Reason Mpc

Reason Mpc

Pound Made Record Lows as Fear of Recession Increased

It was a good week for European equity markets with the FTSE100 finishing the week at 5636, its highest level for nearly two months. US markets didn't have such a good time of it, with the Dow Jones and S&P500 finishing largely flat on the week and the Nasdaq closing well down after a sell off on Friday. There was better news for the Greenback though, as the Pound fell to its lowest level for two years against the US Dollar. Although the Dollar has undoubtedly been strong over the last month, last week's move on Cable (USD/ GBP) was largely a factor of the weakening pound. It made a record weekly low against the Euro and fell to its lowest levels since spring against the Japanese Yen.

 

With stream of bad news coming last week, you didn't need to look too hard for reasons why the Pound was taking such a beating. Fears of recession increased after a CBI report showed the weakest high street activity in 25 years. In addition, Nationwide housing figures showed that the current UK housing slump was the worst for nearly two decades. There was however, some relatively good news from house builder Taylor Wimpey. Despite the dramatic headlines about its write down in land value, Taylor Wimpey closed up on the week. The huge write down on the value of its land bank was largely expected for once.

 

The FTSE enjoyed a good week in spite of this data thanks to higher oil prices and improved sentiment in financials. This two sectors alone account for a large proportion of the UK's benchmark index. Oil traders were on hurricane watch as tropical storm Gustav headed for Louisiana. WTI crude finished the week up around $3.00 as a consequence. US Monoline insurer MBIA indicated that it is continuing to win new business despite a reduced credit rating. MBIA's strong numbers have helped push the financial sectors higher on both sides of the Atlantic, with Barclays and RBS both enjoying gains approaching 10% on the week.

 

Better than expected US GDP numbers also sparked a mini rally in the middle of last week. US GDP numbers came in well above estimates with a 3.3% annual rate of increase. In addition to this, jobless claims came in lower than expected. Although the GDP numbers implied a growing US economy, they also revealed a deeply divided one. On the one hand, exports are shooting up thanks to the weak Dollar, on the other hand consumer spending; the lifeblood of the US economy is still looking dire, once you strip out the effects of the stimulus package. Bush's rescue plan and the Fed's demolition of the Dollar may have stopped the overall economy going into recession, but it is still a close run thing. Next quarter there will be no tax breaks for US consumers and if oil continues to pull back, the Dollar is likely to rise further, thus hurting exports.

 

The S&P Case-Schiller house price index fell less than expected for the second quarter, but US house prices are still down 15.9% year on year. On a more positive note, housing futures based on the Case-Schiller index bottomed at the end of June, and have been rising since. Expectations are for lower levels still, but these levels are now thought to be better than those predicted a few months ago. However, it is too early to say for sure that this heralds the start of the start of the much vaunted turnaround in US house prices. Interest-rate futures are currently implying that banks are again becoming hesitant to lend to each other, on fears that credit losses will increase as the feared global recession kicks in. Increased lending rates will hardly be manna from heaven for home owners on either side of the Atlantic.

 

This week brings a whole raft of top tier economic announcements. Topping the bill on Thursday are the MPC and ECB interest rate announcements and accompanying statements. Both are widely expected to produce 'no change' verdicts, but as ever, it is the forward looking statements that will cause the most excitement. Sterling traders are speculating on a rate cut from the MPC before the year is out. On Friday, the week's biggest announcement is the US Non Farm Payroll figures which will ensure the week doesn't end quietly. Aside from this, this week brings UK manufacturing data on Monday and US Manufacturing data on Tuesday. On Wednesday we get UK PMI data. US markets are closed on Monday for Labor Day.

 

Next week's data has the potential to make or break the tentative rally off the July lows. Analysis from Jason Goepfert of SentimenTrader, showed that the ISE sentiment index reached extreme levels of bullishness on a short term basis. BetOnMarkets.com traders agrees that this index has been a reasonable contrarian indicator over the last few years and with lots of potentially damaging data out next week, the risk is arguably to the downside. A No Touch Trade on the S&P 500 not to revisit the August highs of 1315 could return 62% over the next 16 days.

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By what amount will GDP decrease?

In an inflationary gap, the Federal Reserve increases the targetted federal funds rate to 3.5% in order to dampen investment spending by $100B. If the MPC=.9, and there is no change in the Price Level, by what amount will GDP decrease?

A) $.9T
B) $.75T
C) $1.25T
D) $1T

Recall Multiplier equation (1/1-MPC)
Here's what I think.
GDP Decreases by $1T.
Reason: Because of the "no change in the Price Level" you don't worry about the federal funds rate. And you simply take the $100B * (1/1-.9) = 100B * 10 = 1000T.
Is this reasoning correct?

The reasoning is correct. The info about the rate change is just noise in the problem. Since there is no price change, the only impact would be the effect of the decrease of the 100B investment spending.

using Reason with MPC