As market practitioners we are more concerned with the markets reaction to news than the news itself. Yesterday's announcement that Variable Mortgage resets could be frozen for 5-years is telling in that regard.

During the 1980s the international community got fed up with South Africa's Apartheid policies. Their response was to punish South Africa economically through broad sweeping trade sanctions (which ultimately brought the country to its knees). One far reaching measure was to shut the South African Government and its Corporations out of the international Debt markets. No new debt could be issued internationally.

South Africa's response to the rest of the world - bugger you - and refused to pay anything on their outstanding loans (principal and interest).

In other words, the credit market shut out both lender and borrower.

This situation is not unlike the one we see unfolding today.

By announcing a potential 5 year freeze on variable interest rate mortgage resets, the Government has effectively put a moratorium on mortgage debt. No issuer in there like mind would continue extending loans on the condition they may not fully reap the rewards. Likewise borrowers have no incentive to pay off loans if the Government shows a propensity to bail them out at every step.

The Fed is the grease monkey in the wheel since it's their job to ensure smooth operation of markets. So far their efforts to lower rates have not helped an ailing credit market and have hurt the Dollar. With further rate cuts in the wings and the announcement of a de facto debt freeze you would have expected the Dollar to swoon on the prospect of even larger liquidity injections going forward.

Not so!

Figure 1 - US$ rallying on news of 5yr freeze on mortgage resets

On yesterday's news Stocks rallied hard as earnings uncertainty reduced AND an oversold Dollar rallied strongly. When markets move contrary to expectations it is time to sit up and notice.

The market is indicating a freeze on mortgage resets is likely to repair the credit markets, reduce the need for rate cuts and bolster earnings growth. A tall order indeed! This may also encourage lenders to disclose more fully the extent of their exposure. As a result, we may see a nervous market in December but first quarter '08 may see the beginning of a multi-month rally in Stocks.

International, commodities and growth themes may have a way to go yet...

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