Sunday, November 04, 2007

Fed Ramblings on Sunday Evening

This evening we look back to some of the events of last week. As we saw the headlines on Friday morning, we realized that we didn’t even mention the jobs’ report in our last post. We didn’t mention it because we didn’t think about it which means that we didn’t think it had much to do with the market. The market did get to see a rather nice jobs’ number, up much more than was expected.

When the jobs’ report came out just a while before the open, it gave a lift to the stock futures which eventually gave the opening a fairly green hue. As sometimes happens, the news-related move quickly dissipated so that the market was down about a percent shortly after the opening but by day’s end the market was able to rally into the close.

With it being Sunday evening, we thought we would spend some time on the Fed. We have made several comments on the Fed over the past several posts and would like to present our position on the Fed. So, here we go:

The very idea that the Fed has to “follow” the market rather than lead it dismisses the notion that they have any control over short term interest rates. We certainly do Not believe this. They have the power to say, “No, we don’t like where interest rates are currently or we don’t care where the market would like rates to be. We think rates need to be raised due to the inflationary pressures that easy credit and low rates create.” The Fed has been duped into believing that what’s best for the stock market is best for the world. Short term gains in the stock market do not necessarily provide lasting gains.

The situation over the past ten years has given the Fed very little credibility because it has not only allowed easy credit but also has encouraged it with lower rates. The ridiculously low published inflation rate has allowed them to avoid looking at “asset” inflation. This has never made much sense to us in our normal analysis. The problem is that the idea of independent thinking doesn’t provide anything satisfying when the Fed just jumps in to save the day. Billions of dollars do have some power and the Fed does have that kind of power and money.

When the Fed is in “control” the market actually can’t set rates at will. The Fed can make a difference by controlling the amount of liquidity sloshing around. Instead, when rates on the short end drop to 1% and stay there for many months, asset inflation has a real chance to percolate. The Fed doesn’t really understand that asset inflation can lead to the opposite, asset price depreciation, with the unfortunate speed of lightening. The Fed is emboldened by their past ability to “reinflate” but this time the credit market is in control, not the Fed.

As credit is, and will be, shrinking, the Fed will truly be pushing on a string when it tries to reflate by lowering interest rates. The credit behemoth needs more and increasingly more additional credit in order to sustain itself. This credit (remember it’s called debt) has to be generated by borrowing and borrowing more than was done before. This has been going on but now we will see if that trend has reversed. Losses being reported by big brokers and banks indicate there may be some slow down in borrowing. We will keep an eye on it.

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