Fed Set To Cut; Will They Save Their Bullets?

A: We are about an hour and a half from the fed's next rate cut. The question is not whether they will cut, but by how much. This horse agrees 100% with BR over at The Big Picture, which shouldn't be a surprise to anyone here, that they need to exercise restraint and cut only by 1/2 point; limiting the negative effects on the US dollar & commodity prices while acting nonetheless. By saving their bullets now, they will have more ammo to use as the economy weakens, housing continues to be a drag, and credit markets correct themselves.

Unfortunately, I do not think 1/2 point will be the move. I think they will cut 75 or 100 bps this afternoon as a 'shock & awe' offensive to limit the severity of the slowdown and give the markets what they want. I must admit in hindsight, Ben & company handled the Bear bailout wonderfully as they orchestrated an orderly liquidation and averted a complete financial meltdown. Putting my feelings aside of letting the free markets punish those that are weak and the vultures jumping in to grab whats left, the fed's actions avoided chaos that could have played out as a domino effect of Bear Stearns announcing bankruptcy. The move to bail out BSC does NOT fix the housing problem, it does not fix the expectation for rising unemployment & inflation, and it does not fix the expectation of weakening economic data resulting from the credit storm; hence the rate cut move that will come today.

On February 29th I published a post titled, "Credit Check: Running Out Of Bullets", where I stated:

"With future rate cuts likely resulting in further commodity inflation, I'm concerned that we are going to be running out of bullets soon and will have to deal with a period of financial stress without the fed's strongest weapon available to us."

That was over two weeks ago. Two days ago, Bloomberg published their version of what I was discussing in their article, "Bernanke May Run Low on 'Ammunition' for Loans, Rates":

Federal Reserve Chairman Ben S. Bernanke may be running out of room to pump money into the financial markets and cut interest rates to rescue the economy.

The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with yesterday's decision to become a lender of last resort for the biggest Wall Street dealers. The central bank has cut short-term rates by 2.25 percentage points since September and will probably reduce them again tomorrow.

"They're using up their ammunition on the liquidity and overnight interest-rate fronts," said Lou Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions.

Barry Ritholtz discussed today on CNBC his feelings on the issue and is in the same camp that I consider myself a part of:

"I believe that the FOMC should "man up," show some backbone -- cut rates by "only" 50 bps. They might find out what its like not to be at the Market's beck and call (girl). That should stabilize the greenback, and perhaps send food and energy prices lower (earning Ben the appreciation of consumers through out the country)."

But I do not think it will play out this way; time will tell. In meantime, I urge you to maintain a clear head as you interpret the events that result from this credit storm. Bear market rallies are always sharp and filled with glimmers of hope; I believe this rally to be no different. Time will heal what ails us and it's clear the fed will take every step necessary to limit the severity of the recession and the pains of the de-leveraging process. Yesterday a bear was shot & killed but not before many innocent employees got their retirement plans wiped out. Whats next?

The unknown continues to be:

a) who holds what toxic assets
b) who is experiencing a liquidity crisis similar to Bear
c) when will foreclosures / defaults reverse course
d) when will credit markets normalize; credit spreads continue to narrow
e) effect on global markets
f) pipeline inflation
g) spread to higher quality / other debt classes
h) severity of job losses to come
i) severity of economic weakness
j) effect on local state budgets
k) spread to other markets (ars, muni's, etc)
l) effect on main street

Steps are being taken, but we are not out of the woods. This is not a daily fix, it is a quarterly to yearly fix rooted by housing that will take time to play out! We went from years of credit fueled leveraged bets to a complete STOP in a matter of months; we have been at this STANDSTILL since mid-to-late 2007 and we are yet to see the economic effects of this. The good news is, we must go through this to get out of it, so in my opinion and as I said over 6 months ago, BRING ON THE RECESSION!

PHOTO: Source

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