Good Evening: As was speculated in this commentary last night, the FOMC did indeed take dramatic action today after concluding its two day meeting. The Fed changed its approach to interest rate targeting by offering to allow the funds rate to sway to float within a 25 basis point range. Since the lower boundary of said range is zero, the Fed felt compelled to announce its readiness to undertake further measures. Some will describe these current and future actions as “quantitative easing”, but a better description might be the poker analogy proffered on Bloomberg Television this afternoon: “The Fed is All In”.
Not that investors were paying much attention prior to the Fed’s actions, but this morning’s economic data was again of the “not-since-the-Great-Depression” variety. Housing starts fell almost 19% to an annual rate of 625,000 units, a level not seen since records started being kept in the 1950s. Not to be outdone, CPI fell 1.7% last month, which was the most negative showing ever since our nation’s bureaucrats began consistently tracking it back in 1947. And, adding to this presumably negative backdrop, Goldman Sachs reported a larger Q4 loss this morning than analysts had expected. That GS also admitted its effective tax rate for 2008 would be a mere 1% will probably set some political tongues a flapping in Washington, D.C. (see below). I don’t think either Congress or the electorate envisioned TARP funding to go hand in hand with drastically lower corporate tax receipts.
The first hint that expectations for today’s FOMC meeting were running pretty high came when stocks shrugged off all of the above news items to open 1% to 2% higher. Even Goldman Sachs saw buyers in the early going (GS finished the day up more than 14%). The major averages held those gains and traded in a fairly narrow range ahead of the Fed’s announcement Prior to 2:15 pm est, stocks and bonds were higher, the dollar was down a bit, and commodities were trying to levitate. Expectations by most analysts were for the FOMC to lop 50 bps off the funds rate and perhaps make some vague noises about quantitative easing measures, so the text itself came as a surprise to many market participants (though not to regular readers of either Merrill’s David Rosenberg or this daily missive — see Merrill’s take below).
Envisioning overworked printing presses and fleets of helicopters dropping the resulting emissions on the general populace, Wall Street swiftly moved to upwardly reprice various assets. Stocks jumped, bonds soared, and the precious metals shined. The dollar and crude oil both slumped, but the major averages finished with gains ranging from 4.2% (Dow) to 6.7% (Russell 2000). Treasury rates fell between 9 and 25 basis points as the yield curve had little choice but to further flatten. The dollar was clipped for a 2.75% loss, and only the skepticism of real action from OPEC by the crowd in the crude oil pits prevented a nice move higher in commodities. Advances in gold (+2%), silver (+5%), and various grain contracts did little more than offset the weakness in energy prices, and the CRB index climbed by just less than 0.5%.
Back before the hedge fund industry had a name, the title of “world’s largest hedge fund” belonged to JP Morgan & Company. The creation of the Federal Reserve Board, along with the Great Depression, brought the concept of organized and leveraged speculation to heel for a few decades. The first titleholder of the modern era was the Quantum Fund, a multi-billion dollar entity run by George Soros. As Mr. Soros turned his attention elsewhere during the late 1990’s, the largest hedge fund designation became the subject of arguments in New York, but many have rightly viewed the entire firm of Goldman Sachs and its 30 or more to 1 leverage as top dog during the present decade. The credit crisis of 2008 has caused GS to rethink its business model, and, by transforming itself into a bank, the house of Goldman has ceded the top spot in the hedge fund world to a brand new entrant — the Fed.
The crew in the Eccles building may have to open a Greenwich office, since long gone is their simple, Treasury-laden balance sheet. Courtesy of various programs, policies, and other such bailout measures, the size of the Fed’s balance sheet has grown some 150%, while the average ratings assigned to those swollen assets has shrunk to somewhere well south of AAA. Never a fan of the Fed’s original charter, old J.P. himself would have gagged upon inspecting the balance sheet of the central bank now assuming what was his firm’s spot atop the hedge fund leaderboard. Today, the Fed offered to go even further in defense of its new title.
For his part, Mr. Market cares only that more relief is on the way. Unintended consequences and inflation down the road are problems for the future; restarting the process of borrowing and lending at almost any cost is what the world wants. Fed essentially promised to move heaven and earth to do so in its otherwise restrained press release. I wrote some months back that our credit woes would not yield to anything less than a full promise by the Fed to open its balance sheet and take on any and all assets. Ben Bernanke has indeed remembered his roots as an historian of the Great Depression, and is now fulfilling the deflation-avoiding promises he made at Greenspan’s side in 2002 and 2003. I turned short term friendly toward equities in anticipation of Bernanke’s move to turn the Fed into the world’s largest hedge fund. I don’t expect to retain this positive outlook toward equities for very long, but rather than fret about what might happen in 2009, let’s just enjoy this holiday gift while it lasts. After all, every one of us is an investor in the Chairman’s new fund. Jack McHugh