The Soothing Fed Balm

I love when a bunch of disparate views and data points combine to give some insight into what’s going on. Its often like an intriguing puzzle; none of the pieces mean much by themselves, but put them all together and . . .

The most recent example of this is the Fed’s reaction to Tuesday’s plunge. While some people have talked about the "Plunge Protection Team," I find little evidence the PPT can ever do much more than delay the inevitable. For proof of this, just look at the 78% drop in the Nasdaq from 2000-02. (Without the PPT, I guess we would have seen an 80% drop?)

Besides that, the Fed is aware that inflation is above all a monetary phenomena. The way they could avoid a meltdown is by flooding the system with liquidity — and we know how that always turns out. The Fed did this during the 2001-03, and the resulting rampant inflation, unaffordable housing boom, $75 Oil and $750 Gold is what they have to show for it. Inflation, thought moderating, is still elevated. I suspect the Fed will be somewhat reluctant to open the spigots again anytime soon, as Bernanke knows all too well that there is no Free Lunch.

Despite this — and all the bullish protestations of a strong economy, a soft landing, a goldilocks scenario — Tuesday’s selloff wasn’t even in the books before the pleading for Fed cuts had begun. This morn’s WSJ notes that "Federal-funds futures contracts on the Chicago Board
of Trade — bets about the future course of rates — reflect a
near-100% chance the Fed will cut the federal-funds-rate target by a
quarter-point in August from its current level of 5.25%. Late Monday,
expectations for an August easing were about 40%."

Indeed, the nature of this economy and the market’s cyclical rally since 2003 reflect a system overly reliant on the Government largesse. Not organic growth, but ultra-low interest rates, ginormous tax cuts, and huge money supply increases are the basis of our post-crash economy. Its no wonder the Bulls are always begging for more; They are all-too-aware of what will happen when Daddy Warbucks proclaims No Mas!

I continue to think that hopes for a cut are misplaced. If we are to believe the Fed’s jawboning, it is inflation, and not stock prices, that has the Fed most worried  And that concern is not misplaced, going by the recent Core CPI and core PCE data. Oil, medical care, food prices, all remain quite lofty. 

Soothing words will have to suffice from the Fed, because any action — i.e., an imminent rate cut — is doubtful. 

Here is our round up of "The Soothing Fed Balm" (soon to be available in lotion form):

1. Fed ready to act if
financial crisis erupts: Geithner

This is self explanatory:

The Federal Reserve stands ready to lower interest rates if a financial crisis erupts, said Tim Geithner, the president of the New York Fed, on Wednesday. "As always, central banks need to stand prepared to make appropriate monetary policy adjustments if changes in financial conditions would otherwise threaten the achievement of the goals of price stability and sustainable economic growth," Geithner said in a speech about liquidity in financial markets to a business group.

Geithner said his remarks were general in nature and not related to "the specific conditions of the moment" where the stock prices plunged around the world.

Geithner said liquidity, like market confidence, is very difficult to measure and a reversal of both liquidity and confidence play a critical role in leading to financial shocks. Geithner said financial regulators have a difficult time in predicting when liquidity may reverse. The best way to limit the risk of crisis is shock absorbers in the financial system. "These shock absorbers are substantially stronger today that they have been even in the relatively recent past," Geithner said


2. Fed Injects Short Term Liquidity:

Via COWEN INTERNATIONAL, this commentary was circulated at:  2/28

It’s a short-term liquidity underpin but it’s also the first sign of
concern – and possibly significant concern from the


Firstly, the Fed have had 2 Repo announcements today. This happens on most
Thursday (because of settlement) but never on Wed – at least that I’ve seen in years
watching  this stuff.                            

2ndly, the amounts "submitted" for Repo are low – not in itself a -ve, but
when combined with an extremely high "acceptance" rate (which is what we
have today) it’s usually a VERY bad sign (I call it the Pushing on String
indicator, as it illustrates a keen desire to add liq’y when it isn’t
demanded (and typically happens around crisis events – before, as well as

3rdly, the disribution is heavily wgt’d to MBS (and Agency), accounting for
> 80% of the

Again, this is a v. short-term liq’y underpin for mkts (no doubt supporting
the bounce today), but it also reveals a high degree of concern from the


3. Bernanke’s Congressional Testimony:

All is well, nothing to see here: In the
Q&A portion of Bernanke’s Capitol Hill appearance, he reiterated his views about the long term fiscal challenges of the US. The Fed head said he thinks the economy may strengthen over the rest of
the year, and does not believe the subprime problems will spill over to the rest
of the economy. That’s about as
short and sweet as it gets . . .

