Fed Easings and Market Tops
"There have now been 3 hair-raising instances in the past 20 years when the capital markets broke down badly enough to cause commercial and investment banks alike to stare into the abyss of total collapse. In each case, the stock market fell after hitting recent new highs and the Fed came riding to the rescue.
Here are those periods, the amount of the decline in the S&P off the highs, and how many days after those highs were seen for the Fed to take action:
• October, 1987; decline of 40% off August highs;
Fed eased less than 60 days after the top• September, 1998; decline of 20% off July highs;
Fed eased less than 60 days after the top• August, 2007; decline of 10% off July highs;
Fed eased less than 30 days after the top on July 19** I've excluded September 11, 2001; the fear was of a different nature and Fed was already easing**
Notice any pattern developing? Yes, the times are shortening between stock market tops and the first Fed ease. And, yes, the amount of decline in the S&P before the Fed pulled the trigger has dropped significantly, from -40% in 1987 to a mere -10% today.
Why would the Fed see fit to ease so shortly (less than a month!) after an all time high in the S&P? Saying it's simply Ben Bernanke's "helicopter" mentality is as unfair as it is facile.
Part of the explanation is that the equity crowd is the biggest beneficiary of a credit bubble, and that they are the last in the room to understand why its unwinding matters to them. The more important reason has to do with the rise of securitization's role in the capital markets.
>
Good stuff. Thanks, Jack.
Tuesday, August 21, 2007 | 11:50 AM | Permalink
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My fear is that as the time frame between a top (if that is what we just saw) and Fed intervention shortens, and the percentage of correction allowed shrinks, the Fed ultimately is just encouraging ever riskier endeavors over the long term, as market players price in the Fed saving them in the end.
Posted by: Florida | Aug 21, 2007 12:03:40 PM
>>. Why would
the Fed see fit to ease so shortly (less than a month!) after an all time high in the S&P? >>
If you pushed it up there....you're going to know what the top, or close to it, is. If you did'nt have control of it then you would naturally wait to see if it were truly a top. , like in 1987....
It's all a carefully orchestrated ballet to influence the elections.....however (like in Iraq) the people in charge are just so brazen and ignorant they really have no clue what it's like in the world of reality (where the voters live). So what we will have is a hand-off to the democrats so that they can be fully in charge when the shit hits the fan.....just like Carter.
economic indicators? we don't need those
credit? Nah...not important
losses? Not on my watch-GWB
Ciao
MS
Posted by: michael schumacher | Aug 21, 2007 12:09:45 PM
Or... the Fed is not even looking at the market levels - just at the credit picture. In that case, there is coincidence but not a direct relationship.
Posted by: wally | Aug 21, 2007 12:22:10 PM
I would like to point out, as of this typing, that the S&P 500 is down less than 1% for the month of August. So wtp?
Posted by: Jay Weinstein | Aug 21, 2007 12:25:37 PM
jay-
tell that to Paulsen and Bernancke.........they seem to not realize that.
Ciao
MS
Posted by: michael schumacher | Aug 21, 2007 12:46:37 PM
According to Lacker, who spoke very plainly for the FED, a FFR cut is not needed at this time. The FED understands there will be a repricing of risk, and will do very little in the way of helping the players. The FED believes the economy still has growth left in it, and they are concentrating on it and inflation.
How much plainer can they make it for the so called smart money? Sink or swim boys and girls.
Posted by: SPECTRE of Deflation | Aug 21, 2007 12:51:40 PM
CNBS talking bailout right now. How about we hold those responsible for this debacle to fix the problem? Everyone is now a victim. Nevermind that you make 35K a year, yet you buy a 750K house on a pure speculation play. Now you become the poor homeowner. Only in America folks.
Posted by: SPECTRE of Deflation | Aug 21, 2007 12:58:04 PM
Let's all call the credit card companies, and let them know we poor sould were all confused by the terms of the cards. I mean Hell if we are going to bail, why not everyone because we are all too stupid to understand legal documents. We are victims I tell ya!
Posted by: SPECTRE of Deflation | Aug 21, 2007 1:00:31 PM
So, what is the risk in buying equities now? Even a modest decline will be met with howls and screams of protest and a Fed galloping to the rescue. The pool temperature seems fine.
