Drunk on Fed Rate Cuts

A: Hey Ben, LETS DO ANOTHER SHOT! Ben Bernanke LOVES Patron Silver. Did you guys know that? You should, because he passed out about a million shots of it to investors when he cut interest rates by 50 basis points a few weeks ago. Now, the stock market is drunk on rate cuts; how bad will the hangover be? I've said it before and I'll say it again, don't expect this to be the start of an aggressive easing cycle! In fact, I would say we have at most one more 1/4 point rate cut in the works with a very good chance that there are no more rate cuts by years end; as the markets are telling the fed to take it easy.

Lets break down the fed minutes released yesterday which served up more tequila shots for the market. By the way, Brian is drunk!

READ FOMC SEPT 18th MIMUTES

Interesting points:

* ...the staff marked down the fourth-quarter forecast, reflecting a judgment that the recent financial turbulence would impose restraint on economic activity in coming months, particularly in the housing sector.

* The staff also trimmed its forecast of real GDP growth in 2008 and anticipated a modest increase in unemployment.

* Moreover, lower housing wealth, slower gains in employment and income, and reduced confidence seemed likely to restrain consumer spending in 2008.

* With credit markets expected to largely recover over coming quarters, growth of real GDP was projected to firm in 2009 to a pace a bit above the rate of growth of its potential.

* Headline PCE inflation, which was boosted by sizable increases in energy and food prices earlier in the year, was expected to slow in 2008 and 2009.

* The disruptions to the market for nonconforming mortgages were likely to reduce further the demand for housing, and recent financial developments could well lead to a more general tightening of credit availability.

* Tighter credit conditions were likely to weigh particularly on residential investment and to a lesser extent on other components of aggregate demand in coming quarters.

* Furthermore, recent financial developments had the potential to deepen further and prolong the downturn in the housing market, as subprime mortgages remained essentially unavailable, little activity was evident in the markets for other nonprime mortgages, and prime jumbo mortgage borrowers faced higher rates and tighter lending standards. Moreover, conditions in the jumbo mortgage market were expected to improve gradually over time.

* Although employment probably was not as weak as the most recent monthly data had suggested, trend growth in jobs had fallen off even prior to the recent financial market strains, and participants judged that some further slowing of employment growth was likely.

It's clear that even the fed IS CONFUSED ABOUT WHAT IS GOING ON; I bolded the uncertain remarks above! They really are dependent on future data and don't know the ultimate hit the credit disruptions will have on the US economy! That's what I get from reading these minutes. They acted aggressively in the face of uncertainty in the credit markets to prevent any sudden negative effects to US economic growth. But now that they did that, and markets seem to have stabilized, I don't see how they can act again given that they really are not sure what may be coming in the near term! Recall what I stated when the fed did act back on Sept. 18th in my post, "Fed Acts! Cuts By 1/2 Point!":

The accompanying statement mentions the "return of inflation concerns" and it appears that this VERY AGGRESSIVE MOVE IS A TWO AND THROUGH MOVE! The markets love this with a huge stock rally but how they feel about it when things settle down and they realize that future cuts seem unlikely is yet to be seen!

I think the TWO & THROUGH feeling will prove to be very close to right. I hope they don't cut at all at their next meeting, but given their expectations of downside risk with this credit mess and continued weakening employment, they may do one more 1/4 point ease. The bond markets are starting to flatten out as they no longer are looking for aggressive rate cuts. One thing is for sure, this is NOT a long term easing cycle!

My longer term feeling (2+ years) is that we are in a new world of riskier credit, tighter standards, global inflation and higher rates to come! That does NOT mean the economy is tanking and we will experience a 2000 style of selloff. On the contrary, the US economy is a mature and resilient economy and as such should be able to absorb shocks more easily; although growth will be more modest as well. That is why you are seeing a decelaration in jobs growth. Regarding our weakening US dollars, I think the dollar has a better chance of rebounding in the face of fewer rate cuts & global fed easing's and slowdowns! For example, with the Euro at record highs, economists and politicians are now concerned that their currency will impede future growth; so you may see some action to bring their Euro valuations down in the future which will be bullish for the US dollar!

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