Wednesday, December 12, 2007
A day later, the Fed's policy own goal continues to baffle Macro Man. Why would the Fed disappoint market expectation when there was little risk of negative macroeconomic consequence from delivering the expected 0.50% reduction in the discount rate?
Regardless, the market impact of the 25/25 decision was not difficult to forecast, and now 1450 on the S&P 500 is literally closer to current levels than 1550. Coincidentally, the Federal Reserve is in the process of updating the official portraits of all key staff. On an exclusive basis, Macro Man is pleased to reveal Ben Bernanke's new official picture, shown to the left.
What's troubling about yesterday's announcement is that it suggests one of the following three statements is true:
1) The Fed was unaware of the policy action that was expected by markets, e.g. a 50 bp cut in the discount rate.
2) The Fed was aware of market expectation but intentionally decided to disappoint that expectation on the basis of moral hazard issues, despite the fact that current discount window borrowing is now not noticably higher than it was before the money market crisis kicked off.
3) The Fed was aware of market expectation and did not wish to disappoint it, but prefers to provide liquidity in a dripfeed fashion with incremental changes to the window rate, the term of loans offered at the window, and the acceptable collateral that can be tendered.
None of these options inspires much confidence, does it? Indeed, the Bernanke Fed is swiftly coming to resemble the Duisenberg ECB, which itself resembled nothing so much as the proverbial troupe of clowns packed into a Volkswagen Beetle. While it is admittedly easier for those of us in the peanut gallery to lob criticisms at policymakers than it is to actually bear the responsibility for making decisions, on an objective analysis the Bernanke Fed would appear to score relatively low on market nous and credibility.
Rumours are now swirling that the Fed will do something to amend the functioning of the discount window, with both the FT and WSJ suggesting that further action could happen as early as this week. But this begs the question of why, if the Fed has been carrying this policy option in its locker, did it not unveil it last night? It's not as if there isn't abundant evidence that cuts in the funds rate are not easing financial conditions, which is presumably the aim of cutting rates in the first place.
A full 100 bps of easing in the Fed funds rate has taken 1 month LIBOR down a whopping 15 bps from the levels prevailing at the end of July. Yippie-kai-yay!
Similarly, corporate boprrowing rates have no come lower in nominal terms, and have obviously blown out in spread terms. The Moody's Baa index has shown a sharp rise in borrowing costs recently, with nominal yields now higher than they were in late July. Admittedly, some of this may be driven by the poor quality of the ratings themselves, but the message is clear: what the Fed has done to date is not easing conditions, and as such will not have the desired impact of supporting moderate economic growth.
Now obviously, if the Fed were to announce sweeping changes to the current liquidity structure, then confidence might be shored up and financial conditions ease. After all, even the Grinch relented in the end and celebrated Christmas with the Whos. But when your central bank is being run by a character from Dr. Seuss, it seems fair to suggest that the problems cannot be banished in one fell swoop, and that volatility will remain aa theme into 2008.
No P/L today due to IT issues.