Market Overview

What Coordinated Central Bank Intervention Could Look Like

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In recent days, rumors have circulated that a globally synchronized liquidity operation will be undertaken by the world's major central banks. In theory, the goal of the operation would be to prop up a fledgling global economic recovery and prevent an outright deflationary collapse due to the European banking system's problems.

The operation would most likely entail a combination of rate cuts and money printing. In nations such as the U.S., the U.K., and Japan (where rates are effectively at the zero interest rate boundary) further rate cuts are highly unlikely so traders may expect more quantitative easing. The European Central Bank, at the center of the crisis, would also be prompted to print but could accompany this with a rate cut. Other banks that could cut rates include the People's Bank of China, the Reserve Bank of Australia, and the Bank of Canada, among others.

To prevent inflation from roaring back and to prevent dislocations of the foreign exchange markets, the size of quantitative easing might be proportional to the size of that nation's GDP with respect to world GDP. So, for example, the European Union makes up about 20% of the world's GDP, (at the end of 2011) so they would print that proportion of the total. For example, if the global banks wanted to inject $5 trillion dollars of liquidity, then the ECB would be responsible for $1 trillion. The U.S. would be responsible for a similar amount of about $1 trillion. Other banks would be responsible for proportional amounts.

Rate cuts are also likely in this scenario. If rate cuts are not from the benchmark rates, they could take other forms, including cutting discount rates, cutting interest paid on reserves, or even cutting required reserve ratios. On Thursday, the Bank of England's Mervyn King stated that the bank was ready to embark on even more non-traditional easing measures to make borrowing easier. In England, QE has driven down rates for the sovereign, however rates remain high for private sector borrowers. King also stated that he and Chancellor George Osborne of the Exchequer were set to announce a potential $157 billion measure to support the financial sector and the economy as a whole.

This announcement has sparked speculation that other central banks will follow. It appears as though markets are setting up for a liquidity-fueled rally. However, traders may not wish to front-run this news, for it might be some time before the banks act.

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