Enjoy the champaign while the bubbles still fizzle because once it goes flat the ride's going to get a bit more bumpy!
The long awaited Fed decision arrived with a bang! Ben and company surprised many in the financial community - your's truly included - with a 50 bp cut to the Fed Funds rate. Wall Street cheered the news they had hoped for but doubted with all three major indexes up (Dow Jones up 336 points, or 2.5%, at 13,739.4, the S&P 500 up 43.13 points, or 2.9%, at 1,519.78 and the Nasdaq was up 70 points, or 2.7%, at 2,651.66). The Dow's rise marked its largest one-day jump since Oct. 15, 2002, and its biggest percent rise since April 2, 2003.
Before I go any further with deeper analysis, perhaps you find yourself in the overwhelming majority of those who do not love economic statements and have never read anything the FOMC has published. People often believe the statement which is issued at every Fed meeting regarding rates is some lengthy dissertation which only economists and money managers can decipher – nothing could be further from the truth! Even if you’ve already read today’s statement, and most especially if you haven’t, I highly recommend checking out WSJ’s parsing of it as they dissect what’s new in it compared to prior statements.
What does the Fed cut mean to most people? Rates on consumer debt, car loans, and Home Equity lines will all benefit. But because Home Loan rates are tied more closely to inflation, it is not uncommon to see less of a reaction...or even an opposite reaction in mortgage rates. Pricing on Mortgage Backed Securities (MBS) actually were down 10 bps immediately after the announcement but the bond traders eventually joined the stock rally to end the day up 40.5 bps. The intraday rebound of 53 bps was even higher than that of last week's advance after the dismal jobs figures. The chart below shows we've just about gained back all we've lost over last week.
Now for the downside
Good news, right? The financial junkies on CNBC might like you to believe so... but, don't get too excited. My sources inside the mortgage bond arena tell me that this was more of a knee jerk reaction and "me too" attitude of bond traders of wanting to join all the noise from the stock traders' party one floor up! Bonds have a history of trading lower after a Fed rate cut. Don't be surprised to see home loan rates increase in the coming weeks after the hangovers bring rational back into the market place and traders realize that this bandaid could do more to hurt the economy than provide long term relief.
The Fed cut hurts rates of return on investments, which gives foreign investors less incentive to invest in US securities. This has sent the Dollar much lower against the currency of most major foreign countries.
Peter Cardillo, chief market economist at Avalon Partners, commenting on
MarketWatch said "that while a rate cut offers a
'psychological lift' to the market, a related rally is likely to be limited 'because of the fact that
a rate cut doesn't really solve the present problems.'" What are the major indicators that this is the case? Currency, gold, and oil.
``We will see further sharp declines in the U.S. dollar,'' said Clifford Bennett, chief economist at Sonray Capital Markets Ltd. in Sydney. ``The 50-point cut suggests the Fed has garnered enough information of a real risk to a sharp economic slowdown. That's never good for a currency. Neither are rate reductions.'' Bennett further added the dollar may fall to $1.85 a Euro in three years. (A European Vacation anyone!? Pack your bags and go now while you can still afford it!)
The dollar traded declined to a record low of $1.3988 against the Euro (has lost 5.6 percent this year against the Euro), a 30-year low of 98.80 cents per Canadian dollar, and weakened to 115.84 yen from 116.08 on the Japanese yen.
Lastly, the New York Board of Trade's Dollar Index, comparing the U.S. currency against six primary peers including the Euro and yen, touched 79.105, the lowest since September 1992. (See Bloomberg's excellent article for more info on the dollar)
Black bottom line is
- a weaker dollar makes foreign goods more expensive for us to buy, which adds to inflation pressures
- inflation reduces the value of the $2.5 trillion in Treasury bills China and Japan, our largest debt buyers, currently hold. "So what?" you might ask? Aside from lost value in the bonds or T-bills already issued will face when rates go up (see the "Bond Market Volatility" section for more info), foreign investors get the double whammy of the dollar based investment losing value due to the fall of the greenback! Ask yourself, if foreign appetite for US debt falls off, who will step in an take their place? As demand for our debt drops, Wall Street and DC will have to offer higher interest rates to attract buyers to our bonds and T-bills, does that sound good to you?
Black Gold and Gold Gold
Although the place of oil plays far less of a role in inflation today compared to the Cold War era (hence the Fed's insistence on primarily basing their judgements based off of "core" inflation readings which strip volatile components such as food and energy), it none the less is still a factor. Oil gained 94 cents, or 1.2 percent, to $81.51 a barrel yesterday, a record close. It's not just because refineries are preparing for heating fuel supplies or even bracing for hurricane shut downs. Turns out that cheaper money can lead to greater consumer optimism and in turn - greater demand! Econ 101 review: > demand with same or reduced supply = higher prices! (Smell inflation anyone?)
