The Soothing Fed Balm

Friday, March 02, 2007 | 09:01 AM

I love when a bunch of disparate views and data points combine to give some insight into what's going on. Its often like an intriguing puzzle; none of the pieces mean much by themselves, but put them all together and . . .

The most recent example of this is the Fed's reaction to Tuesday's plunge. While some people have talked about the "Plunge Protection Team," I find little evidence the PPT can ever do much more than delay the inevitable. For proof of this, just look at the 78% drop in the Nasdaq from 2000-02. (Without the PPT, I guess we would have seen an 80% drop?)

Besides that, the Fed is aware that inflation is above all a monetary phenomena. The way they could avoid a meltdown is by flooding the system with liquidity -- and we know how that always turns out. The Fed did this during the 2001-03, and the resulting rampant inflation, unaffordable housing boom, $75 Oil and $750 Gold is what they have to show for it. Inflation, thought moderating, is still elevated. I suspect the Fed will be somewhat reluctant to open the spigots again anytime soon, as Bernanke knows all too well that there is no Free Lunch.

Despite this -- and all the bullish protestations of a strong economy, a soft landing, a goldilocks scenario -- Tuesday's selloff wasn't even in the books before the pleading for Fed cuts had begun. This morn's WSJ notes that "Federal-funds futures contracts on the Chicago Board of Trade -- bets about the future course of rates -- reflect a near-100% chance the Fed will cut the federal-funds-rate target by a quarter-point in August from its current level of 5.25%. Late Monday, expectations for an August easing were about 40%."

Indeed, the nature of this economy and the market's cyclical rally since 2003 reflect a system overly reliant on the Government largesse. Not organic growth, but ultra-low interest rates, ginormous tax cuts, and huge money supply increases are the basis of our post-crash economy. Its no wonder the Bulls are always begging for more; They are all-too-aware of what will happen when Daddy Warbucks proclaims No Mas!

I continue to think that hopes for a cut are misplaced. If we are to believe the Fed's jawboning, it is inflation, and not stock prices, that has the Fed most worried  And that concern is not misplaced, going by the recent Core CPI and core PCE data. Oil, medical care, food prices, all remain quite lofty. 

Soothing words will have to suffice from the Fed, because any action -- i.e., an imminent rate cut -- is doubtful. 

Here is our round up of "The Soothing Fed Balm" (soon to be available in lotion form):

1. Fed ready to act if financial crisis erupts: Geithner

This is self explanatory:

The Federal Reserve stands ready to lower interest rates if a financial crisis erupts, said Tim Geithner, the president of the New York Fed, on Wednesday. "As always, central banks need to stand prepared to make appropriate monetary policy adjustments if changes in financial conditions would otherwise threaten the achievement of the goals of price stability and sustainable economic growth," Geithner said in a speech about liquidity in financial markets to a business group.

Geithner said his remarks were general in nature and not related to "the specific conditions of the moment" where the stock prices plunged around the world.

Geithner said liquidity, like market confidence, is very difficult to measure and a reversal of both liquidity and confidence play a critical role in leading to financial shocks. Geithner said financial regulators have a difficult time in predicting when liquidity may reverse. The best way to limit the risk of crisis is shock absorbers in the financial system. "These shock absorbers are substantially stronger today that they have been even in the relatively recent past," Geithner said


2. Fed Injects Short Term Liquidity:

Via COWEN INTERNATIONAL, this commentary was circulated at:  2/28 10:52:56

It's a short-term liquidity underpin but it's also the first sign of concern - and possibly significant concern from the Fed.                                 
Firstly, the Fed have had 2 Repo announcements today. This happens on most Thursday (because of settlement) but never on Wed - at least that I've seen in years watching  this stuff.                            

2ndly, the amounts "submitted" for Repo are low - not in itself a -ve, but when combined with an extremely high "acceptance" rate (which is what we have today) it's usually a VERY bad sign (I call it the Pushing on String indicator, as it illustrates a keen desire to add liq'y when it isn't demanded (and typically happens around crisis events - before, as well as after).

3rdly, the disribution is heavily wgt'd to MBS (and Agency), accounting for > 80% of the total...          

Again, this is a v. short-term liq'y underpin for mkts (no doubt supporting the bounce today), but it also reveals a high degree of concern from the Fed...


3. Bernanke's Congressional Testimony:

All is well, nothing to see here: In the Q&A portion of Bernanke's Capitol Hill appearance, he reiterated his views about the long term fiscal challenges of the US. The Fed head said he thinks the economy may strengthen over the rest of the year, and does not believe the subprime problems will spill over to the rest of the economy. That's about as short and sweet as it gets . . .

Bottom line: For now, the Fed is all talk no action. Expect that to continue for some time.


Fed ready to act if financial crisis erupts: Geithner
Greg Robb
MarketWatch, 9:08 AM ET Feb 28, 2007

Friday, March 02, 2007 | 09:01 AM | Permalink | Comments (23) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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You think bonds are a good place to go for '07? If so-- Treasuries?

Posted by: Tom Barta | Mar 2, 2007 9:50:08 AM

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