Trader’s Narrative

The 3 month Treasury Bill rate is an important fixed income security that I keep track of, not because I trade it but because it is a remarkably accurate gauge of panic in the equities markets. It is also very prescient in leading rate changes by the Federal Reserve board.

Thanks to its predictive qualities, I said that the Fed should lower rates as far back as last summer. When I show most people the data that proves that the Fed actually chases after the bond market they are astonished. Even a lot of traders aren’t aware of the real relationship between the bond market and the Fed.

In any case, just a few weeks ago this important rate was close to 2%, where it had been followed lower by the Fed Funds rate. But now it is 0.03% !! Two things stand out: a drastic move in a short time frame, and the fact that this is as close to zero as you can practically get. Unless I’m wrong, this is the lowest rate the US has seen for this fixed income security.

To give you an idea of the magnitude of this, here is a very long term chart of the 3 month Treasury Bill covering many other financial crisis:

The chart is logarithmically scaled so each move shown is standardized as a percentage. Notice how the 1987 crash, the September 11th attacks and ensuing chaos hardly register when compared to what we are witnessing now.

Ben Bernanke famously quipped that as a last resort the Federal Reserve could always drop dollars from a helicopter… if you listen carefully, you might just hear the whine of the engines warming up for takeoff.

No, I don’t want the Fed to cut rates because that would give a hyper boost to the stock market. And no, I’m not calling for rate cuts because of the housing market, the sub-prime meltdown or the subsequent shutdown of the collateralized debt market.

Rather, I believe the Fed should cut rates immediately because that’s what the market has been trying to tell it for too long.

Take a look at the chart below. It compares the 90 day treasury rate (black) to the Fed funds rate (blue). As you can see, the Fed funds rate follows the market set short term rate.

But the Fed got out of step with the bond market sometime this spring. As the rate fell, the gap between the two became more and more obvious. The two have not been this out of step in a long time.

The collective vote of the market is loud and clear. No committee, no matter how esteemed and knowledgeable, can know as much as a diverse and free market.

So this is my crazy call: the Fed will (or rather should) cut rates sooner rather than later.