Monday’s trading didn’t give us much more to go on and probably with good reason, the pending, or should we say impending, rate decision due on Tuesday. As the world waits for Bernanke and company to present their case, there isn’t much going on in the way of trading. Tuesday should bring some of the traders back to the market.
We find the news all over the place but the media seems to want to keep the public in a state of confusion. What we mean is they are trying to say different things: that the market won’t react much to the interest rate moves or the market will go down unless the Fed lowers 50 bps or that the 25 bps move won’t do anything to help the economy for some time.
While we hold that the Fed is there to protect the banks, if the Fed lowers 50 bps the market will believe it’s party time; and, more important, the Fed knows this and will hesitate to oblige such market wants. The market doesn’t believe that the economy counts when it comes to trading. All that matters is that the Fed provides lower rates in order that the market goes up.
All things being equal, the Fed dropping rates 50 bps is akin to saying that the banks are in some difficulty and the economy is suffering. We think the Fed has to lower rates by 25 bps. The reason is that the credit market already has moved to this new level. The Fed never acts unless this is the case. Well, in this case they have been doing their best to make that happen by providing liquidity to the dry market. At the same time, the mere cutting of rates means that the central bank wants to stop a slide that is going on in credit. That is the way you can tell that the market is going to have trouble, the Fed is trying to encourage more borrowing by lowering rates. What they truly want is for a graceful bubble pop because they know the credit contraction has begun and a major contraction would take down the banks as well as the economy.
As we are seeing with Northern Rock in England, the central banks of the world are doing whatever they can to avert an out and out run on the banks. The central banks are all a little nervous with the global situation as it has been requiring their attention recently. They want the problems to go away and one way to do that is to step up and provide the liquidity.
But, we need to get back to market analysis: We think the market will find any rate cut worthy of buying at least for a few minutes but that may not be very much. If the Fed is foolish enough to give the market what it thinks it wants, a 50 bps cut, the market will party for more than a few minutes but not more than a few days. If only a 25 bps cut comes, then the market will pout a little but will dutifully trade up for a few minutes and then realize that there is no upside and will sell off. With no rate cut, is that possible?, there will be an immediate drop in the market with a big rally after that lasting long enough for the Dow to move up around 13,550 or so. Just for reference, the Dow closed today at 13,403.
Let’s discuss this tomorrow evening after the Fed is done with their business…