Fed's Reckless Bubble Blowing - Part II
Ben Bernanke and the Missing Bond Vigilantes?
By Frank Barbera CMT. September 18, 2007
Over the last few years working in the hedge fund business, I can remember the eerie calm that fell over our trading desk ahead of each Fed meeting. For about 15 minutes ahead of the ‘Big Announcement’ the phones would slow, people would begin to crowd around, and the period of quiet anxiousness would begin. Eyes on the second hand, I would usually check all my trading screens, then make sure everything on my trading desk was in order, I'd stack my papers – reshuffle a few here, a few more over there, pace around the desk where my carpeting was wearing thin, and I'd make sure I knew where everything and anything I could possibly need could be found in a moment's notice.
For a trader, it was a feeling that must be somewhat akin to what a thoroughbred horse must feel when stepping into the starting gate -- that sense of anxiety, the palpable tension -- and then would come the TV reporter's voice, ‘the voice’ with the ‘Big News’! Only most often, it wasn't ‘big news;’ most often, it was no news of consequence at all. Most often, the increased transparency at the Fed had telegraphed what would be the outcome long in advance. Everyone would then laugh and that would be it -- back to work we'd go. Of course, the markets still managed to go wildly insane for about an hour or two after most meetings, and sometimes on the REALLY predicable ones, nothing much would happen.
Well, boy, was today ever different. For starters, coming into the day, the wave of anticipation in front of this particular Fed meeting was unlike anything we have seen in many years, literally headline after headline over the last few days on virtually every financial web site attributing this or that market reaction to the perceived upcoming action by the Fed. Among Fed meetings, cast against the backdrop of the unfolding Credit Crisis, this meeting was the Super Bowl of Fed Powwow's. Coming into the day, 86% of polled investors believed the Fed would cut rates by 1/4% on fed funds with nearly 38% pointing to additional 1/2% cut on the discount rate. What did we get? We got the ultimate surprise -- a 1/2 point rate cut, and a 1/2 cut in the discount rate! A double whammy of Fed rate cuts.
For most market observers, the half point ‘cut’ scenario, which coming into today was seen as only an 11% chance, seemed a long shot as investors perceived the Fed as being in between a rock and a hard place, sandwiched in a box between the Dollar and the Economy. Would Helicopter Ben really risk branding itself as a feeble inflation fighter by aggressively cutting rates? While some may still believe that the Fed is data dependent, and that they will wait and see what happens with future economic data, today's action seems wildly out of whack with what is still 4% GDP growth, wildly out of whack with Oil at $81, wildly out of whack with Gold near $735; yet it is all highly consistent with a man who only a few years ago was quoted as talking about using the printing press as a mechanism for the lender of last resort.
Welcome to Weimar Revisited!
Forget about any ‘Moral Hazard,’ and forget about the purchasing power of those hard earned Dollars. Clearly, that is the message that the Fed is sending to the International community with today's action. A shocking, potentially reckless move, where will the Bid be found on the greenback, and at what point will foreigners decide that a 4.48% yield on a 10 year Bond doesn't cover the bet? (Heck, it ticked up a whole basis point today.) Only time will tell, but for now, the Fed's stark message seems to be re-inflate at all costs. In pursuing this arguably high-risk path, the Fed is opening the door to a potential Pandora's Box. Conspiracy theorists may argue that Central Banks are working together, and that despite a lower value for the Greenback, foreign money will continue to be recycled into US Dollars. Yet, what if that is wrong? What if foreign money decides to flee the Dollar market? In that reality, this high stakes gambit by the Fed could blow up in its face, as exiting foreign capital hammers the Dollar and begins to send long term rates sharply higher. At that point, we face a melt down, as rising long term rates would be another nail in the coffin for the US Residential Market, and could continue to generate chaos in credit markets. A marked departure from the Greenspan gradualism, the Fed appears to be leaving its equilibrium at the political alter of an election year, and at the special interest alter of Wall Street investment banks. How ironic that if presumed foreign cooperation is renounced, the Fed could end up standing alone in a long suffering melt down. Looking back at past interest rate cutting cycles, we see that the trend in the US Dollar has not been anything but ugly. Now, with the US Dollar on the verge of all time record lows against most major currencies, is it possible that today's aggressive rate cut will be seen as anything but an Admiral Farragut style ‘Damn the torpedoes, full speed ahead’ decree of a global ‘we don't care’ weak dollar policy?