Posted by: sn | Aug 21, 2007 1:13:46 PM
I think Lacker's comments should be looked at very carefully. If the FED is serious about letting risk reprice, then equities are in for trouble. Lacker also said that market volatilty is not the barometer the FED is using to determine the need for a possible cut.
But be sure and take all this with a grain of salt, as it seemed that Poole was speaking for the FED just last week and got steamrolled less than 48 hours later.
Posted by: shoeless | Aug 21, 2007 1:19:51 PM
But the Fed didn't ease yet. Just an easing on the discount window. That doesn't affect anything.
Gartman says today they will ease in September and start the cycle down.
We're getting quite a few fear mongers here. I wish Fred would come back and provide some balance.
Posted by: Josh | Aug 21, 2007 1:22:54 PM
The risk in buying equities now could be that the hedgies are playing chicken & lobbying hard in the hopes that the Fed takes more action, stock prices surge, and then the hedgies can make all of the necessary sales at "fair market value" for those redemption requests they're sitting on. --Just one of the myriad ways the common man can get played when prices detach from the companies against which they are supposedly issued.
Posted by: dukeb | Aug 21, 2007 1:24:14 PM
A banks worst nightmare is for the commercial paper market to stop functioning. The banks offer CP backup lines when times are dandy and believe the lines will never be drawn. So when CP investors fail to allow CP issuers to roll their CP, the issuer draws down against a CP facility.
The banks freak out because they correctly perceive the issuer's failure to roll CP as CP investors no longer wanting the risk. The CP investors are shifting that risk to the banks. So the banks suddenly find themselves lending money against a facility they never really expected would be drawn AND the underlying credit conditions have changed adversely so the CP facility pricing doesn't reflect the current perceived credit risk of the issuer.
The banks respond by tightening conditons across the entire credit spectrum. And if credit creation slows, so will the economy. So, in my opinion, if the CP market doesn't start functioning more normally, then the FED will lower the FF rate dramatically and in very short order. Not to bail anyone out, but to prevent a recession created by a slowdown in credit creation.
Posted by: Groty | Aug 21, 2007 1:30:27 PM
"the amount of decline in the S&P before the Fed pulled the trigger has dropped significantly, from -40% in 1987 to a mere -10% today. Why would the Fed see fit to ease so shortly (less than a month!) after an all time high in the S&P?"
Because the S&P was already down 18% from where it was in 2000 in inflation adjusted dollars, BEFORE that 10% decline. During the previous declines, the stock market had been rising faster that the underlying inflation rate.
.
Posted by: VJ | Aug 21, 2007 1:49:04 PM
Not to be left out, we have a liquidity problem in Merry Old England:
Borrower draws on BoE emergency loan
By Stacy-Marie Ishmael and Gillian Tett
Published: August 21 2007 12:01 | Last updated: August 21 2007 12:01
The Bank of England said it made an emergency £314m loan to an unidentified party on Monday through its standing facility, which allows banks to borrow unlimited amounts at a penalty rate of 6.75 per cent.
The UK base rate is 5.75 per cent. It is the first time the facility has been tapped since the onset of the liquidity crisis in financial markets, the Bank said.
A spokesman for Northern Rock, which has been at the centre of liquidity concerns, said it had not used the facility.
The BoE’s move is likely to attract intense interest, given the current level of market anxiety, and could provoke speculation about why any borrower would choose to fund itself at a rate above the prevailing market levels.
In particular, there is widespread debate in the financial world about the degree to which funding problems in the commercial paper market may be creating liquidity challenges at banks.
”This isn’t necessarily a huge deal. If we weren’t in this sort of market environment, this wouldn’t have raised the level of interest that it has,” Tom Jenkins, banking and financials analyst at the Royal Bank of Scotland. ”It’s interesting that it happened at this point, but it doesn’t automatically suggest there is a wider crisis in the making.”
The Bank has always stressed in its monetary policy framework that it does not wish the market to consider the use of the standing facility to carry a stigma, and banks have tapped the window on a fairly regular basis in the past when they have faced short-term issues in their liquidity management.
The Bank’s framework has hitherto contrasted with the monetary system in the US, where the use of the window has traditionally carried such a high stigma that banks have gone to great lengths to avoid using it.
