Posted on 09/08/2007 8:50:50 AM PDT by frithguild
LAST WEEK I made the bold, if not downright crazy, prediction that that the Federal Reserve would not cut interest rates at the upcoming FOMC meeting on Sept. 18, despite widespread panic in credit markets.
But then again, it probably seemed crazy when I said to buy stocks three weeks ago when it looked like they were going to zero. At this point stocks have recovered half their losses in this correction, and stand less than 5% below all-time highs.
I still love stocks here. But as we get closer and closer to the FOMC meeting day, I'm getting more and more nervous about that rate cut prediction. The expectations embedded in Treasury bond and fixed income futures markets are clearly calling for a rate cut — in fact, they're screaming for a rate cut. I'm getting concerned that when push comes to shove, the Fed 's not going to want to disappoint those expectations, and take the risk of setting off another bout of volatility.
And this morning's report of four thousand net payroll jobs lost doesn't help my cause very much.
But at the same time, there's one thing we know for sure: The Fed doesn't want to cut rates. If it did, it would have cut them already. The simple fact that the Fed is waiting for the official FOMC meeting speaks volumes. It means expectations or no expectations, a rate cut is not a sure thing. I can still dream!
So let's do some scenario modeling. What if the Fed does cut rates, and then again what if it doesn't?
If the Fed doesn't cut rates, then an awful lot of people will be surprised, disappointed and scared. I would think there would be an immediate and severe negative reaction in stocks, and a general hue and cry that Ben Bernanke isn't half the man that Alan Greenspan was.
But then I think cooler heads would prevail. The reality is that Bernanke doesn't really need to cut rates. The Fed is pumping billions upon billions of dollars every day into the economy through ordinary open market operations at the existing fed-funds rate of 5.25%, so no lower rate is really needed.
And if anyone looks carefully at the real record of Greenspan, they'd realize that Bernanke has already done more in this panic than Greenspan did in 1998 in the Long Term Capital Management crisis. Then stocks fell 19.5% before Greenspan cut the fed-funds rate. In this panic, Bernanke has already cut the discount rate — and stocks never fell even 10%, based on closing prices.
And if Bernanke hangs tough, I think soon it would be understood as a sign of strength, confidence and leadership. After the initial shock, I think stocks would quickly recover.
So what happens if the Fed does cut rates? Because that's what everyone expects, it probably won't have a lot of impact. If the cut is 25 basis points, then some people will carp that it should have been more. But other than that, it probably won't make much immediate difference unless the FOMC puts out a statement that radically changes the Fed's long-term outlook in some unexpected way.
If anything, I would think the news of a cut would be somewhat of a stimulant to stocks. At least the risk that there would be no cut will be off the table. The Nervous Nellies out there will understand that Bernanke is on the job.
But at the same time, I think that a rate cut will have other effects — and less benign ones. In fact, with the market so completely expecting a rate cut right now, we're already beginning to see some of those effects.
Have you seen what's happened to the price of gold this week? As I write it's over $700.
Have you seen what's happened to the price of oil this week? It's up to within a percent or two of all-time highs.
Have you seen what's happened to the dollar on foreign exchange markets this week? As I write it's making new all-time lows.
There's just one word for all that: inflation.
The fact is that we got into the present credit crisis because of inflation. I know it hasn't shown up much in the official statistics like the Consumer Price Index, although that is higher than the Fed would like. But for the last several years, the Fed has been printing way too much money. So much, in fact, that banks practically gave it away in — you guessed it — subprime mortgage loans, where the borrower barely had to even be alive to qualify.
Now, with the Fed already injecting billions into the troubled markets every day — even before interest rates are lowered — the fires of inflation are being stoked all over again. The Fed seems to think that the only way out of the mess that too much money created is to print even more money.
If the Fed does cut rates, then the problem gets even worse. And if it cuts rates more than once — which is exactly what all the markets and the brand-name Wall Street economists are predicting — then it will get a lot worse. I've written in this column about inflation often over the last three years. I've said gold was going to $1,000. If the Fed cuts rates, then I'm going to have to admit I was wrong.
Then gold isn't going to $1,000. It's going to $2,000.
And oil is going to $200. And the dollar is going to collapse against the yen and the euro.
And I think in their heart of hearts, many members of the FOMC actually know this. That's the reason I say they don't want to cut rates, and haven't already.
But fear and temptation are ugly things. Under pressure, the best of us can go against our better judgment.
I'm still hoping the Fed will stand tough here. But in case they don't — and I have to admit it's looking like they won't — I want to be long gold, oil, energy stocks, and basic materials stocks.
