You know what they say, don’t fight the Fed

You know what they say, don’t fight the Fed
December 17, 2008

Vincent Farrell, Jr. is Chief Investment Officer of Soleil Securities, a New York based investment management company. Over his long career on Wall Street, he has worked for numerous distinguished firms. Mr. Farrell graduated from Princeton University in 1969 and received his M.B.A. from the Iona College Graduate School of Business in 1972.


Bernanke did what he said as far back as a speech in 2002. He went all in and cut the Fed Funds rate essentially to zero, and promised he would be in the long end of the market buying bonds. All of which should pull interest rates down across the board. This morning’s Libor setting (London Interbank Offer Rate) was lower by 27 basis points to 1.58%. I would guess it’s heading lower and would look to 1% before too long. The ten-year Treasury is trading at 2.10% by far the lowest it’s ever been.

I think bond buyers will go out the risk spectrum seeking some yield, and rates on corporate bonds should come down. Rates on 30-year fixed rate mortgages are heading below 5%. With rates so low money market funds will have trouble covering expenses and I think cash will flow to bank deposit accounts. A growing deposit base will give banks some breathing room and a chance to return to profitability. That might help the “jumbo mortgage” rate to fall below the low 7% area it’s trading at now. This is a key rate to me. A jumbo mortgage can’t be sold to Fannie or Freddie. It can’t be lumped into a securitized collateral bond as here is no market for such things right now. It would be a loan a bank would willingly make knowing it would stay on its books. If I were to look at just one rate for signs of a credit thaw, it would be the jumbo.

The good news the past few weeks has been the market rallying in the face of unrelenting bad news. Since its late November low to yesterday’s close the S&P 500 index is up 24%. A new bull market !!?? The Fed’s moves yesterday are widely interpreted as good news, so don’t be surprised by a sell off. Rallying on bad news and selling off on good news makes a certain amount of sense.

Lehman failed September 15, just about 100 days ago. Since then the stock market has lost about $3 trillion in value. We have had 26 days of a 4% move (up and down) and the government reported that consumers net worth has fallen by $7 trillion in the past year to $56.5 trillion from $63.6 trillion a year ago. The system has been shocked to an extreme and it will take a while to settle out. The typical bottoming process takes some number of months, even up to a year. We are two months into the current attempt. We have had a very nice rally in a bear market, maybe more encouraging than some in that it was into the teeth of worsening news. But I believe it was a bear market rally and while I hope/think the recent lows will prove to be a bottom, I do expect additional tests of those lows in the months ahead.

But I further believe that the Fed’s actions will work. We financed World War II in much the same fashion as the program being implemented now. Bernanke asked for permission for the Fed to issue its own bonds, usually a Treasury Department function. As I wrote the other day, I believe Ben sees the need to drain liquidity from the system (which selling bonds would do) and wants to act at his discretion to stifle any threat of inflation. I do like his longer term view.

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