Above: U.S. Dollar and Fed Funds Rate
Looking back at the action in Rate Spreads in recent weeks, as we noted in last week's update with the rise in European Libor Rates, the Dollar was already under tremendous pressure. Now, slash short term rates, and we tilt the scales to a even more dramatic deterioration in the Rate Spreads via our major partners.
Above: US less European Short Term Interest Rates, the spread was already going negative, even before today's monster cut. What will happen to the Dollar from here? Does the Fed care?
With these spreads already slipping into negative territory, the action today by the Fed sends a very negative message to global investors, that the US will not support its money. That is potentially the most dangerous concept any central bank can breed, and in that light, it seems that the level of outrage directed at the Fed should be that of a "scathing rebuke." We have moved from one serial bubble blower in ‘I didn't get it!’ Alan, (see 60 Minutes interview last weekend) to now a man, who for the second time in a decade, seems to be steering the country toward yet another wrong choice.
Before this one is over, if the Fed does not change course, we may all pay the penultimate penalty of having walked down the path toward hyper-inflation. The sheer arrogance of the Fed may not be in question today, especially by a gleeful US Stock Market smelling "bail out" for the insider cronies; but in a different reality, that of a burgeoning currency crisis six months down the road, with Fed credibility shot, the situation may have a much darker complexion. At that point, there may be little in which to rejoice.
Personally, I had hoped that the new Fed Chair would be a man of greater character, and that much of the negative press associated with his prior academic writings was perhaps exaggerated. The action today resonates as being even more poorly thought out than Mr. Greenspan's bathtub ruminations on Adjustable Rate Mortgages and more likely than not, serves as notice to one and all that we may be embarking on yet another new and grand Fed experiment; one in which we will all get to find out how many times an hour the price of coffee and T-Shirts can change value.
The picture above is a chart of what a currency devaluation looks like -- in this case, the Argentine Peso several years ago. The picture of the people's faces in this photo essay show the anguish of what this type of decline did to the average individual, most of whom were profoundly affected by the emotional distress.
When governments step back from backing their money, all kinds of negative concepts come into play. In Argentina, the ‘Corralito’ followed the collapse of the Peso, inflicting even more grief on top of grief. What has been missing in the last few weeks in the Credit Markets has been confidence, and what the Fed did today, rather then instill confidence suggests a prompt move in the other direction.
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Corralito (pronounced ko.raˈli.to) was the informal name for the economic measures taken in Argentina at the end of 2001 by Minister of Economy Domingo Cavallo in order to stop a bank run, and which were fully in force for one year. The corralito almost completely froze bank accounts and forbade withdrawals from U.S. dollar-denominated accounts. The Spanish word corralito is the diminutive form of corral, which means "corral, animal pen, enclosure" the diminutive is used in the sense of "small enclosure" and also "a child's playpen". This expressive name alludes to the restrictions imposed by the measure.
Left: A photo from the Empty ATM, Angry Argentines try to gain access to their Bank.
While the Precious Metals are extended near term and appear due for a set back of some kind, for those of us who thought the Fed would ‘do the right thing’ today's move serves as a loud wake up call, a call which can only be answered by the safety of precious metals. At the close, the DJIA ended higher by 332.39 index points or 2.48% at 13,735.81, the S&P higher by 43.13 at 1519.78 or 2.92%, while the NASDAQ gained 69.10 or 2650.76, a gain of 2.68%. Nearby December Gold finished higher by 8.40 at $732.20, while the 10 Year Bond edged high by a full basis point, (wow!) to end at 4.48%. That's all for now,
© 2007 Frank Barbera