Bottom line: For now, the Fed is all talk no action. Expect that to continue for some time.


Fed ready to act if
financial crisis erupts: Geithner

Greg Robb
MarketWatch, 9:08 AM ET Feb 28,

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What's been said:

Discussions found on the web:
  1. Tom Barta commented on Mar 2

    You think bonds are a good place to go for ’07? If so– Treasuries?

  2. Michael Schumacher commented on Mar 2

    Not an endorsement of the PPT however if they did not intervene at the middle and end of 2000 the drop would have been very quick and very ugly. Most likely “they” are now on defense as they have to create this “soft” landing that they have pushed down our throats for the last year. Shorts are just going to have to have a longer timeframe to work unless Goldman Sachs just up and leaves (after they’ve done something similar to the tweaking of it’s comm. index like in septmeber ’06 with unleaded gasoline) the market alone–sure they will. And Tuesday afternoon at 2:59pm was just a “glitch”….LOL


  3. A Rahall commented on Mar 2

    My view for what its worth is that the Fed is talkign dovish whilst acting hawkish by keeping rates at 5.25% for a while to create some destruction somewhere – smiling as they keep the screws tight.

  4. lewis commented on Mar 2

    Add Bill “My Bad” Gross to the PPT, his monthly column over at PIMCO is all about explaining how the Fed rate cut is inevitable, and like Joe Theisman, this is a man who never met a microphone he didn’t love. The curious part of his ten little Indians storyline is that one of the main characters that will get eliminated with an interest rate cut is the Dollar, and Mr. Dollar doesn’t appear in his story. Guess he just doesn’t want to think about that storyline.

    It looks like those of you thinking Bernake isn’t cutting rates are going to become a small, lonely crowd.

  5. Mike_in_FL commented on Mar 2

    I think the “crisis” we’ve seen so far has been anything but. Even if you measure from the absolute high on 2/20 through the absolute low (so far) on 3/1, we’re only down 5.7% on the Dow. The subprimers have gotten crushed, as I’ve been telling people to expect for many, many moons. But other than that, there’s no sign of contagion … yet.

    If we get a real panic, though, I think Gentle Ben is every bit as likely as Easy Al to cut rates and throw money at the market. Is it “right” for them to do so? Of course not. It just keeps inflating asset bubble after asset bubble after asset bubble, each one replacing the last. But the Fed seems to think this is sound policy. Heck, Fed Governor Frederic Mishkin DEFENDED that approach to asset prices in January, as I talked about in this post:

    My two cents, anyway.

  6. Jdamon commented on Mar 2

    OK, the bears are all out of the woods right now with talk of impending doom and gloom. I get it, the market is severly overvalued at P/E multiples of 15 – 16. However, where is a LONG-TERM investor to go right now? Is the only answer to stay in cash until a stock market crash occurs or is it to stay away (or short) stocks exclusively?

    Can anyone give me an answer to this or do we all just want to talk about how terrible the Fed is and how end of days are comming?

  7. RDuke commented on Mar 2

    Agreed the PPT cannot have much effect on long-term movements, but that is not its goal — its goal is to prevent near-term catastrophes and hysteria-driven panics, 1929/1987 style meltdowns.

    The public can be managed through a long bleed-out, but short mass-panics are hard to control.

  8. brion commented on Mar 2

    pssst JDamon-
    “Tulips” babe…..They’re poised for a comeback.

  9. KirkH commented on Mar 2

    Preparation F? I don’t understand why the markets don’t price in the fact that most economists didn’t predict the last few recessions. Is it just too much liquidity? Dow priced in gold sure makes it look that way.

  10. Sailorman commented on Mar 2

    Being economically ignorant, I looked up the definition of liquidity in wikipedia:

    “Market liquidity is a business, economics or investment term that references an assets ability to quickly be liquidated or converted through an action of buying or selling without causing a significant movement in the price and with minimum loss of value.

    A liquid asset has some or more of the following features. It can be sold (1) rapidly, (2) with minimum loss of value, (3) anytime within market hours. The essential characteristic of a liquid market is that there are ready and willing buyers and sellers at all times. An elegant definition of liquidity is also the probability that the next trade is executed at a price equal to the last one. A market may be considered deeply liquid if there is ready and willing buyers and sellers in large quantities. This is related to a market depth, where sometimes orders cannot strongly influence prices.”

    How does one inject that into a market?

  11. Gary commented on Mar 2

    Kohn is the best. Note his statement on Feb 21. Was anybody listening?