As household ``debts become cheaper to service, there's more money floating around to spend on things like gasoline,'' said Rowan Menzies, an analyst with Commodity Warrants Australia.
Gold futures in New York jumped to a 27-year high yesterday, when the December delivery contract rose as much as $11.70, or 1.6 percent, to $735.50 an ounce. (Anyone who's read "The Truth About Money" by Ric Edelman - a GREAT READ - will remember that historically gold is a top indicator of investor fear and inflation - oh, there's that "I" word again!)
"That was fun! Can we play it again!?"
In an article titled "Will Hair of the Dog Come Back to Bite Financing of New Deals?" the WSJ pointed out that " the Fed's move could also backfire, helping spur another round of carefree borrowing that ends with an even bigger credit-market hangover. The risk is that the Fed's move reignites the debt-driven euphoria of the past few years and sets the stage for a nastier crash down the road." Instant gratification and delayed judgement - just like apple pie and the NFL... American statues cemented in our dangerous habits! This is a very real threat and what critics against Fed intervention citing moral hazard have been fearing all along.
Arm Chair Quarterbacks!
While I disagree with the 50 bp cut, I haven't lost all hope in Big Ben. His move to cut the discount rate and, more importantly, open up accepted collateral to include mortgage backed assets as well as extend the lending period from overnight to 30 day renewable terms was brilliant (Countrywide sure thought so! I will post a paper on this later detailing how it saved the mortgage market.) Bernanke's move, bold as it was, does give him room to sit tight come October and stay put if economic indicators don't drastically change. Today's cut was the first since the last rate hike 14.5 months ago - the longest stretch of neutral position in 9 years. He may very well be patient and wait another 14 months before his next move! (Not where my money's on, but he surprised us today... he could surprise us over the next year) All the speculation I read out there from Bill Gross' "we need another 1% to avoid recession and keep GDP near 2.5 or 3 percent" to Drew Matus' (Lehman Brothers) resurrection of "one and done" - there is no shortage of speculative commentary out there from all different camps. The reality of it all is the single biggest factor in US economics right now, the Mortgage Market Meltdown, has not passed through town never to rear it's ugly head at us again. With $800 billion in subprime resets alone over the next 14 months, we've got a lot more damage to be done to the housing market to carry us through 2008 (oh, and don't forget those "no income/no asset/no job" Alt A loans in the pipe!). Will the tech revival save us? Will foreign investment in US equities sustain Wall Street? Will a democratic White House intent on giving health care to all implode the US Fed as hard as subprime resets imploded 130+ big lenders this year!? Only time will tell! (I'd much rather place my money on JUST WHEN the San Diego Chargers get their act together and play like the talented team they're supposed to be!)
I couldn't resist!
Here are the two most interesting quotes I found from Economists weighing in at a WSJ blog:
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We applaud this bold move. We think the Fed’s intentions here are threefold, first to get more bang for the buck by surprising the markets, second to make it clear the Fed is serious about maintaining stability and third to make room for the incoming data flow to tell them what is happening in the real economy. By easing more than expected now it will be easier for the Fed not to act again on October 31 unless the data are catastrophic… The risks of this ease are trivial compared to the risks of not acting boldly to limit the damage done. If the economy turns out to be strong — ! — they can always reverse it. Don’t bet on it. –Ian Shepherdson, High Frequency Economics
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Today’s irresponsible 50 basis point reduction is really just the hair of the dog that bit us and is a tacit admission that our economy is addicted to cheap money… A Fed bailout in the form of rate cuts will neither prevent the recession nor keep house prices from collapsing. It may slow the process down a few quarters, but it will cost us dearly. –Peter Schiff, Euro Pacific Capital
Ahh, and a few blog comments, I just couldn't resist after reading the last of the three I'm posting here!
PS - This is my first really in depth post. Frankly, it took hours to complete (not complaining, fun work, but it is 3:04 AM PST with both my son and wife sound asleep :o) ...SO, would you help me out and rate this post 1 to 5 and comment with your feedback? I'd really appreciate it! Thanks!
Sincerely,
Sean Rafferty, CMPS
sean@yourpersonalmortgageplanner.com
As a Certified Mortgage Planning Specialist – the only designation officially recognized by the Financial Planning Association – I analyze my clients’ unique situation and life goals to create a plan for them which provides the clarity and road map necessary to achieve true financial independence.
Want to know more about CMPS mortgage planners, go to: http://www.cmpsinstitute.org/public/why_you_need
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A big mistake! With the dollar declining and oil prices rising, inflation is back and in a big way. The antidote to this was not to cut the rates!! This short term euphoria being exhibited in the marketplace will surely be exchanged with long term pain. The Fed has just shown its hand, it’s sole purpose is to encourage and reward those irresponsible speculators who brought this mess on. As a borrower, any savings derived from the lower interest rates will be more than made up in the form of higher commodity prices.