The
Fed Buys a Round
John Riley, Chief Strategist
08/17/07
The party was
beginning to wind down, some people started to leave and there was
even talk of some party-goers getting sick from overindulging.
But have no
fear, Bartender Bernanke is here, and he’s got just what everybody
needs – a little more of the hair of the dog that bit ‘cha!
So everybody back into the bar, the party isn’t over, the
drinks are on the Fed!
And just like
that, everybody forgets all their problems and crowds back into
the party like nothing ever happened. They rush past the bodies
of the mortgage brokers too sick to stand on their own, they step
over the collapsing Dollars on the floor and they completely ignore
those party-pooper, teetotaler Bears outside warning about the evils
of excess and greed.
Panic
The markets have been marked by a single investment theme recently
– PANIC. Panic drove markets down as investors wanted out
and panic drove them back up as investors panicked back into the
market, not wanting to miss a single penny of gain.
The surprise
was that panic was not limited to individual investors. No, it swept
through the hedge funds and professionals that should know better.
Worst though, it even infected the Federal Reserve. They are supposed
to be the stable guiding hand of the economy. They are supposed
to be in control.
Friday morning
they were anything but. They were reactionary and reckless. They
saw the US market having taken a few hits in the past couple of
weeks and the housing market reeling from collapsing prices, but
it wasn’t until the overseas markets started to fold, and
fold they did, that the Fed decided to act.
The Federal
Reserve is nothing if not organized and methodical. The FOMC meets
eight times a year, usually on a Tuesday. We’ve all seen what
happens on those days, waiting to see if smoke will come from the
chimney, I mean what direction interest rates will go. And we’ve
all seen how the market reacts to the FOMC’s announcements.
The markets wait eagerly for the news from the Fed.
Moves on interest
rates outside of the normally scheduled FOMC meetings are rare.
And ½ point cuts in the discount rate are almost as rare.
It shows the Fed is in panic mode. The Fed’s decision to cut
rates hours before the markets opened in NY was as much to calm
the US markets as it was to settle the overseas markets.
Liquidity
Markets were driven down recently as investors in virtually every
market, stocks, bonds, and commodities were trying to re-liquefy
as quickly as possible. It didn’t matter what the investment
was, it didn’t matter what the fundamentals were, all they
wanted was to be a bit more liquid, have a bit more cash.
It goes back
to our article (“Money, Money…”) written last
month. The markets had ground to a halt because of a lack of liquidity.
And investors wanted nothing more than to re-liquefy.
For the past
couple of weeks, the Fed pumped tens of billions of dollars into
the system, trying to help float the markets. But none of it helped.
That was the scary part. And that is what probably got the attention
of the Fed.
So they did
the ultimate, they lowered the Discount Rate. There is nothing more
powerful the Fed can do. This is the Fed at its most influential.
Consensus
in Agreement
Already accolades are pouring in from every corner of the bar…
errr… Wall Street praising the Fed for their actions. One
head of a mid-size brokerage said it was “exactly the right
thing to do” as Bernanke topped off his Vodka Martini. A Wall
Street strategist was heard to say “We knew the Fed wouldn’t
let us down…” as he handed an empty beer stein to the
ever-ready bartender. Smiles were on everyone’s faces again
as the sunrise shone through their newly filled drink glasses raised
in honor of a generous barkeep.
Conclusion
It is also the Fed manipulating markets and eliminating what makes
markets work right in the first place, properly priced risk. But
if you know that the Fed will always come along to bail you out,
what difference does risk make? What risk is there in a market that
is not allowed to have declines, to eliminate excesses? Will the
Fed always come to the rescue and bail out investors? Is that their
job?
The answers
to those questions will be debated for the next several weeks, but
our opinion is that natural economic cycles are bigger than anything
the Fed can do and natural cycles always win. A cycle delayed only
gets bigger and more dangerous.
But until then,
its belly up to the bar, the Fed is buying and nobody has a care
in the world! (Oh, no… none for me thanks. I’ll be outside
with the teetotalers waiting to clean up the mess after the party
crashes.)
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