Monday, August 20, 2007

More on the Fed

Today’s market gave us very little information on the current state of affairs. The market is still trying to figure out how it wants to go down but it will try to convince all players that the bottom is in. The thing is that the bottom won’t be in until most everyone is out.

In our last post we mentioned that the Fed’s move was purely to bail out the banks and we didn’t seem to get much questions on that statement. Tonight we thought someone should challenge us so we will. The stock market fully anticipated a rate cut as early as the afternoon of Thursday. We discussed the huge 300 point rally that came late in the day on Thursday. This was the result, most likely, of the participants expecting the rate cut news as being a buy sign. Well, Friday morning after the announcement, the market opened up another 300 points for around 600 points in an hour of trading.

For some, there was another reason for the move, options expiration. We normally talk about the turn around that characterizes the week of options expiration. Normally, there is a move into Wednesday sometime and then a reversal into Friday. This doesn’t always happen but we kind of expected it last week. When the rally didn’t occur, there were some who suspected that the Fed took the opportunity to Make it happen. The Fed decided for some reason to wait until Friday morning to act and we just have to wonder ourselves if the options expiration was part of their thinking. Volume was very high most of last week so maybe they actually panicked as the market was dropping on Thursday without thinking of options but it does seem too coincidental. Thoughts?

Subsequently, the market is expecting a Real rate cut in the form of a funds rate cut at the next FOMC meeting, in September. The last we heard, there was a 100% probability of a 25 bps cut built into the futures market with an 86% chance of a half point cut. It wasn’t too long ago that the Fed was “fully committed to fighting inflation”, yeah right. We have been saying all year long that the Fed’s next rate move would be down and it would happen before the end of the year…but we digress.

The other thing we have said is that the Fed is Always behind the market and only moves when the market says it’s ok to do so. In that regard, today we saw a huge flight to quality, meaning that money moved to the Treasury market. You can see a front page article on Tuesday’s WSJ that talks about how the Fed didn’t quite do enough to alleviate the “flight to quality”. People are trying to avoid risk by moving money from more risky assets to T-bills which causes Prices on T-bills to rise thereby lowering the rate available. That rate dropped over one percent during today’s trading such that the T-bills were yielding 2.5% at one time. That is quite a bit below the Fed funds rate of 5.25%. We will see if these rates can get back to “normal” over the next few days.

One other topic on interest rates is the Bull market. The stock market thinks that if the Fed lowers rates that the stock market will go up. We have history to look at here and you all know what has happened to the market as the Fed moved rates up from 1% to the current 5.25%, it has gone up. Now, they market wants lower rates because there will be higher stock prices. We say, maybe there will be a temporary rally (witness the Thursday and Friday rally) so there will be an opportunity for someone to Sell.

There will be periodic rallies that should be sold, but for the most part stocks should not be purchased, in our opinion. One problem is that the market remains oversold so maybe we trade sideways for a few days to alleviate this issue. Once that occurs, expect further declines.

No comments: