Fed Delivers A Wink and A Nod

By Dr. Duru written for One-Twenty

November 28, 2007


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Early yesterday, I stated the following: "Everything hinges on some kind of catalyst. In 2006, it took the Fed to give the market clearance to break the T2107's downtrend. The next Fed meeting is not for another two weeks on December 11. Something tells me that the market cannot "wait" that long and will need some kind of hint, a wink, and a nod from the Fed to save itself from the increasing weight and burden of the downward pushing T2107."

Boy did the Fed ever deliver today: hook, line, and sinker on the hint, wink, and a nod. Is Big Ben reading my missives?!

Anyway, today's monster rally on hopes that the Fed will indeed cut rates in December took the S&P 500 up 2.9% and the NASDAQ up a whopping 3.2%. This is the exclamation mark after Tuesday's move that stopped Monday's sour mood dead in its tracks. I will even go so far as to say that we have now seen the low for this latest swoon. I am basing this on the analyses I have written about in the past two missives. I will also say that momentum is finally building for the strong finish to the year I have been talking about. For those of you who remain cynics and bears, I understand your viewpoint. But things simply got too sour not to sweeten. Everything that is bad is known and folks have been busily extrapolating from that to the worst possible scenarios, shadows, and horrible cockroaches. Sure, this rally too may get faded, but do not underestimate the power of liquidity and the printing press or even the expectations for more liquidity and easy cash. In 2006, the Fed bandwagon blasted the market through what certainly looked like the overdue end of the bull. As we close out 2007, the market may again choose to sail with the Fed's tugboat. So, for now, consider the August lows successfully tested and look for the new low from this week to hold.

So what was so exciting this time around? Vice Chairman Donald L. Kohn spoke during the C. Peter McColough Series on International Economics, Council on Foreign Relations in New York City. The title was deceptively simple: "Financial Markets and Central Banking." Apparently, it was what Mr. Kohn said at the very end of his remarks that the market interpreted as the key wink and a nod:

"As the Federal Open Market Committee noted at its last meeting, uncertainties about the economic outlook are unusually high right now. In my view, these uncertainties require flexible and pragmatic policymaking--nimble is the adjective I used a few weeks ago. In the conduct of monetary policy, as Chairman Bernanke has emphasized, we will act as needed to foster both price stability and full employment. "

This statement has been interpreted to mean that "nimble" and "flexible" equate to anything is possible, including more rate cuts. Kohn tells us that he already said this "a few weeks ago." So, this begs two questions: Why did the market not respond with a huge rally then? And why did it continue selling off afterwards? Of course, nothing in the mass media that I have seen even bothers to pose these questions, much less answer them. Unfortunately, the Federal Reserve did not post a copy of this speech, so I cannot even speculate on an answer, but I encourage you to do your own Googling to track down that speech. In the meantime, just be happy that the market chose the bullish interpretation this time around. Maybe the wink and the nod was not as obvious last time around.

Finally, I have to remind the bears of something else I mentioned before. The Fed is on the alert and will do what it can to prevent a spreading credit crunch from taking out the broader economy. You can argue all you want about whether the Fed can succeed, but how much do you really want to fight with those who control the printing presses? Kohn refers to the Fed fade in recognizing how the persistent panic in financial markets has worked to nullify Fed actions to-date:

"An important issue now is whether concerns about losses on mortgages and some other instruments are inducing much greater restraint and thus constricting the flow of credit to a broad range of borrowers by more than seemed in train a month or two ago. In general, nonfinancial businesses have been in very good financial condition; outside of variable-rate mortgages, households are meeting their obligations with, to date, only a little increase in delinquency rates, which generally remain at low levels. Consequently, we might expect a moderate adjustment in the availability of credit to these key spending sectors. However, the increased turbulence of recent weeks partly reversed some of the improvement in market functioning over the late part of September and in October. Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses. Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce more intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses a well."

Needless to say, market's should remain highly volatile, and there will not be a straight shot from A to B. Just make sure to be careful out there!

DR. DURU®, 2007