    “Finally, in today’s global economy, very settled financial market conditions–narrow risk spreads and low expected market volatility–coexist with unprecedented current account imbalances among nations and interest rates that are low by historical standards. In such a world, it would be imprudent to rule out sharp movements in asset prices and a deterioration in market liquidity that would test the resiliency of market infrastructure and financial institutions.”

  12. DavidB commented on Mar 2


    Any indication of what the commercial shorts/longs have been up to this week? I thought I read it here(I know I read it somewhere) either this week or last that they had gone short in a big way which could partly explain this mess we’re looking at this week

  13. Si commented on Mar 2

    I think Barry need to get a little market read out on this site. If I have to go to other websites just to check how the market is doing and see another so called expert call for a rate cut I’m gonna, erm, eat an extremely large choc cake all by myself. From what I can tell the reasons behind why they keep saying it seems simple……..I can only run a long only portfolio now and I don’t want to look like an idiot.
    As for myself I’m not even that bearish, but the market wiggles, thats part of the beauty of it. Why the hell the fed should have anything to do with that, especially after a nice big bull move is beyond me.

  14. costa commented on Mar 2

    Should I be putting my money into a CD or my 401k. I just hate to be buying at the top here, when if i was trading i wouldnt be buying. I rather take teh money i put into my 401k and put it into a CD, while this market does what it has to do

  15. MarkM commented on Mar 2

    Shillers PE10 was near 30 at the Feb top. Hussman’s peak to peak earnings PE ratio was 25. Crestmont’s was 26.

    The PE of 15 mantra is crap.

  16. winston munn commented on Mar 2

    I don’t believe the Fed is being wise, prudent, conservative, or aggressive – the Fed is trapped in its own catch-22 of being unable to raise rates to slow inflation as this would cripple the economy, but at the same time not being able to lower rates as this would cause a flight from treasuries and a collapse of the dollar.

    I think the Fed is rightfully nervous, and Wednesday’s repos should just how jittery they feel.

  17. diva commented on Mar 3

    Ironically, the Fed has created the very inflation they abhor – by raising rates. If they raise rates more: inflation will go UP.
    The entire interest rate mechanism is faulty.
    The most important thing they ‘could’ do would be to keep the value of the $ constant. (They have failed)
    The FFR is a lousy way to ‘try’ and do that.
    PS – IF the Fed does nothing at all:
    Inflation will stay stable/trend down until the Fall. Then: katie bar the door.
    You have been warned.

  18. Barry Ritholtz commented on Mar 3

    Diva, please explain how the Fed creates inflation by rasing rates — that makes no sense to me.

    They create inflation by printing money and lowering rates.

  19. wunsacon commented on Mar 4

    Barry, just a guess: raising short term rates makes borrowing money more expensive. Companies, if they can, pass along the higher costs of business to their customers.

  20. greg0658 commented on Mar 4

    Barry – sure the Fed can cause inflation by raising rates …

    because the cost of borrowed money by a near monopoly business must be paid for by a consumer. If this consumer has no savings to counter this uptick, standard of living inflation ensues to that type individual. If housing interest rates climbed, wouldn’t that be a major inflation. Thats not a question even though it posed as one. Is the cash based economy the near monopoly I talked of? That’s a question.

    What a balancing act Ben has.

    Lower rates and the companies listed on NYSE, NASDAQ etc print cash.

    Raise rates the non gambler zero sum saver (the pawn / regular guy) guts gored.

    I refuse to gamble, its not in my nature. But I must buy goods to survive or play any game in town.

    Barry – are you going to tell me I must gamble or else? Thats a question. (or) Maybe tell me I’m on the wrong website.

    Reading over before posting “near monopoly business” I wanted to tweek that, but can’t, any business to stay in business is a near monopoly in a sence, if it wasn’t they would cease and desist, because of free markets, but there is the element of tooling up to compete in the “near monopoly’s” favor.

  21. Barry Ritholtz commented on Mar 4

    Raising rates makes money more expensive. It is the opposite of when the Fed lowers rates, makes money cheaper, and therefor helps to create inflation.

    Higher rates me decreased Home sales, abd thereforer decrecreased durable goods sales.

    Remember 0% financing for autos? GM, Ford & Chrysler could afford that when the Fed rates were 1% and prime was just over 5%; Now imagine the Fed is at 8% and Prime is 11%.

    Think any auto mfr could afford free money to buy cars (i.e., 0% financing) — what might that do to auto demand? Then how about Steel, Plastic, Aluminum, etc?

    I don’t see how raising rates would cause inflation.

    Its a reaction to existing inflation, but not a cause . . .

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