The Great Fed-Funds Fake-Out of 2008
Many traders believe that the bottom is in on the stock market because the Federal Reserve Bank kinda, sorta, might-be, hinting at a pause. Everybody knows that when the all-seeing Fed stops cutting rates, that the recession is over, right?
Well, maybe not this time. The chart below shows that the Fed has gotten way out in front of the market this time around. Chairman “Chainsaw” Bernanke has cut rates almost twice as fast as Alan Greenspan did during the last recession.
That could be a good thing, but it might be a bad thing too. How? Well obviously it indicates sheer terror on the part of the Fed due to the financial panic we all know about. And that terror is not over yet.
If the banking panic were over,
- Bernanke wouldn’t still be trying to beat down the Libor rate which has vetoed his attempt to reduce rates on mortgages.
- You wouldn’t see a long line of banks, hat-in-hand, bumming cash off of Bernanke at the discount window.
- You wouldn’t see Bernanke swapping out perfectly good treasuries for crappy mortgage paper just so banks could pretend that they were still solvent.
Perhaps the bottom would be in if the Fed’s rate cuts really were helping the economy. But they are not. By the Fed’s own survey of bank managers, credit is still tightening. So far as anybody can tell, the rate cuts have done almost nothing.
Credit spreads have tightened from panic levels showing that the financial system is not breaking down. However, that is not really big news. One thing that we have learned over the years is that the global financial system bends, but it doesn’t break.
Yes, the Fed’s rate-cuts are well known to work with a lag. But the lag varies, and this time it will be a long lag. Why? Because the banks are simply destroying assets faster than the Fed can pump them up.
Credit is tightening. The economy is contracting. It ain’t over.
Note: The red dots on the chart show the fed-funds interest rate. The first “line in the sand” that Greenspan drew at 1.75% failed. The market just plunged right through it, and the next one at 1.25%. Even if Bernanke draws a line-in-the-sand here at 2% doesn’t mean that it will stick. Greenspan didn’t take his foot off the gas until he was certain that the economy was adding jobs. Bernanke won’t either. Rate hikes in 2008? Dream on…
May 16th, 2008 at 10:08 pm
Hi Matt,
thanks for your posting. Very interesting again.
One thing you have to keep in mind though is the fact that Greenspan didn’t have an INFLATION problem. So whatever the FED will do - cutting or hiking rates - it’ll always have a drawback. Either on the consumer or on the whole financial system.
May 17th, 2008 at 8:27 am
Hi Dressguard,
Yes, that is an excellent point, but it is not a point that the Fed is making. The Fed is still pretending that there is no inflation:
…and…
I think that the Fed is hinting at a pause as part of the campaign to boost the dollar and put a dent in commodity prices, but that is just talk. To really crush inflation, you have to raise rates high enough to crush the economy. And the way that the Fed pretends that there is no inflation indicates to me that that is not in the cards. As long as the Fed pretends inflation is 2%, they are signaling a possibility of more rate cuts.
Matt
May 17th, 2008 at 12:48 pm
Good points. But is this good for the stock market? If they keep the current rate the pundits could say the crisis is over. If they cut rates again the pundits on the other hand could argue that this is good for the financials which are a leading sector in the S&P. So I don’t know right now what to make of your postings. I think you are assuming the FED will cut rates and the stock market will go down. Right?
Thanks again for your brilliant blog. I’m reading Bloomberg, CNBC, Reuters, Financial Ninja, Karlsson’s blog, Financial Times, Market Preview, RGE (Prof. Nouriel Roubini), The Housing Time Bomb, Mr. Mortgage, Mish’s blog, Market Watch on a regular basis. But your blog is by far the most interesting one.
May 17th, 2008 at 1:02 pm
Many traders think that a Fed pause equals an all-clear signal to pile into the stock market because it is a signal that the recession is over. I am saying that is a mistake.
I’m glad that you like my blog. I try to write interesting things.
Matt