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Federal Reserve Still Behind The Curve at Trader’s Narrative





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So the Fed had a working weekend. On Sunday they cut the discount rate by a quarter percent to 3.25% and today, they cut the Fed Funds rate by 75 basis points to 2.25%. The market almost unanimously rejoiced and rushed to buy with both hands, eventhough the Fed Funds futures indicated most were expecting a full 1% cut.

Is that enough? are we out of trouble now?

I don’t think so (just yet).

One of the theories of why we are in such a fine financial mess today is that we’ve had lax monetary policy. I’d like to propose another, without necessarily disagreeing or disproving that school of thought.

It goes something like this: while lax monetary policy is bad, what we are dealing with now isn’t just the after-tremours of the Greenspan bubble era. Since his first days as Chairman, Bernanke has refused to listen to the bond market.

By ignoring it, he has compounded the problems that were there to begin with. And instead of giving the economy the flexibility it needs to go through a short transition period to “fix” itself, he has in effect, extended this painful process (indefinitely).

I’m referring to Bernanke’s insistence to remain, month after month, firmly behind the 3 month Treasury Bill rates. This is something that I noticed last summer, when I wrote that the Fed should cut rates immediately.

And if you take a look at this long term chart of the Fed funds rate compared to the 90 T-Bill rate, you can easily compare the Bernanke Fed to the Greenspan Fed. Greenspan let the market lead him by the nose. His talent was in making every one believe he was in charge… the Maestro, orchestrating the economic symphony, while in fact, he was just flailing his arms around randomly.

Which brings us to today’s interest rate cut:

federal funds rate cut march 18 2008

Unfortunately, since last month the gap has gotten worse! The Federal Funds rate gap is now 133 basis points away from what the short term bond market is saying it should be at.

So while another 75 point basis cut is dazzling, until the Fed actually gets in front of the short term bond market for at least a day or week, I can’t see this mess getting mopped up.

And believe you me, there is a fine mess out there. The Bear Stearns(BSC)/JP Morgan Chase (JPM) story has grabbed everyone’s attention but there is a lot more happening out there:

      MF Global (a subsidiary of MAN Capital) was taken behind the toolshed
      Carlyle Capital Corporation is about to go tits up
      Hedge funds and private equity funds are being closed right, left and center

So on the one hand, things are darkest before dawn but on the other, the way Bernanke is dragging his feet worries me.

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7 Responses to “Federal Reserve Still Behind The Curve”  

  1. 1 Bill K

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    Ok I am finally sold on this bottom at least for a while, after being a hold out for a while. I liked the strong panic selling and recovery on Monday on extreme volume (over 6 Billion on NYSE) which included put/call ratio of 1.5 overall and a nice big burst up on the VIX to 35.60. I liked the strong upmove on Tuesday and that is what really sold me as I sat 100% on the sidelines missing the whole rally. Add all of this to the fact that the sentiment indicators are all showing extreme buy signals I think we have some upside ahead. I went from all cash to 60% invested on the close today after the 2.5% sell off. The Fed has the back of the market now and blow ups will be minimized if they come. I am now hoping for a powerful bounce. I am thinking that it is possible that the beginning of the end for the commodity bull run is here, that would help curb inflation. There has been a lot of selling on all commodities in the last couple of days including Oil and Gold. All of these commodities are in bubble territory in my opinion. Bursting those bubbles would be good for the dollar too. Could things finally all be coming together or is it just a mirage?

  2. 2 Bill K

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    I fogot to mention when the S&P 500 dipped under 1270 a few times on Monday and then came firing back I was very impressed.

  3. 3 Babak

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    Josh,
    I mistakenly erased your comment while trying to clean out the spam. Please write it again. Thanks.

  4. 4 MrEd

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    Ahhh, it’s easy to blame Greenspan. If it were only true. I see we are all sold on a rally AGAIN. Don’t bet on it. Show me the money.

  5. 5 Ben

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    I just stumbled this site and love it. I feel as though I am stalking the Fed as they keep dropping rates, the whole institution is interesting to me. I have a feeling that right about they get as close as they dare to Greenspan’s previous huge low, they are going to crank it WAY up. Hard and fast and they are going to try and make a bundle by leveraging all the new traffic they will have started due to banks getting comfy at these lower rates. A good read, I’ll be back.

  1. 1 MortgageNewsClips: Blood On The Streets, Another 75, Great News!, Lehman Repos, CA Sting, $2 Bill, Bear Poison, 2005-2007 Alt-A, Merrill Shorts, 2009, Thornburg’s Soul, Robert Novak, Risky, Behind The Curve, Euro vs US, Shut Down
  2. 2 Bond Market & Fed Funds Rate Together Again, Finally


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