US$ Stabilizes as US Interest Rates Bottom Out
by Gary Dorsch, Global Money Trends. April 24, 2008
In today's highly sophisticated financial marketplace, there is no longer any need to employ Federal Reserve officials to figure out the most appropriate target level for the federal funds rate. Instead, it’s already done by remote control, by the astute traders in the US Treasury and Chicago interest-rate futures markets, who are usually several steps ahead of the political appointees sitting at the Fed.
US Treasury dealers are calling the shots on monetary policy these days, wresting control from Fed chief Ben Bernanke, whose primary job is to simply to follow the direction of 2-year T-note yields, and bail out Wall Street whenever it gets into trouble. Bernanke administers a $200 billion auction facility that enables Wall Street dealers to swap toxic mortgage bonds for pristine US Treasuries.
Highlighting this gentleman's agreement between the Fed and T-bond dealers, the April 24th edition of Wall Street Journal reported the US central bank is likely to lower the federal funds rate by a quarter-point to 2.00% at its upcoming April 30th meeting. But a few Fed rebels are concerned that lowering interest rates could fuel inflationary pressures to the detriment of the American consumer, so the option of holding interest rates steady at 2.25% is also on the table, the WSJ indicated.
But the end of the road for the Fed's rate cutting campaign was already telegraphed by US Treasury dealers last week. Yields on the US Treasury's two-year note jumped by 50 basis points to close at 2.25% last week, and extended to 2.42% today. Two-year notes are yielding roughly 17-basis points more than the fed funds rate, so dealers place the odds of a Fed 0.25% rate cut on April 30th at less than 50 percent.
On April 15th, NBER chief economist Martin Feldstein, a close confidant of Mr Bernanke, publicly called for a halt to the Fed's easing campaign. "It would make sense for the Fed to stop cutting its target rate at between 2% and the current 2.25%, because to go lower could exacerbate the problem of inflation emanating from high commodity prices," Feldstein said on CNBC television.
The Bernanke Fed's super-easy money policy has been generating inflation worldwide, and is readily seen in the declining value of the dollar, soaring food and energy prices, and street riots in parts of Asia and the Middle East. And it’s eroding the purchasing power of Americans' paychecks. According to US government data, prices for basic items that a middle-income American family buys each day, such as groceries, gasoline, heating oil, and health care are up 9.2% from a year ago.
But the Fed's main job is to rescue the banking system in times of crisis, and to prevent a meltdown in the global financial system. In its biggest rescue operation on behalf of Wall Street since WWII, the Fed arranged a shot-gun marriage between Bear Stearns BSC, the fifth biggest US investment bank, and JP Morgan, at the eleventh hour, to prevent BSC's $13-trillion derivative positions from exploding.
The Fed slashed the fed funds rate by three-quarter points to 2.25% on March 17th, and agreed to swap up to $200 billion of US Treasuries to 20-primary dealers for a wider range of collateral, including toxic AAA sub-prime mortgages. The Fed ignored accusations of "Moral Hazard" for bailing out greedy and reckless Wall Street bankers, and instead, presented the cost of the rescue operation to the American public and the world at large, with sharply higher commodity prices and inflation.
From Wall Street's perspective however, the last Fed rate cut to 2.25% appears to have improved market psychology towards the banks and brokerage stocks, and put a floor under the Philadelphia KBW Bank Index, with a "triple-bottom" pattern at the 75-level. Stock market operators are acting under the notion that the worst of the sub-prime debt crisis is behind the US banking industry.
The improvement in market psychology towards the banking sector can be seen in the price action of Citigroup C.n, which suffered more than $46 billion in write-downs over the past three quarters, yet its share price is 8% higher, since it reported a larger-than-expected $5.1 billion first-quarter loss on April 18th. Citigroup C.N sold $6 billion in preferred shares this week, at a dividend yield of 8.40%, to plug-up the holes in its balance sheet.
The Fed has pumped half-a-trillion dollars into the financial system in the form of open market operations and special emergency lending measures. Much of the excess cash in the financial system has not yet shown up in the US and global economy yet, because the banks are afraid to lend the money. But once the credit crunch eases, this massive liquidity could not only expand bubbles in commodity and stock markets, but also threaten hyper-inflation in global economies.
Mr Bernanke has told Congress that the Fed will do whatever it takes to rescue the banks on Wall Street, throwing price stability to the wind. The Fed's latest rate cutting campaign has jacked-up the price of crude oil to as high as $120 /barrel. But using the Fed's favorite intellectual justifications, the central bank can afford to open the monetary spigots when the economy is weak. Then when the economy recovers, the Fed can reverse course and tighten money policy. But that puts a great deal of faith in the rookies at the Bernanke Fed to know when to tighten.
For now, Wall Street dealers are taking matters in their own hands, and have stabilized the US dollar, by lifting Treasury yields to their highest in 3-months. The US dollar is also receiving artificial life support from the British and Canadian central banks, which have slashed their interest rates in recent months, capping the British pound and the Canadian Loonie. The Saudi Arabian central bank is inflating its M3 money supply at a 26% annual rate, to keep its archaic dollar-peg intact.
But European Central bankers are refusing to engage in this clandestine game of "competitive currency devaluation" with the Bernanke Fed, and instead, have held the repo rate steady at 4% throughout the global credit crisis, utilizing a stronger Euro to offset cost pressures from higher commodity prices. Fighting inflation is the top priority for the ECB, said Greek central banker Nicholas Garganas. "Our monetary policy is not led on what the markets expect. I'm very concerned about the high inflation rate. Inflation risks remain on the upside," he said.
Unlike the rookies at the Bernanke Fed, the hawks at the ECB aren't bullied by German schatz traders in Frankfurt, who campaigned for a series of ECB repo rate cuts to 3.25% earlier this year. In mid-February, when German 2-year yields fell to as low as 3.1%, but Bundesbank chief Axel Weber warned that market expectations for ECB rate cuts were out of step with the inflation outlook.
"Current interest rate expectations on financial markets do not reflect an appropriate assessment of the inflation risks, at least for a stability-oriented central banker," he said at the University of Siegen. ECB member Gonzalez-Paramo added, "The markets, like the ECB on the other hand, analyze the information in their possession as best they can. In some cases, they reach the correct conclusion, while in other cases they make errors." Since then, the German 2-year yield has shot upwards by 75 basis points to 3.85%, snuffing out speculation of an ECB rate cut anytime soon.
The latest upward spike in German schatz yields haven't fully matched the upward surge in US T-note yields, giving a slight advantage to the US dollar, and capping the Euro at $1.600. ECB chief Jean "Tricky" Trichet also tried to deflate the Euro with some old fashioned jawboning. "We have observed during the recent period of time sharp currency fluctuations. And we are concerned about their possible implication for financial and economic stability," secret code words for covert intervention.
© 2008 Gary Dorsch