is avoiding recession in the world's largest economy.
  Where does this leave bonds? For now, Treasury yields gradually are getting reacquainted with economic fundamentals. After plummeting to breathtakingly low levels, yields have edged higher as capital once again trickles into spread products and heads back overseas, as evidenced by the 20- to 30-basis-point backup in yields and a flatter yield curve. Rumored to be among the sellers of Treasuries was George Soros' Quantum fund.
  Treasuries have lost some favor as a number of investors have downplayed the risk of additional hedge-fund meltdowns, while others think an IMF package for Brazil will mark an end to the spread of the Asian financial contagion. Japan, meanwhile, is experiencing a slight revival of investor interest, now that the yen has strengthened and one of the country's biggest banks, Long-Term Credit Bank, has applied to be taken over by the government as part of Tokyo's Resolution Trust Corp.-style restructuring plan.
  But a massive correction in Treasuries doesn't seem on the near-term horizon. The main negative is that Treasury yields may have fallen too far in recent months, when the flight to quality became extreme. Indeed, the U.S. economy won't overheat any time soon, and inflation isn't a big risk. As such, it's reasonable to call last week's decline in prices a return to balance. The bond ended Friday yielding 5.175%, compared with 4.964% a week earlier. The two-year note, meanwhile, ended the week at 4.165%, versus 3.884%.
  Looking ahead, the recent range for the 30-year bond's yield, 4.75%-5.25%, seems likely to linger for a while. A key reason not to expect a meltdown in Treasuries is that international forces that sent long-term yields to the lowest levels in 30 years won't disappear soon. Notes Robert Hoye of Quantum Research: "Financial volatility is here to stay for a while."