While other major central banks – including the European Central Bank and the US Federal Reserve – have acted to inject liquidity into the financial system to ease lending conditions, the Bank of England has so far not intervened by taking any unusual measures.
However, the standing facility is open to any participants in the market, if they require them, and officials at the Bank have drawn up a list of additional measures that they may implement if the overnight rate in the sterling money markets remains high for an extended period.
Posted by: SPECTRE of Deflation | Aug 21, 2007 1:53:31 PM
sorry for repeating myself, but why is it so hard to understand what current administration in every country want.
if USA stock market falls...its a clear signal of slowing economy...consumer stops spending...business stops spending and stops hiring.....there we have a recession. (am i right?)
if USA goes into recession.....China goes into depression....so does india (and maybe all emerging economies dependent on usa consumers)
so i am assuming that everyone in the world....including our own GWB are going to try their best to postpone recession as long as it is possible (not on their watch).
Posted by: techy2468 | Aug 21, 2007 1:59:31 PM
Off Topic:
if i remember it right....buffett and gates foundation was buying homebuilder stock back in Jan/Feb 2007 thinking that they were cheap..
right now i saw a news that buffett is buying countrywide, and its share [price has gone up 10%
anyone has insight into this??
Posted by: techy2468 | Aug 21, 2007 2:02:22 PM
But the Fed didn't ease yet. Just an easing on the discount window. That doesn't affect anything.
Are you sure about that? Just because they haven't changed the target doesn't mean they are actively defending the existing one.
http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm
jb
Posted by: James Bednar | Aug 21, 2007 2:05:10 PM
Time for a paradigm shift in American manufacturing. But I guess that comes after the collapse next year?
Posted by: John Thompson | Aug 21, 2007 2:05:42 PM
The comparison to 1998 is real, but to 1987 is superficial at best (so far at least). Anyone working on a bank, fund or corporate money market desk knows this has nothing to do with equities, and if those touting equity bargains paid attention to how utterly dysfunctional the wholesale lending markets have become, I think you'd get your down 20%+ comparisons. Besides, the Fed has so far acted only to provide temporary liquidity - cutting the discount rate and expanding repo operations is not a rate cut.
Posted by: Turbo | Aug 21, 2007 2:11:01 PM
We are already in a recession......you think the dept. of commerce is going to release ANY information that hints at it? No.. recessions are not talked about until they are well into there own cycle. So..with that in mind then we will begin to hear about the recession we are in.. say about the end of November 2008 ;-)
Just like last time..except we had a little side show called a contested election that allowed the recession to be full blown just before Bush "won"......neat how it's about to happen all over again.
Ciao
MS
Posted by: michael schumacher | Aug 21, 2007 2:15:02 PM
Here's one for the conspiracy guys:
The danger in the Fed lowering rates is a dollar crash and higher future inflation.
But as we saw from 2002-6, there is no inflation from low rates! [tongue in cheek]
So lower away boys! LOL
Also, groty is right about CP in my opinion. There are SIGNIFICANT withdrawals from money from money funds to treasuries. There is a system shutdown problem if that happens---it is a modern run on the bank....
Posted by: Jay Weinstein | Aug 21, 2007 2:17:18 PM
Look at the historical chart people, we are do, I would suggest "in need" of a recession has everyone forgotten that the pendelum swings both ways?
Posted by: Justin L Tindall | Aug 21, 2007 2:17:28 PM
The Fed could care less about the stock market. (Joe six pack isn't even involved yet).
The Fed has its eyes squarely on the frozen ABCP (and CP) market(s). This will be orchestrated brilliantly. They'll cut the FFR and the DR, which will also bring down the Prime Rate (luckily for the resets). This will also be timed with a few key Corp debt offerings THAT WILL BE OVERSUBSCRIBED. That will mark the turn to a more liquid capital markets.
Posted by: Fred | Aug 21, 2007 2:27:03 PM
As James Bednar points out, the Fed has already been easing, as of 8/10. The Fed Funds rate is a market rate, which yesterday was 5.03%. If the Fed cuts the target rate to 5.00%, it won't effect the current Fed rate because it is already around 5.00%. Unless the Fed does another stealth rate cut.
Posted by: Chris M | Aug 21, 2007 2:32:09 PM
