Fed Panics: Set-Up for the Next Leg Down?

Although the initial reaction is one of euphoria, today's surprise discount rate cut by the Federal Reserve may have unintended consequences. In fact, it will likey be the trigger for the next leg down in the unfolding bear market.

For one thing, the move suggests that policymakers are worried -- really worried -- about the state of the economy, despite repeated assertions to the contrary. That is likely to force a rethink by nervous bulls in corporate America and elsewhere who have reluctantly accepted the party line that all is well.

The abrupt shift in stance, following meeting after meeting where policymakers expressed concerns over the pace of inflation, may also signal that thinking has become muddled at the Fed. Or that monetary policy is now in the hands of investment bankers and hedge funds. Some might even start wondering whether Bernanke & Co. have lost their way, at least in the near term. Not exactly a reason for optimism at a time when credit markets are under siege and risk is being dramatically repriced.

Clearly, the bears were caught off guard by the surprise cut. However, while a burst of short-covering and speculative buying can heighten the drama and paint a picture of benevolent central bankers riding to the rescue, it will also add to confusion about where policymakers stand. What happened to the new, more transparent Fed? Worse still, is this a sign that we returning to the bad old bubble-blowing days of the Greenspan era?

Finally, although equity markets have been under a great deal of pressure lately, the S&P 500 index is still basically up on the year. What’s more, the latest reading on gross domestic product signaled to many that U.S. growth remained on track. The big risk in shooting off a round of monetary bullets this early in the game is that the effect doesn’t last very long. In that case, the mood is likely to be even uglier during the next round of liquidation and deleveraging.

All in all, today’s move, while positive for sentiment in the short run, is unlikely to represent anything more than a temporary shot of adrenalin for wounded markets. Once the injection wears off, the bearish disease will likely be back in force.

Comments

[chas]

Banks can borrow at 4.75% (market fed fund rate) from other banks. Why would a bank go to the discount window at 5.75% when all you are doing is alerting the regulators that they need to come and do an audit on your business. Also, if a bank borrows at 5.75% who would they lend to and at what rate? An example, conforming loans are available at 6.5% Commercial paper borrowers can get money under 6% This cut will not help the credit crunch.

[Yogi]

There's a rumor going aroung the financial blogosphere that this was done to help mortgage lenders that don't participate in the Fed Funds market, and that Countrywide Financial (CFC) may be one of the potential benificiaries. I would be interested to know if anyone can confirm this.

[Jive Dadson]

Chas asks why the banks would go to the discount window when they can get better rates from other banks. The answer (according to ABC radio this morning) is that the discount window is making 30 day loans and it is taking securities from the sub-prime lenders as collateral. Try peddling those to another bank!

Ron Paul '08!

[Michael]

This is all putting lipstick and perfume on a pig that is destined for the slaughter house! As John Hoefle has succinctly laid out in the following article: "The game is over!"

Panic is in the Air as Financial System Implodes

http://www.larouchepub.com/eiw/public/2007/2007_30-39/2007-33/pdf/26-29_732.pdf

[aperian]

it was stated on cnbc that countrywide could now go to the discount window and fund their business that way instead of having to buy 12% money. to me the fed just bailed out the country's largest mortgage company...................

[Bruce Allen]

You sir are right on the money(no pun intended). People who think the storm has passed are blind fools. Truth is, we haven't even reached it yet. HA! When the ship starts tossing and turning, many souls are going to lose a LOT more than their lunches I'm afraid. Just watch and see. We haven't seen anything yet folks... Stay tuned for part 2.

[Stephen Lord]

Ah, I remember the days when people would look at me really strange (at minimum) or just blatantly call me a "chicken little" or "buffoon" because I had the unmitigated gall to say that this is going to end up very badly and ugly. They couldn't believe that I could be so negative because the economy was "so strong". Now the tide is turning and all of a sudden, they are not talking to me anymore about the finances and economy of the U.S. (I guess they're too ashamed to say they were wrong and I was right) Bruce, you are right on. This is only just beginning and it's going to get a lot uglier and VERY, VERY painful. Those poor sheeple that refused to use the brain God gave them and instead listened to the talking-heads. All I can say is "Too bad".

[Mike O]

I would like to know if this damage is repriced in the market or is this the beginning of the end?

[Bruce Allen]

Mike,

It's hard to say where all this is going. While I don't sense an immediate crash overnight, I do sense that by the end of this decade, we will be a VERY different nation with VERY different priorities. We'll have a LOT more to worry about than keeping up with Joneses...

Last week, our Comptroller General, David Walker, also sounded an alarm bell that the entire Global Financial System is under strain. I hate to be so pessimistic and dismal about these things, but the truth is folks, we've simply had it too good for too long. The amount of government, business, industrial, and personal debt has reached obscene levels. I simply don't understand how we ever reached the point where a three-bedroom home costs half-a-million dollars! The entire global economy has become an out-of-control game of Monopoly.

[daveDave]

This isn't a liquidity problem it is a insolvancy problem
inflation running at 10-15% real world numbers
and those that think this is just a down turn
tell the 2 block long lines of people in Ohio at the food banks
this is heading for depression
for all the ppt can muster will be like a bandaid on a fractured skull
the economy is simply leveraged out of existance
The AMerican economy is insolvent they can print all the funny money they want to the dominoes are all lined up indeed many have already tumbled