Fed Decision and Market Reaction
The Fed announced their decision to cut the fed funds rate and the discount rate by 25 bp’s. The accompanying statement did not explicitly highlight economic weakness, the subject of market participants’ greatest concern.
At about the same time GE announced information about its earnings outlook. This was called "tepid" by TheStreet.com, since they said profit growth would be "at least 10%" when the expectations were for 13%. Bloomberg’s report is less downbeat, pointing out that the forecast handily exceeded the recent predictions of Citigroup analyst Jeff Sprague. CNBC had a story saying that the initial reaction was partly based upon some observers of a WebX presentation who did not see the words "at least" in the 10% forecast. (We watched this, but during trading could not TIVO for an exact quote.) GE rebounded from its lows, but the reaction pushed the S&P below the 1490 level that has been a battleground of technical support and resistance.
This is an interesting situation. I have been in the financial business for 20 years, but before that I worked at a high level in government and was on the faculty at a major university. This defines the perspective of "A Dash" where we are eclectic in our approach. We see things from various perspectives, trying to understand the viewpoints of different players.
Market participants — traders, pundits, and hedge fund managers — have a very high level of confidence, necessary for the decisions they make. They are not always good at seeing things from alternative viewpoints.
Nearly all of my colleagues on RealMoney joined in criticism of the Fed, as did Jim Cramer on his television show. They see the Fed as either less intelligent than they are, less-informed, or naively academic. We disagree.
Right after the announcement, I posted the following observations on RealMoney. (Regular readers know that I was a long-time subscriber to the paid version of the site before joining them as a commentator.)
- For a multi-year period the Fed has looked at the same data as have
market participants and the public and seen more economic strength. In
general, the Fed has been correct. Few thought that a soft landing
could be achieved and no one would have expected economic growth at the
pace of the last two quarters if they had known about energy prices and
the housing/credit situation.
- Most economists see the current economic data are consistent
with Q4 growth of about 1.5%. One noted forecasting firm sees zero
growth and economists now see a 40% chance of a recession in 2008. This
is the reason that the Fed started cutting rates, a policy that has a
- 25 versus 50 bps today makes little policy difference. Neither
does a 25 bps in the discount rate. The Fed has made it clear that
discount borrowing should not carry a stigma.
- The Fed does not have sole economic responsibility. Lowering
rates does not by itself solve the housing situation. Raising the loan
limits (to include jumbos) at Fannie and Freddie would help, as would
reducing the capital surplus requirements. Bernanke has advocated both.
There are qualified buyers who cannot get loans.
- Fed members are probably amazed at the market reaction,
believing that they not only did what seemed right on a policy basis
but something close to market expectations.
- Wordsmiths need to come up with synonymous phrases for "behind the curve." I am sick of it already!
- The increased transparency of the Fed is not helping that much
so far. It seems like a good idea, but the committee statements wash
out much of the tone that those of us in the market would like to see.
- Brian Gilmartin (one of my RealMoney colleagues) says the Fed is doing fine. There is evidence for this
viewpoint. If one looks at a thirty-year record of the US economy it is
pretty obvious that recessions have declined in both frequency and
severity, despite various economic shocks. Fed policy shares part of
the credit for that. The Fed does not take responsibility for avoiding
or piercing "bubbles", despite the emphasis on that criterion by many
in the markets.
- Today’s market reaction seems excessive. It includes the effect
of the GE announcement (which may have had an erroneous element) and
the technical selling from breaking support at SPX 1490, as Scott Rothbort noted
in a timely fashion.
After the Close
I later posted another RealMoney piece, inserted below.
CNBC ran a Steve Liesman "breaking news" piece during their Fast Money
program. Liesman reported that the market "could be misreading" that
today’s quarter-point rate cut represents the whole Fed response to the
credit crunch. A Fed source who asked not to be named said that they
are considering a range of tools to address the liquidity issue, ideas
that would see the light of day "sooner rather than later."
Some will think that the Fed is trying to make up for a policy
mistake. As readers can tell from my earlier post, I do not agree with
that viewpoint. The Fed sees the FF rate as a tool that does not
directly address the liquidity issues started by the housing and
mortgage problems. We will see some other initiatives from them (long
term repos? purchasing mortgage debt?) and there will be other stories
Also, the first take on GE earnings growth was wrong, according
to CNBC. They stated that some who saw the WebX presentation omitted
the words "at least" from the 2008 outlook of 10% profit growth. The
stock traded higher when some got the additional language.
I covered some short futures contracts after hours on the Liesman story. We shall see.
Conclusion and Implications
The Fed is still in the early stages of trying to achieve more transparency. The official statements read like they were written by a committee — and they were!
The Fed took an action that met the widely-published expectations of the economic community. They were surprised by the market reaction. They did not convene another meeting to come up with more ideas. Bernanke obviously did think it wise to leak information indicating that more actions are coming, and probably soon. This was not a change in policy based upon the market move, as some will maintain. It was a continuing effort to communicate policy intentions.
Could the Fed have done better in signaling intentions? Sure. But that is not the question for investors and traders. The question is what actions they will now take and what the market reaction will be.
The old adage, "Don’t fight the Fed," is taking on more dimensions in a world where they are looking for the right tools for the problem. The Fed sees interest rate cuts as a blunt instrument that does not really solve the credit crunch issues. We agree with that perspective.
We expect further articles from key journalists elaborating on possible Fed plans. It is in their interest, and that of the country, to maintain confidence, so they will act to do so.
As this becomes apparent, we expect a positive reaction in stocks and financials, rejoining the 1490 battleground that technical analysts are following.