If the Fed doesn't cut rates, those are good growth plays anyway. But if the Fed does cut rates, they're your insurance policies against an ugly inflationary future.
Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors.
We did not have inflation problems when it was down before. This guy needs to re-think his position on real world economics and history.
What is "it" and when was "it" down?
Only if he is a believer of the new economy and the new thinking that the government can control everything. If he is a believer in classical economic theory, he thinks we are in a serious bind ala early 20th Century Germany and Argentina and later Russia.
For most of this century. Before the 17 rate increases the fed did. As recent as 04 it was as low as 1%. I refininced my house for a fixed 30 years at 4.1%
The longer the Fed waits, the more it will have to cut rates later, which will be inflationary. Not to mention all the economic damage that will occur in the meantime, which will also be inflationary.
I guess Luskin hasn't checked the effective funds rate. It's generally been below 5.25% since this liquidity crisis began on Aug. 9th. And the Fed has been using repurchase agreements to add liquidity, not outright purchases. His use of the phrase "pumping" gives the wrong idea.
I wish people like Luskin would help out us amateurs with some names and ticker symbols. I especially would like to know of some good closed-end mutual funds or ETFs in these categories. Or companies that have a decent yield with their growth potential.
Why does no one at the FOMC or the media get that?
Left unsaid by this guy is the reason for oils surge. It neatly coincided with predictions for 6 more named Atlantic storms this season.
"Have you seen what's happened to the dollar on foreign exchange markets this week? As I write it's making new all-time lows.
This is not necessarily a bad thing since it makes our goods and services less expensive to foreigners.
They do, it’s just that the gloom and doom scenario plays better.
“...in 1998 in the Long Term Capital Management crisis. Then stocks fell 19.5% before Greenspan cut the fed-funds rate. In this panic, Bernanke has already cut the discount rate — and stocks never fell even 10%, based on closing prices.”
You’re quoting the S&P-500 index...in 1998, the AMEX Broker Dealer index was down 50%, similarly that index this time was down 29% when Bernanke’s announcement appeared! But recognize the Dollar volumes involved, and the focus on institutions (not retail markets) and the similarity exists in the Fed’s reaction.
Quite a different situation in 2004. Interest rates had to be low for a prolonged period of time because we were in a deflation. Not so now.
Commodity producers add very well. They did so back in the 1970s, too. Easy money ==> higher prices, very simple.
But, you're ok, you refinanced at a good time, and that's the only thing that matters. Food and fuel prices be damned.
The interesting question here is: will Bernanke's Fed be able to unwind/cure/counter Greenbean's 18-year reign of foolishness?
“Have you seen what’s happened to the dollar on foreign exchange markets this week?”
The Dollar Index had dropped to below 80 on 8/06 (first time since 1992), on the ‘credit rumors’. For the next 10 days it had risen to above 82 on 8/16, when Bernanke cut the Discount Rate. It’s now falling on rate cut expectations...it closed at 80.5 on friday. And it’s all relative...Were the ECB to cut rates before the Fed, the index would rise. The markets are stabilizing now (including the ECB, which has stopped jawboning increases). So the actual ‘future’ direction is anyone’s guess.
Wow...in ‘04 “we were in a deflation. Not so now.”
So you don’t buy Cramer’s rant that we ARE in Deflation now, I take it! Certainly Moon’s house price is not inflating, correct? Congress is spending 4.2% of GDP on Defense in ‘08 vs 6.9% in 2004....that’s not inflating! There are many deflationary expectations, and some inflationary ones....tough for anyone to do the math! Especially for the future :)
Two things that blow my mind about this situation are as follows:
1: That supposedly sophisticated, conservative fund mgrs ALL OVER THE WORLD could have fallen for and eagerly sought out this toxic debt. AND, they sought it out most eagerly when it was rated (see last point) as being only a skosh more risky than T-bills!
2: And these same supposedly sophisticated fund mgrs are so bloody freaked out by what’s going on with these markets that they run to Treasuries so violently that on big market smackdown days, they’ve been able to drive T-bill rates close to 2% and on that one day about 3 weeks ago, UNDER 2%! I can’t even fathom the amount of buying frenzy that would create this effective yield. But I do realize that this means that this sludge is literally everywhere. From “no payments for 3 years” deals on big-screeen TVs and mattresses; from utilities selling forward their expected cashflows from customer (gas, elec) payments; to the shopworn examples of toxic real estate debt that have been all over the news. It’s stunning.
Here (cannot even excerpt per FR rules) is some indication of what I’ve been predicting for a while. The S is starting to hit the fan over the ratings agencies that blessed these piles of nonsense.
http://news.independent.co.uk/business/news/article2941937.ece
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